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Developers Ready for a
Slowdown...
‘No Time for Amateurs’
As the
market slows and rumors of recession show signs of becoming reality, The
Dealmakers surveyed prominent developers to get their thoughts on the
state of the industry. (Note: Because this survey was completed six weeks ago
and with a turbulent economy, this picture could be totally different today.)
Questions ranged from the
specific (What percentage of your leasing of space is done with brokers?; Has
your occupancy factor decreased or increased in the past year?) to the more
general and forward-looking (Are there retail categories that you think are
over-served? under-served?; What new concepts have you seen in the past year?).
Some we spoke to didn’t want themselves or their companies identified.
In general, the development
community is prepared for a retail slowdown. Some even see it as a buying
opportunity, determined to make lemonade out of a lemon, as the saying goes. The
economic slowdown hasn’t come as a surprise to most shopping center
developers, and a majority can be described as cautiously aware.
"This is not the time for
amateurs," one developer said off the record. "We have been preparing
for this market for 24 months and we anticipated the fall in the stock market to
within 30 days of it happening." Another boasted, "We are stronger
than ever and will be adding people. We are boutique guys. We are lean and mean.
I am looking to buy centers." Mike Cohen of DLC (914-631-3131) echoed the
confidence of many who were polled, but warned that continued vigilance is
important. "We are positive on conditions ahead and just bought 500,000
square feet in the Midwest," Cohen said. "But we have the same
concerns as anyone else."
Even those who focused on
economic concerns were at least slightly optimistic. Jay Brown of Jaylon Inc.
(847-491-6787) noted that, while things are getting tougher, it may be a blip as
opposed to a trend. "The stock market has turned all predictions upside
down. But I’m optimistic that with the continued, expected lowering of
interest rates, aggressive tax cutting, along with a more pro-business
atmosphere in Washington, this downturn will be short lived," Brown said.
"Consumer confidence is a key to a healthy retail market. When consumer
confidence lags, retailers suffer." Another developer said: "This will
be a tumultuous year. Retail tends to knee-jerk-follow the stock market, and we’d
all better fasten our seat belts. Still, there are plenty of opportunities for
the right kinds of deals."
Michael Bowen, chairman of
Westwood (231-722-9999), a privately held opportunity fund primarily invested in
office and retail properties said the "current economic environment"
is exciting because of its Darwinian properties. "It drastically reduces
the level of ‘stupid’ money in the real estate game, you know the attorneys,
doctors etc. who think our business is an easy get-rich-quick scheme,"
Bowen said. "Many of our acquisitions are from these types. The change also
brings reality back to the retail community. In a country that is drastically
over-stored, a more conservative approach to store locations and expansion is
not a bad thing. If you have the right location you will always have users, even
if it’s a ‘B’ or ‘C’ site. Boring old real estate returns don’t look
too bad to most investors right now!"
While most developers agreed the
nation in general is over-retailed, and their markets are no exception, there
were varied opinions about which sector was next to have major problems. Home
improvement, apparel, restaurant, bed and bath, pet and office supply,
discounters and supermarkets were all mentioned. "Cannibalism" was a
word we heard often in our interviews on the topic of over-storing. The general
feel is that it’s the "retailers’ own damn faults." Many expect an
increase in retailers’ surplus property portfolio due to stupidity, egos and
Wall Street-driven strategies, rather than the tried-and-true rule of location,
location, location. (Of course, it was the developer who sought out these
"cannibals" for his center. It is a little like the John complaining
the prostitute charges for sex.) Yet, it’s extremely important to note that
this group of highly experienced developers didn’t see any retail categories
that are under-served.
The collapse of some of the
larger movie theater chains in the past year may be a harbinger of things to
come for deals that were done with finance taking priority over good retailing.
One respondent’s comments about theaters was especially telling of the
frustration of entertainment developers. "Thank God some of them (most of
them?) hit the wall -- there were way too many just when the customers’
entertainment habits are changing drastically," he said. "Maybe the
bankruptcy judges will do what some of the real estate committees, lenders or
landlords didn’t have the guts and/or /brains to do in the last 10 years --
throw out the leases."
Dan Baumgard of Baumgard
Development (305-661-0110) explains the problem this way. "The theaters
were all debt-finance driven and had turnkey built-to-suits," Baumgard
said. "You can retire debt, but you can’t retire rent." Baumgard
said the same could be on the horizon for larger single-tenant buildings.
"The big box guys are in trouble. Power centers have a problem if they lose
two or three anchors and the spaces are configured so that it will be hard to
cut up."
The movie theaters weren’t the
only sector to, as one respondent put it, "cannibalize themselves."
One talked about supermarket chains: "To hear these guys whine about small
profit margins, you’d think their world was ending... but I never met a poor
grocer. Wonder what kind of dinner they serve with that whine?" Another
developer said, "Pet supply stores are the frozen yogurts of this decade...
way too many of them and some of them obviously built for the stock market, not
for smart growth."
On the whole, the real estate
professionals polled agreed new concepts are scarce. Everything has started to
look the same, and the few new ideas out there are too localized to have any
national impact. Since the advent and extinction of entertainment centers, there’s
not much to talk about in the realm of exciting retailers or new ideas. The last
big and long-lived phenomenon is the power center, and now we’re beginning to
see the cracks in its armor. Shannon Green of Bend Properties (949-261-6464)
said she thinks the perceived soft economy may be stifling the next big thing.
"Consumer confidence is down and now Mom and Pop’s don’t know if they
will make it," Green said. One trend that has nearly ended is the threat of
Internet retailers to brick-based merchants. Brown said e-tailers have settled
into a much less significant niche than what was once feared. "Fifteen
months ago with the Internet growth for retailers online, there was plenty of
discussion about whether or not shopping centers would be hurt by all of the
online activity," Brown said. "As a result of last year’s Internet
tank, with so many online retailers closing shop, we can rest easy that the
Internet, although it will have a place with consumers, will not negatively
affect existing shopping centers."
The role of the broker has become
dramatically more relevent to the developer -- a true case of codependency has
emerged. Green said some mid-sized markets may be under-served because of the
tenuous relationship between brokers and retailers (see broker story).
"The broker doesn’t want to take his client to a big space out in the
middle of nowhere," Green said. Broker representation of tenants at the
national and regional level has significantly increased. Although percentages
from respondents didn’t show a consistent trend, many developers have noticed
a more professional and, as one put it, "efficient" industry than in
the 80s or even the early 90s. Green observes that the change has been dramatic.
"Most national retailers, about 75% to 80%, have a broker, yet only two
years ago it was more like 15% to 20% of the national retailers had a
broker," Green said.
Brokers also are beginning to
notice that they need each other more than ever. A developer who uses local
third-party management and leasing companies for his company’s entire
portfolio has noticed more brokers cooperating in order to finalize more deals.
"One hundred percent of our leasing is done with brokers, however what I
have noticed is that probably more than half of the space is leased with the use
of a co-broker," said the developer. "I don’t know if this is
telling me we have the wrong brokers on the job, or if the brokers ARE talking
to each other."
The Internet, while it takes the
blame for the tech stock and dot-com crash on Wall Street, is taking an
expanding role in how developers structure their business. Cohen said his
company, DLC, is taking advantage of the relative ease of electronic
communications. "We are using the Internet more. We still do a lot of
advertising, but we’re gathering retail and brokers’ e-mail addresses for
quicker and more frequent contacts," Cohen said. Another respondent said
what used to be a luxury has become a necessity. "We are now much more
electronic-oriented, i.e. knowledge of computers and Internet is absolutely
required, as opposed to being an option," he said.
Others have become more assertive
in more traditional marketing techniques. "We’re a little more aggressive
with our leasing signage," Brown said. "We’ve added permanent ‘For
Lease’ signs in strategic places, along with more ‘Managed by’ signs.
These signs have increased our leasing activity." Another developer
explains that their marketing efforts have become "more focused,
cost-conscious and they are producing up-front, in-depth market studies in order
to sell the proposed tenant." Some have stayed consistent with what has
always worked for them. Andrew Hascoe of Bryant Development (914-701-4300)
explained that technology won’t change the basic industry. "Nothing has
really changed. It is all very similar stuff. All marketing is in-house, direct
to tenant. Mass marketing is ideal to get into the marketplace," Hascoe
said.
Vacancies have always been a sign
of trouble with a location, and a high vacancy rate nationwide would be a major
red flag. That flag doesn’t appear to have been raised yet. Developers told us
their vacancies have stayed fairly constant, and most respondents said their
occupancy factors are staying the same or even increasing. One institutional
owner has had a decrease in its vacancy rate, but noted there appear to be more
foreclosures of retail centers. Another said, "Vacancies are stable,
perhaps down a little. Our market is virtually zero-percent vacant for good
space because we never overbuilt in the 80s and 90s." Of course, the
fallout from the theater chains and big-box discounter closings has not been
totally absorbed by the market. When asked whether there is vacant movie theater
or department store space, one response was, "Are you kidding? Of
course."
Theaters and department stores
aren’t the only empty spaces. "We don’t have any vacant theaters, but
we did have a vacant department store in one center. A portion of it was leased
to a theater a couple of years ago and the theater is open and operating,"
he said. "The 13,000 square feet remaining of that department store is,
however, still vacant. We have had more vacant grocery stores and in-line drug
stores. We have a vacant home-improvement store." The effect on the leasing
staffs of these companies has been positive. None of the respondents were
cutting employees and more than 25% of them are adding staff. One developer said
his company’s structure requires adding people, creating a management
challenge. "Our leasing personnel are on a specific program for one or two
projects, max," he said. "It can become difficult to manage,
personalities are difficult. Leasing agents are creative people and we need
enough activities to keep them active."
Clearly, this year’s economic
problems are not new, at least not to the seasoned professional. We asked
developers to comment on how their industry has changed in the last 20 years.
"Cycles" and "preparation" were buzzwords frequently used by
real estate survivors who have been through this kind of market before. Brett
Albrecht of the Abbey Company (714-740-8800) said he sees the tide turning back
toward the regional centers’ advantage. "We have seen cycles from
regionals, to mall-busters and back to regionals," Albrecht said.
"Architecture is coming back, lending itself to themed centers, also
lending itself to ‘Mills-type’ concepts. But things are constantly being
redesigned. This industry is not forgiving at all. If you stop moving forward
you die." Said another: "The development business is cyclical.
Finally it’s returning to common sense and good business judgement, driven by
lenders."
The "follow the money"
development model has had mixed results for the industry. One developer said
there is "too much emphasis on what looks good on paper -- not in
reality." He said he sees "an increasingly homogeneous tenant mix;
meaning less entrepreneurism, less diversity and more difficulty in finding and
promoting new retail ideas and concepts. Now, more attention is being paid to
existing centers -- finally. The power center (consisting) of all big-boxes will
have significant problems in the years ahead -- and some have problems now.
Credit and easy construction does not mean long lived centers. But we need to
place the finance folks back into finance and out of the control of imagination
and ideas. Lord knows that’s essential."
Brown talks about a shift to
destination retail and away from the tenets of good location, a theory that says
all the good locations are taken so we have to create something so attractive to
consumers that it becomes its own location. "With land getting so expensive
over the past decade, new developments are more anchor-based than
location-based," Brown said. "Fewer busy intersections are available
for development, so developers have depended upon big-box anchors to draw
traffic to an otherwise secondary location."
Hascoe has seen similar trends in
the rise and fall of big boxes. "They became much more interested in profit
and cost than consumers and their wants, more interested in Wall Street and
their stock price, than Main Street and their needs," Hascoe said.
"Until they realize that their ultimate user is the customer and not the
shareholder this is not going to change." Hascoe said the current
development money setup provides a better experience for everyone from developer
to consumer. "I find that there is a lot more focus on pre-leasing and much
less development on spec. No more ‘build it and they will come’ philosophy
and that has a lot to do with financing," Hascoe said. "I think that
is very positive and will lead to less problems in the industry, but you will
still see a lot of continued shakeouts and consolidations in retail."
Michael Pollock of The Michael Pollock Co. (480-888-0888) agrees that lenders’
insistence on credit tenants has solidified the market. "Now it’s tenant
driven. In the 80s we were building with OPM (other people’s money). Now you
have to have tenants that are alive and breathing. It’s a more disciplined
market, and you’re required to have pre-leasing," Pollack said. "Any
developer who is building without them is suicidal."
Ed Jaten of Arc Properties
(973-249-1000) said even with uncertainty and consolidation, the industry is
healthy. "There will always be certain key retailers who will want to
expand. It now takes more creativity on both sides to find right locations in
markets that are under-served," Jaten said. "Today it is a more
competitive and professional industry, more efficient in terms of
professionalism and expertise with less cost overruns."
Developers who have been in the
industry a while have learned to see the ebbs and flows in time to prepare.
Their experience has left them with the sense that nothing lasts forever.
"This is the kind of market that makes widows." Pollack said. "So
many people said things in the late 80s to make themselves or others feel better
but we have learned that not telling the truth makes you look like an even
bigger fool. It does no one any good to be the ‘rah-rah’ cheerleader in a
non- ‘rah-rah’ market."
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