Testing Assumptions

Written by  //  March 11, 2011  //  Retail Feasibility  //  No comments

testing assumptions

Private sector developers often conduct a feasibility study to test whether a particular project is viable given local market conditions. A good feasibility study should indicate the supportable amount of floorspace, as well as optimal market positioning and development strategies to minimize risk.

Municipal community plans should also undergo the same rigorous testing to ensure planned retail space is supportable without detriment to existing retailers. Thousands of examples of failed planning can be found in small towns across the US and Canada where government officials were blind to the implications of highway oriented retail development on downtown main streets.

Every retail feasibility model should begin with well defined assumptions which are clearly laid out. Each stage described previously helps to create these assumptions – understanding the market, knowing your constraints, creating a vision, and providing a “first run” test by looking at anchors. By this point, a general direction for the retail node in question should be forming. The final stage is to test these assumptions, both quantitatively and qualitatively.

Unfortunately, this is the opposite of how the typical retail demand analysis is presented. Generally, assumptions are hidden by layers of sophisticated looking calculations as subjective opinions are deemed somehow unworthy. With very few exceptions (grocery stores in rural Nebraska perhaps), it is impossible to calculate scientifically and prove the feasibility of retail. Even the most sophisticated models have major assumptions buried within them somewhere.

Putting your assumptions upfront forces you to be honest about the true feasibility and risk involved in any given venture.

To illustrate this point, consider the following case study which is based on an actual market feasibility analysis.

Case Study Project Attributes

  • Located in downtown of North American city (pop. 2,000,000)
  • 95,000 ft2 site
  • High visibility and vehicle traffic
  • 2 blocks from a highly successful regional mall
  • 600,000 ft2 of allowable commercial space (office or retail) + additional space for hotel / residential

As retail rents are far higher than office rents in this area, it is attractive to consider building all commercial space as retail. Retail centres in the city average $400 in sales per ft2 annually. At this rate, 600,000 ft2 would produce $240,000,000 in annual retail sales. To reach this target, only 1.2% of retail sales in the city would have to flow to this retail centre.

1.2% may sound reasonably low, but 600,000 ft2 is absolutely an unreasonable amount of floor space given the market context.

A quick “back of the envelope” analysis shows why a feasibility study must recognize and confront key assumptions.

Assumption #1: Multi-level retail over 2 floors has always failed in the local market.

With a 95,000 ft2 site, an absolute maximum of 190,000 ft2 of retail space (including common areas) is possible – assuming no setbacks. Subtract common areas out (+/- 35%) and we are left with 123,500 ft2 of supportable retail space. Leasing the second floor still will be difficult however and smaller anchor stores (sub-anchors) will need to be included. Several stores in the range of 20,000 ft2 are known to be looking for space in the downtown area, as well as several larger restaurants. To lease the second floor, 2 sub-anchors are planned with the remaining space being given to a cluster of four large restaurants. In the end, 32% of the available floorspace is devoted to sub-anchors and the remaining 68% is left for smaller, higher revenue generating stores (inline tenants).

During the Anchor testing process, it is discovered that a prominent department store currently unrepresented in the city is looking for space.

Here is how this new information changes our rough analysis:

  • The department store requires 160,000 ft2 and will locate over 4 levels – Basement, Ground, +2, +3, and +4. The department store will take up 40,000 ft2 of the total site area.
  • After subtracting the footprint of the department store, we are left with an unused land area of 45,000 ft2.
  • To calculate the amount of inline tenant space we can expect to build, 35% of this land area is subtracted to account for common areas, leaving us with a Gross Leasable Area (GLA) of 30,000 ft2 per floor.
  • With a department store anchor, our experience tells us that with a good design it would be possible to put inline tenants on the Basement, Ground and +2 levels. 3 Floor x 30,000 ft2 gives us a total of 90,000 ft2 of inline space.
  • In total, the project would comprise of 90,000 ft2 of inline space (strong revenue generation) and 160,000 ft2 of anchor space (weak revenue generation) – 250,000 ft2.
  • This gives us a ratio of 36% inline space to 64% anchor space. Malls typically have a ratio of 60% to 70% anchor space, but may be as low as 50% in dense urban environments. Our project falls within the typical range but raises concerns on financial viability given our downtown location.

We now have two scenarios each with their own set of assumptions created through a rough back of the envelope analysis:

→ Without Department Store Option: 123,500 ft2 GLA (68% Inline, 32% Sub-Anchor)
→ With Department Store Option: 250,000 ft2 GLA (36% Inline, 64% Anchor)

This process takes only a few minutes and being able to do it on the fly is an important skill. The next stage is to test these assumptions, quantitatively and qualitatively.

About the Author

Reurbanist

Reurbanist is a multi-disciplinary firm that blends land use economics with urban planning and economic development. At its core, Reurbanist believes that great urban places that are compelling and vibrant must find success at both a fiscal and social level. Stronger cities and urban destinations translate into improved job growth, municipal tax revenue, and a higher quality of life for residents.

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