LOCATION, LOCATION, LOCATION —
WHICH IS BEST?
- Why do some major retailers willingly LOSE money for the first few years of operation?
- Why will most successful businesses pay a premium for the best locations?
- Why will some major retailers close a store and continue paying rent, and open up a new store across the street?
“RENT” VS “PROFIT”: Why cheaper rent doesn’t necessarily spell greater profits.
When comparing sites, you should not rely on the dollar amount of rent paid as the primary consideration of a good location. The key factor to consider is the NET PROFIT that each location could generate.
While rent may represent a considerable portion of the total operating cost, the difference between the cost of a poor location and a better location may actually be quite small. When viewed as a percentage of total operating costs, the difference may be quite insignificant, as the following example demonstrates:
In this example, a 40% increase in rent increases total expenses by only 10%!
In many situations, the total operating costs include a much smaller percentage as rent. Therefore, any increases in rent can result in an even smaller effect on the total expenses. Furthermore, a low cost location with minimal exposure may increase your advertising budget dramatically in order to offset the decreased customer traffic that a mediocre location generates.
Therefore, if a higher rent location generates an increase in sales that more than covers the increased rent, then that is an indication of the best choice!
THIS IS CALLED THE: SALES TO RENT RATIO
The is a handy way of looking at the relationship between rent and sales. This ratio explains the dollars of gross sales generated for every dollar paid in rent.
In other words, you would select Site C as the best choice because it should generate 7.6 dollars in sales for every dollar of rent paid.
Market Demand Vs Competition
Obviously, in applying the previous ratios, you must place importance in estimating sales correctly, as errors in either direction will give an inaccurate reading. To accurately estimate potential sales, you must analyze both Consumer Demand and the Competition.
FIRST STEP — CALCULATING CONSUMER DEMAND
Consumer demand is a function of Market Population, Traffic Count, or a combination of both.
A Demographic Report will provide all the information necessary on a given area, however you must first determine the DISTANCE customers travel to visit your establishment. For example, a food warehouse such as Costco or Sam’s Club can draw people from 20 miles away (and MUCH further in some rural communities), while a local neighborhood grocery store may only draw customers from a mile away. A convenience store that sells milk and bread may only draw customers from the immediate neighborhood and rely on traffic passing by for the rest of their volume.
How do business owners estimate drawing power? Trade associations and franchisors can provide you with industry standards for your type of business entity. If you own an existing business, you can survey your customers by gathering information on ZIP codes or telephone exchanges. Other business owners outside of your market area may also share this type of information with you.
Also, you must determine whether your business is destination oriented or impulse/convenience oriented. If your business is destination oriented, customers will purposely seek out your services or product. With an impulse/convenience oriented type business, customers will visit your establishment while on the way to or from another destination. These types of business benefit most by being located in a center anchored by a major chain store thus providing them with a nearby draw or on a free standing location with a strong traffic count. Is your product so unique that your customer will come to you wherever you locate, or are you the best choice because of low price or convenient location?
Once you factor in the above items and determine traveling time/distance of your customers, you can begin the process of estimating Market Demand.
Various demographic providers, many commercial real estate brokers have access to these, can provide a Merchandise Potential Report that estimates the demand for various products in a given market. The reports are calculated using United States Census information and typical consumer spending patterns for that region based on its particular demographics including the size, age and income of the market population.
After examining the “Market Demand” report to see how much consumers are expected to spend for your product, you should take a look at potential/future demand. Although no one can predict the future with a crystal ball, estimates exist for future population or demand.
What new housing projects are slated for development?
What rate of growth do government reports such as the census predict?
Typically future growth is a function of past history, as well as trends. You can obtain most of this information at your local library, from the research department of the newspaper, or by ordering studies from demographic companies that provide estimates for your trade area.
SECOND STEP – ANALYZING THE COMPETITION
Two measurements will give business owners an indication of how much pressure they will face from competition.
- The Estimated Sales in a given market vs. the number of competing stores in that market.
- The Population within a given market vs. the number of competing stores within that market.
A Business Summary Report will indicate the number of businesses already present in the surrounding market. You can obtain this information by either ordering one, or better yet, if your market is small enough, by simply driving the appropriate streets and noting existing competition.
As an example, we will assume Total Consumer Demand of $6,520,000, and 19 competitors. We can now estimate sales per store by dividing the Total Consumer Demand by the amount of existing stores in the delineated area.
Total Consumer Demand $ 6,520,000
/ Existing Stores 19
= Sales per Store $ 343,157
Obviously, all stores are not created equal and some stores sales will fluctuate from the average depending on their management and marketing. Since we only need an estimate, we will assume that all stores generate equal sales.
Another guideline, and double-check of the Total Sales Vs. Competition Study, is the COMPETITION/POPULATION RATIO.
When we combine population information with the previous two analysis, we can analyze the target market in more detail and begin the process of drawing a more accurate conclusion.
For instance, if there are 108,861 people within a three mile radius (size of trade area), we simply divide the amount of people by the amount of stores (19) we get 5,729 people per store !
If the estimates generated from the demographic reports show promise, you could explore the competition a bit further. Plot all the competitors on a map to determine their location relative to the sites that you are considering.
After completing the survey of current competition, you must conduct a complete check of proposed developments. First, you should check with all shopping center owners (even the sites not worth consideration) to see if more of your competitors plan to open new stores in this market place. In addition, most county and regional planning commissions can provide you with a complete list of buildings slated for imminent development. For example, if you are opening an Italian Restaurant, you may find that an Olive Garden Restaurant will be built on the pad site directly in front of your in-line location.
☑ HINT: Look for an area that has a high amount of residential growth but a small amount of commercially zoned land available, as this will limit future competition. Developers of newer communities usually allocate a smaller percentage of commercially zoned land in conformance with strict planning codes. Modern city and county planning departments recognize the blight that comes with allowing too much commercial zoning and the over-building that can follow.
TOTAL Vs. TARGET POPULATION
We can perform the previous calculation by using the Total Population of a market area, or by using only the “Target” Population of market area. Normally, not every resident is a potential customer, therefore a specific “target” market exists that may use your goods or services. Accordingly, we examine the actual profile of the total market population in regards to age, income, number of households, etc. How many people or households are too poor, too rich, too young or too old to use your services?
* Convenience store proprietors typically prefer a younger, lower income, blue collar population. Their research finds that their average consumer has little time to shop, is more convenience oriented, and buys a higher percentage of beer, milk and cigarettes. Therefore, when a convenience store site selector looks at a mobile home park of 5,000 elderly people, he may see no sales potential at all. The reason being is that this sector of the population has more time available for shopping and is typically more price sensitive. On the other hand, this site near the mobile home park may arouse a STRONG interest with a grocery store owner if the residents fit the profile of his typical customer.
Business owners can determine their customer base by utilizing similar methods as estimating their drawing power.
- Find an existing location that is doing well, (yours or a competitors), and order a demographic report for that site to determine the size and makeup of the surrounding population. If you are using a Commercial Leasing Consultant, they should be able to assist with this very easily.
- On site surveys can be conducted by salespeople and/or managers.
- Have customers fill out information cards (for a contest, drawing, etc.) and use the information for your studies. Information requested by this form might include distance from facility, age, sex, children, family income etc. (This type of information is commonly acquired by national retailers when the cashier requests your ZIP code upon check-out.)
This process of identifying your customer base by age, sex, family status, and other characteristics is known as market segmentation.
USING “TOTAL” POPULATION
After determining the Total Population of your market, and how many competitors there are in that market, simply compare alternative locations.
Example: Italian Restaurants
In this example we might choose site “D” because there are 5.3 people per foot of restaurants, rather than only 2 to 3 in other sites.
(In this case we have taken the number of existing Italian Restaurants and totaled their square footage’s. In other instances, like an accounting or legal office, it might be easier and just as effective by dividing the population by the number of facilities to come up with a number of people per office.)
USING “TARGET” POPULATION
We then determine that the most likely customer for our restaurant and our competitor’s is from 25 to 55 years in age and earns a household income above $40,000 per year. We determine the following Target Populations and analyze the competition’s effect on the market.
Example: Italian Restaurants (Same as previous)
In this example, we used the same four sites as the previous example, however after analyzing the Target Population, we decided on site “B”. Because we’re using the targeted population rather than the entire population, site B becomes more attractive than site D.
WHAT AMOUNT OF POPULATION OR SALES WILL ENABLE ME TO TURN A PROFIT?
National companies know exactly how much population it takes to support one of their stores, and the effect of their competition opening another nearby store. For example, a grocery store may vacate a store and continue paying rent on that location while relocating to a newer, more modern facility. While the grocery chain may sublet that space to another type of business, they would rather pay rent on both places than to see their competition cut into their market share.
For start up businesses, you should run a proforma for your business using the sales estimates supplied from the demographic data as your gross sales. If you plan on purchasing a franchise, your franchisor can provide you with average operating expense figures as well as cost of sales. You can also hire on a consultant to assist you with the proforma or better yet , visit a similar business not in your market area. They may be more than happy to share any information with you.
WHAT KIND OF DEMOGRAPHIC REPORTS ARE AVAILABLE AND HOW DO I ORDER THEM?
Demographics obtained from the most recent census are available at your public library . However, you may find it easier ordering this information from a company that specializes in compiling and interpreting this data. Google can help you there, if you are not using a Commercial Real Estate Advisor who can do it.
Demographic Reports commonly indicate:
- Total population * Number of households
- Population by race * Owners Vs renters
- Population by age * Household income
- Population by sex * Married Vs single
Other reports available for purchase include:
•Traffic Volumes • Lifestyles
•Consumer Behavior • Hispanic Profile
• Kid Eze Report • Age 65+ Report
• Crime Data • Labor Force Trends
• Environmental Hazards Report • Education Trends
• Demographic Trends • Income Trends
• Household Income by Age • Socio-Economic Report
• Household by Age, Race, and • Daytime Marketplace
and Hispanic Origin • Shopping Center Market Analysis
HOW ACCURATE ARE THE DEMOGRAPHIC REPORTS?
Most demographic companies derive their information from the latest census data. Projections are based partly on history and trends. One thing the demographic reports don’t mention — seasonal residents.
If you conduct your business in Ohio or Mississippi, this may not concern you. However, if your business resides in Florida, Arizona, or any other place where the northern population “visits” to escape the winter, you should take a closer look at part time residents.
For example, a well known restaurant chain put a new location on the corner of a busy intersection in Palm Beach County. The demographics looked great as well as the traffic count. When summer hit Florida, they discovered that over 60% of the residents within a mile radius were seasonal residents. The traffic was a bit slower too!
You can find out the seasonality of your customers in a few ways. First of all, take a good look at the surrounding housing. Does it consist of condominiums or single family homes. Ask a few of the condo managers for the percentage of full time residents. You can also check with the area newspaper. Since local utility companies now encourage their seasonal customers to keep telephone and electric service year round, the newspaper is one of the few remaining sources of this data.
The newspaper’s research department tracks both subscriber and non-subscriber households quarterly. They will also tell you the length of the season as well as the length of stay for different residents.
You can apply these percentages for the seasonal months for demographic adjustments. In this way, you can better estimate your gross sales and number of customers for the slower seasonal months.
TRAFFIC COUNT AND SALES ESTIMATES
What if demographics don’t effect your business as much as the traffic count? Say you open a gas station and expect that most of your business is derived from the traffic passing by your location. You estimate that each customer will spend on the average of $10.00 and about 4% of all cars passing buy will stop in your service station. You would calculate your average daily sales volume as follows:
Average daily traffic: 20,000
times 4 percent stop-off: .04
times $10 average sale $10.00
equals the potential market $8,000.00
Of course this is just a rough estimate. When looking at estimating sales from traffic counts you must examine the location’s accessibility to traffic. Are there median strips preventing cars from accessing your business? Does traffic bottleneck near your location preventing potential customers from turning into the site? Thus, the potential market is the maximum that is likely to be realized at the site.
We can apply the same formula for any business that draws customers from another source other than demographics. For example, Tim considers leasing space at a train station lobby for his newspaper stand. About 5,000 passengers ride the train daily. He figures about 20% will buy either a book, newspaper, or magazine from him with an average sale of $2.00 per person.
Average daily foot traffic: 5,000
times 20 percent stop-off: .20
times $2.00 average sale $ 2.00
equals the potential market $2,000.00
DEFINING YOUR TRADE AREA\ MAPPING
Up until now, we assume that you know the trade area of your business. Typically, for small business owners, the business is located close to where they live. For some office tenants the choice may be a bit different. They may consider proximity to their key corporate clients, commuting time for employees, proximity to hospitals or governmental buildings important for their business.
Whether opening your first location or your tenth, it sometimes helps to list all of your requirements, gather the information, and plot the information on a map. This process, known as mapping, will give you a better idea of the perfect location for your business. Mapping takes into consideration such criteria as demographics, traffic counts, facilities, competition, and zoning. You can plot these factors on a map physically or use computer software to create the overlay system and look at all of the factors simultaneously.
For example, say that Dr. Smith plans to open a specialty medical office. His average patient is over 65 years of age with an average income of $35,000. He also would like a shopping center location with bus service to benefit from new walk in patients. The closer this location is to the hospital, the better. He plots the information on a map and the best location becomes obvious.
If your first location is successful, you will probably open your second location close enough to your current spot but not too close as to divide your customer base. If you’re thinking about franchising or multiple locations, you may look at several different markets across the state. You can obtain information about these markets from your Tenant-Rep or Commercial Leasing Advisor, the Chamber of Commerce, Government offices, Census Data (found at your local library), area brokers, utility companies, just to name a few.
CASE STUDY #1 : RACQUETBALL CLUB
SITUATION: Joe Smith owns a very successful Fitness & Racquetball Club, “FIT & FUN”. His two sons want to expand the family business to include two new “FIT & FUN” stores which they will manage. Joe has been at the same location for 15 years and knows his trading area and customer base very well. His sons want to stay close to family and friends as well as benefit from the excellent reputation developed by “FIT & FUN”, so they will limit their expansion to the Jacksonville, Florida market.
Joe and his sons have identified their best customers as being singles with incomes over $35,000, and families with children ages 6-13 and incomes in the mid $40’s. Additionally, since many of their customers stop in for a lunch workout, they want a strong daytime population. They prefer a location similar to their current place which is in a large, shopping center anchored by a major grocery chain.
SOLUTION: Since, Joe and his son’s have lived in the area for many years, they know of the different surrounding areas which would best support similar stores. Accordingly, they pick out four areas and then drive the streets looking for possible sites and note all existing competition.
They call for information on the various sites and request that the Landlords provide demographic information along with site plans and rental information.
After completing this research, they review the Consumer Demand figures and, project Per-Store Sales (based on amount of competition surrounding each site), and Sales to Rent Ratio (based on the quotes given them by various Leasing Agents).
They also double-check these sites by calculating the Competition to Target Population Ratio. The choice becomes very obvious, and they proceed with their new locations.
CASE STUDY # 2: AUTO ACCESSORIES
SITUATION: Sam Johnson, swamped with business at his Boston auto accessory shop “CAR STUFF”, wants to franchise his business. However, he doesn’t know where to franchise or what to charge for different franchise territories without first knowing how many units each territory could support. He DOES know his existing customer base consists of mostly affluent men in their mid 20’s to mid 40’s. Most of these customers shop at the adjacent upscale clothing stores.
SOLUTION: Sam decides to examine his franchise potential first, and will limit his initial franchise/expansion plans to New England.
FIRST, Sam posts a map of the area in his store and asks his customers to put a blue pin in the spot where they work and a red pin in the spot where they live. After a week it becomes obvious that his customers come from up to eight miles away, and most of them live in the affluent neighborhoods.
He then draws his current trade area on a map and faxes this information to a demographic company. Within a few hours, the demographic company faxes back to him the full demographic report on his targeted location. Sam learns that:
His population base is 86,000 people
45% of the population is aged 25 to 54
average median income is $39,000, 51% female
Sam then orders demographic data for all of the New England area ZIP codes and picks out the locations which best match his current location. He also orders a Shopping Center Facility Report which tells him the number and location of centers in each region. Sam then decides that regions which contain far more than 86,000 people probably could support more than one store, and he prices the franchise rights for those regions accordingly.
This chapter provides you with the tools necessary for site evaluation, and answers the questions presented at the beginning of this chapter:
* Why do some major retailers willingly LOSE money for the first few years of operation?
Because they want to “lock-up” the best location, and they know that as the area grows in population, their sales and profits will more than make up for any losses incurred during the earlier years.
* Why will most successful businesses pay a premium for the best locations? Because these better locations, while costing more, will bring in higher sales and profits.
* Why will some major retailers close a store and continue paying rent, and open up a new one across the street?
Because the store’s needs change over time relative to store size and layout. Also it may cost them LESS to pay rent on two locations than to deal with a competitor who might move into their old store.
QUESTION: If estimating sales proves to be difficult, is it SAFER to go with the location with the LOWEST rent?
ANSWER: Not necessarily, it could just as easily pose more risk, because a less attractive location may generate fewer sales. In fact, tenant turnover (failure) increases in the lower priced locations.
Sales/profits remain the top site selection criteria — not lower rent. Analyzing the market demand and competition are the best ways to determine the best site.