Retail Traffic

Inside The Chinese Box

Two years ago billionaire Alex Wu's Dongguan San Yuan Ying Hui Investment and Development Co. opened the largest shopping mall in the world in China — the South China Mall — to great fanfare. The 7.1-million-square-foot megalithic shopping center and amusement park located north of Hong Kong in Dongguan City, is the length of six football fields. It boasts windmills, theme parks and a replica of the Arc de Triomphe and is organized into seven “zones” based on international cities and regions including Amsterdam, Paris, Rome, California and so on. Shoppers can even ride a gondola on a Venice-like, mile-long canal built along the perimeter.

Trouble is, according to many observers, while the project's premise is to roll the glitz of Hollywood and the feel of Disneyland into an uber-retail environment, it is failing to live up to those lofty expectations. According to Morgan Parker, president of Taubman Asia, Taubman Centers' Hong Kong-based subsidiary, and others who have visited the sprawling complex estimate the mall's retail space sits half empty.

The problems are manifold. Since the South China Mall is situated in a suburb, it is borderline inaccessible to the vast majority of Chinese residents who don't have cars. (There are only 11.5 million cars owned by individuals in all of China.) To say the least, foot traffic has not been brisk. A Bloomberg News account of the property in mid-April described the mall as “almost deserted.” The property's planners anticipated 100,000 shoppers a day would pass through the property. But a mall spokesperon acknowledged that foot traffic is currently just one-tenth that amount.

What's more, observers say, the property has a patched together feel and violates many of the fundamentals of mall design — some laid down at the dawn of the mall era. “You see corridors with blind spots hiding tenants,” explains Ross Glickman, chairman and CEO of Urban Retail Properties in Chicago. “You see corridors ending in walls.”

With the mall struggling so much two years after its opening, some wonder if it will ever live up to the initial hype. (For its part, Dongguan San Yuan says the mall is still in a “development phase” and expects its sales performance to improve.)

And the South China Mall is just the tip of the iceberg (though an extremely large tip). Unless you've been living under a rock, you know that China is booming and so is mall construction there. Industry professionals on the ground in Asia estimate that hundreds of new properties have cropped up in the past three years, clustered in and around the nearly 160 Chinese cities with populations of one million or greater. Meanwhile, as many as 600 more malls are under construction or in the development pipeline, according to David Hand, managing director for the Beijing office of Jones Lang LaSalle and head of China retail. Nearly 30 million square feet of new mall construction is in the works in Beijing alone, according to Bryn Davies, executive director of retail services for real estate services firm CB Richard Ellis, Greater China.

A much smaller number — perhaps 5 percent — are 2-million-square-foot Goliaths. But those projects alone will mean that by 2010, China will be home to seven of the ten largest malls in the world.

At the same time, just because these malls are going up doesn't mean any of them will be successes. Observers say the majority of the malls are being constructed by inexperienced local developers who are repeating the same mistakes made at South China Mall. Most developers have little understanding of how to plan or design a coherent shopping center that offers more than just a motley assortment of tenants.

There's also a lack of viable local retailers to fill the space. For U.S. developers considering how to enter the market, the prospects are especially complicated. Price of land in the three booming areas of China — around the Pearl River delta, the Yangtze River and Beijing — has skyrocketed. And, entering the market is impossible without the help of local partners, who are just as likely to help you as they are to suddenly end the partnership and strike out on their own after getting what they need. “You have to wake up and understand the reality,” Parker says.

That's not to say U.S. developers should just pass on China if a chance presents itself.

“Across the spectrum of development, from small to large, the opportunity is massive,” says Hand. With a retail market standing at an estimated $700 billion, a real growth rate of 8.5 percent forecast over the next three years, and an annual 64 percent average increase in disposable income among urban households, any developer with international aspirations has to consider a foray.

The bottom line: most U.S. developers interested in testing the Chinese market in the short term will need to rethink their strategies and not just expect to set up operations that try to fill the same niches they do in America. That's why, for example, CBL & Associates Properties, of Chattanooga, Tenn., which has built up a more than 70-million-square-foot portfolio of regional malls predominantly in secondary markets, has teamed with private equity firm Bain Capital to become an investor in a local mall developer that specializes in building what are called “deco-malls” — properties that are filled entirely with large and small merchants hawking furniture and housewares.

Anatomy of the market

Just what is the lay of the land in China? There are, of course, the mega malls, which have gotten the most attention. Besides South China, there's the Golden Resources Mall in Beijing with 6 million square feet, the Beijing Mall with 3.4 million square feet and the Zhengjia Plaza in Guangzhou with 3 million square feet — all of which are larger than the King of Prussia Mall with its 2.8 million square feet of retail space. All of these have been built in the past five years.

Golden Resources, which until South China came along was the largest mall in the world, is faring better than its larger rival. It opened in November 2004 and stands 90 percent occupied. It counts a department store, home decorating center and hypermarket as some of its largest tenants and overall features more than 1,000 shops and restaurants.

But a common problem many of these monster malls face is their location. Unlike the majority of other malls built in China, which are in urban areas, the giant malls are typically situated on the outskirts of big cities. “It requires some effort to get there,” says Ira Kalish, director of consumer business for Deloitte Research in Los Angeles. With or without a car, most Chinese residents still prefer to shop in the city.

Other problems, while more acute at larger centers, are shared by all properties. The vast majority, according to industry experts, have taken a backward approach in how they've been designed, planned and leased. More eager to simply fill space, little thought is spent on whether the tenant mix is right. In general, the malls seem to be an attempt to ape what Chinese developers may have seen overseas, but without knowing how those properties were put together. Hand says, they have yet to demonstrate “a basic understanding of everything from tenant mix to creating a pleasant customer experience.”

Take the matter of design. In U.S. malls, anchors are situated at opposite ends so shoppers have to pass every tenant if they want to visit multiple anchors. Escalators and elevators are placed at the ends of corridors. And on higher levels, all walls and railings are clear so shoppers can see what's above or below. In China, many developers have positioned bigger stores at the entrances on the upper level, but then buried smaller specialty retailers on lower levels with no easy way to get from the main artery down to the lower level. And some railings and guard walls are opaque.

Then there's overall strategy. According to observers, Chinese developers do not identify the type of consumer they're targeting and then come up with a tenant roster to correspond to that demographic. “There's a ready, fire, aim approach,” says Ian Thomas, president of Thomas Consultants, a Vancouver-based consulting firm specializing in retail development. “It's the Field of Dreams: The feeling is, if we build, it they will come.”

The result is a haphazard tenant mix, an eclectic array of retailers with no common price-point or target customer. You will find an upscale department store flanked by a low-priced supermarket. “It's a hodgepodge,” says Gene Spiegelman, executive director of retail services for Cushman Wakefield, the New York-based retail services firm.

More significant is the fiscal approach. Chinese developers tend to treat their centers as if they were condominiums. Rather than securing financing and leasing space to retailers, they sell space in the mall to investors who are then free to rent it to whomever they want. That adds to the already haphazard nature of the tenant mix. Even worse, it means that the owner of the property loses the ability to dictate mall hours and conduct property repairs. “You'll have corridors with leaks because the roof is leaking and no one can agree on when or how to fix it,” says Parker.

The problem, in part, stems from China's relatively paltry supply of retailers. Unlike the United States, it doesn't have a plethora of chain stores — the bread and butter of U.S.-based malls — from which to choose, says Parker. “The basis of any retail market is the indigenous companies in that country,” he says.

And that means desirable retailers will increasingly be able to call the shots. Already, in some underperforming malls some tenants are getting free rent so that the owner can save face, says Parker.

The exceptions

The market is riddled with problems. But not all malls in China are suffering. There are a handful of successful, well-run, high-end shopping centers, says Hand. What they have in common is that they've been built by international developers with a track record in commercial real estate. The biggest presence is from firms primarily headquartered in Singapore and Hong Kong.

Now, a new generation of local developers, who have learned from past mistakes, are starting to build more sophisticated malls. Seasons Place in Beijing, for example, built by Beijing Financial Street Holding Co. Ltd. and set to open this summer, has a 95 percent occupancy rate, with tenants such as Louis Vuitton and Gucci. There's also the 1.3-million-square-foot Solana in the same city, being developed by Beijing Blue Harbor Properties Co. Ltd., which has been more thoughtfully leased and is geared specifically to young families.

In some cases, Chinese developers are also reviving existing malls with new strategies. Take the 3-million-square-foot Super Brand Mall in Shanghai, a property Davies describes as a “failed mega mall.” According to Davies, by working more closely with retailers, management has attracted such brand names as Toys ‘R’ Us, Sephora and Zara.

What does it all mean for U.S. developers? For one thing, entering the market requires teaming up with a reliable local developer or partner who understands the lay of the land. Especially important is knowing how to maneuver the maze posed by provincial governments that approve all projects.

It's also crucial to choose a viable strategy. Thanks to the complexity of the market, the difficulty navigating government bureaucracy and the still immature nature of development, “International developers need to change their business model,” says Davies. Plus, there's the matter of acquiring prime real estate in the most desirable areas. Although there is still plenty of land available in Shanghai and other first-tier cities, prices for prime real estate have skyrocketed.

The field is considerably more open in second-tier cities located in inland China where the government has started a push to encourage development.

One developer taking advantage of that opportunity — and diverging from its standard model of development in the U.S. — is the nation's largest mall owner Simon Property Group. In 2005 the REIT announced a joint venture with Morgan Stanley and Shenshen International Trust & Investment to build up to 12 multilevel shopping centers, each anchored by Wal-Mart. The first, slated to open in the second quarter of 2008, will be a 470,000-square-foot mall with 150 retail stores located in Changshu.

For Simon, it's the most savvy way to gain a toehold. But it's not looking to expand the effort just yet. “There will be no further activity in China until we get some more experience under our belt,” said president David Simon during a recent analyst call.

CBL too is being cautious in its approach in China. It is only making a passive investment and not trying to establish a beachhead. Along with Bain, CBL has invested in local firm Jinsheng Group, a Chinese mall operator and real estate development company.

“We hope that this will lead to more opportunities with this company and others,” says president Stephen Lebovitz, adding that the firm's goal is to capitalize on the growing demand for home furnishings among Chinese consumers. That segment is forecast to experience 11 percent growth between 2005 and 2010, according to Retail Forward. Jinshen's six “deco-malls” will range between 500,000 square feet and one million square feet and house 50 to 100 retailers.

Urban Retail is taking yet another tack. In the U.S. it is primarily a third-party manager (though it has recently kick-started its development operations). In China, it is looking to build lifestyle centers. By the end of this year, Glickman says Urban plans to break ground on a property in Shanghai called Dragon City. The 2-million-square-foot project will include as many as three hotels, office, residential and retail space.

And then there's Taubman, which has been operating in Asia now for several years, though it has primarily looked at South Korea to date. Parker says China isn't primed for the typical upscale malls that the Bloomfield, Hills, Mich.-based REIT specializes in, so it's considering other options.

“We've looked at 200 shopping center development opportunities in the last two years and have not elected to go along with any of them,” Parker says. For now, the solution is Macau Studio City, a casino-resort that will boast 750,000 square feet of tony boutiques catering to the well-heeled.

At the same time, Parker predicts, by 2010, China will be mature enough to embrace the type of enterprise Taubman would be interested in developing. “I want retailers and consumers to evolve so that when I arrive, they can understand the difference between what makes for a good center,” he says.

Five Biggest Malls in China

Location: Dongguan
Year Opened: 2005
GLA: 7.1 million square feet

Location: Beijing
Year Opened: 2004
GLA: 6 million square feet

Location: Beijing
Year Opened: 2005
GLA: 3.4 million square feet

Location: Guangzhou
Year Opened: 2005
GLA: 3 million square feet

Location: Shanghai
Year opened: 2005
GLA: 2.6 million

Source: Retail Traffic research

TAGS: Development
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