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Passing Cold Front For Developers, Retailers

Waccamaw Pottery, a 44-store home decor chain based in Myrtle Beach, S.C., planned to open six new stores in 1999. But that was before the current capital markets crunch left some developers without the funds to go forward with scheduled projects.

Waccamaw, which concentrates its stores in shopping centers in the Southeast, now faces uncertainty about the timing of its expansion plans, laments Marc Campbell, the firm's senior vice president of real estate.

"If some of the centers we are looking at are not completed, we just will not open as many stores," Campbell explains. "But hopefully that is not going to happen."

Campbell acknowledges that the much-publicized volatility in the lending market has raised enough questions to concern him. And this restrained lending climate is raising similar questions with both developers and retailers across the country.

Not surprisingly, 87% of respondents in Shopping Center World's 1999 Industry Forecast chose the economy as the issue that would gain the most attention in 1999. Other topics not far behind were the redevelopment of aging malls, entertainment and retail consolidation (see related story).

REITs forced to the sidelines The securitization of real estate both on the equity and debt side has been long sought after by executives in the real estate industry. But turmoil in the capital markets in recent months has shown that no investment vehicle -- no matter how strong it appears -- is immune from problems.

"In the past three months, the availability of capital has diminished dramatically," reports Bernie Freibaum, executive vice president and CFO of Chicago-based General Growth Properties.

In addition, the players involved have begun to change as many of the REITs have been forced to the sidelines due to languishing stock prices.

"We are seeing more interest from smaller and newer developers," says Jeff Gunning, A.I.A., vice president with the Baltimore-based architectural firm RTKL Associates, who handles many of the firm's retail projects.

In recent years, approximately half of real estate acquisitions have been made by REITs. But signs of change are appearing, as two-thirds of respondents to the 1999 Industry Forecast agree that property acquisitions by the REITs will subside to some degree next year.

"They will not be as big a factor in the market," echoes Bob Burke, senior managing director with CB/Richard Ellis Retail Services, Newport Beach, Calif. "Now the buyers will be more pension funds and private capital sources."

Of course, these investors are not new to real estate, but they will be better able to compete for properties with REITs out of the equation, at least temporarily. These institutional and private investors are less affected by the volatility in stocks and CMBS.

"It will affect us less because we obtain financing from more traditional sources," explains Rebecca Maccardini, director of operations for private developer Forbes-Cohen Properties, Southfield, Mich.

But the real question seems to be how long the stock market volatility and credit limitations will last. The answer may determine just how long and to what degree development will be curtailed.

"Where they have a choice, retail developers have put some projects on hold," says Gregory J. Spevok, director of national marketing with New York-based Bear, Stearns. He cites the dramatic increase in spreads from mid-August through October as the reason for any halt to expansion plans.

The spread between real estate yields and 10-year Treasury bills increased to 540 basis points through the second quarter of 1998, up from about 450 basis points last year, according to "Emerging Trends in Real Estate 1999," published by PricewaterhouseCoopers and Lend Lease Real Estate Investments.

"I have seen one or two smaller projects delayed to the following year," observes Steve Dodds, vice president of real estate for The Bombay Co., Dallas.

General Growth's Freibaum also has observed projects put on hold. "But," he asks, "will this be a two-month problem or an eight-month problem?"

"Financing will be more challenging in the first half of next year," says Spevok. "The larger the deal, the more difficulty developers will encounter." But he expects improvement in the second half of the year, as do others.

"Although the capital situation is dismal right now, I see it rebounding late in the first quarter 1999," predicts Charles D. Krawitz, vice president and regional originations manager for real estate capital markets with Chicago-based LaSalle National Bank.

The volume of new retail development scheduled to open next year will probably not be affected. "There is a lot in the pipeline for 1999," says Maccardini. "So unless the capital crunch gets more severe, the totals should remain about the same as 1998."

There is an expected delay in what occurs in the capital markets and its impact on development. "I don't foresee a drying up of new retail development, a result of the capital situation, for 12 or 18 months," says Wayne O'Hara, senior leasing representative and head of acquisitions for The Linder Co., Indianapolis.

Renovation projects will not slow as much as new construction next year. In fact, nearly three-fourths of SCW's Industry Forecast respondents report they will be renovating centers in 1999.

"Competition is requiring more than ever that older centers be redeveloped and remarketed in order to keep up with new centers," says Gunning. "There always will be a need for older centers to keep pace."

Only cream of crop finding capital Some argue that the bottom of the capital crunch came in October and that the market is slowly working its way back. "The cost of capital has begun to fall once again, if only a little," stresses Spevok.

But a little doesn't appear to be enough for the market, as yet.

In general, the rising cost of capital and dwindling availability is still the order of the day, but not all lending has halted.

However, only the cream of the crop will be considered by lenders. "There has been a real increase in the flight to quality. Lenders are only looking for premiere opportunities," explains Maccardini.

"Well-capitalized buyers and capital providers are 'cherry-picking' shopping center loan and acquisition opportunities," says John Oharenko, vice president with GMAC Commercial Mortgage Corp., Chicago.

For example, grocery- and drugstore-anchored retail is still in great demand, while unanchored retail has come under more scrutiny. "Everyone is starting to look at the fundamentals more closely," Krawitz says.

Oharenko says next year's winners will be the owners and lenders who are funding the best quality neighborhood, power and regional centers.

Most industry insiders view the recent downturn as an inevitable correction. They say it will have short-term, ultimately positive effects on the real estate market by preventing potential overbuilding.

Thus, supply-demand fundamentals will remain in better balance, which should strengthen the foundation of REIT stock prices and enhance interest in CMBS.

Downturn has silver lining Now more than ever, the fate of commercial real estate is tied to global markets and Wall Street -- the result of securitization.

Freibaum explains that large hedge funds, which use large amounts of debt to invest all over the world, experienced huge losses in Asian markets and were forced to sell CMBS to satisfy margin calls. This sales activity led to the increased volatility in the CMBS and stock markets.

"So, in this case, the debt market started a [panic of sorts], even though there weren't any obvious problems with the real estate market in the United States," he says.

Agrees Spevok, "It had nothing to do with the domestic real estate fundamentals."

Although some real estate professionals express concern about the supply-demand situation, many caution against easy acquisition of capital, which creates the potential for overbuilding.

Pointing to speculative excess in recent months, Spevok says, "Lenders have been tripping over themselves to make deals and have simply been too aggressive."

Maccardini notes that the majority of overbuilding may be in discount store space, leaving many opportunities for specialty retail formats.

However, with the market perhaps on the cusp of overbuilding, tighter purse strings might be just what the doctor ordered. With time, Spevok says, the correction will be looked upon as a very mild, favorable and well-timed event for the marketplace.

"It is good that [the correction] happened when it did," he says. "It caused capital to pull back before it became too excessive."

And although REITs are currently perceived to be on the losing end of the correction, a longer-range view portrays them as a benefactor of the change.

"The outlook for REITs is brighter now," says Spevok. "Their valuations had soured in large part due to the potential for overbuilding. So the revaluation that has resulted will end up being a positive for REITs."

Consolidation leaving void The largest threat to the supply-demand balance in the retail market may not be from overbuilding but rather from retail consolidation.

The cannibalization of retail chains in nearly every retail category is expected to continue, leaving vacant an increasing number of redundant store locations.

Howard Makler, chief operating officer of Stuart Makler & Associates, a Huntington Beach, Calif.-based firm that handles leasing and disposition of excess properties, says the fastest growing segment of his business is in these redundant locations.

"Our inventory has increased from 9 million sq. ft. to 15 million sq. ft in the past few years," he says. "By this time next year, we expect it to be 20 million sq. ft."

Topping the firm's client list are drugstores, with more than 500 locations up for lease or sale; music stores and grocery chains are also gaining in number.

Makler cites Warehouse Entertainment's acquisition of Blockbuster Music and Trans World Entertainment Corp.'s acquisition of Camelot Music as two major changes in the music business. In the grocery segment, both Kroger and Albertson's recently have made major acquisitions, which could drastically alter the makeup of that retail arena.

In SCW's Industry Forecast, grocery stores are predicted to experience the greatest consolidation among retailers.

"Supermarkets are going through a tremendous amount of consolidation," says Burke of CB/Richard Ellis. "As a result, the traditional supermarket-anchored center will be extremely volatile for the next few years."

Burke adds that the volatility in the grocery segment will be somewhat determined by how aggressive Wal-Mart and Kmart are with their grocery concepts. "If they decide on a major rollout of those concepts," he says, "it will have a great impact on grocery market share."

Tracking development trends One development trend expected to grow in 1999 is the incorporation of big-box tenants into regional malls. These 35,000 sq. ft. to 100,000 sq. ft. tenants are being added to malls from surrounding power centers for their ability to increase shopper traffic.

General Growth has added several traditional big-box players to its latest mall project, the 1.2 million sq. ft. Coral Ridge Mall in Coralville, Iowa. These tenants include Best Buy, Barnes & Noble, Scheels, Old Navy and a 14-screen theater.

Lifestyle retailers -- such as Crate & Barrel, Restoration Hardware and Pottery Barn -- are also receiving more attention in mall projects. "They are being given department store visibility and prominence with both exterior and mall entrances," reports Gunning of RTKL. "This makes the malls more accessible and gives them more of an urban feel."

Besides possessing drawing power, big-box tenants fill large amounts of space traditionally filled by numerous small tenants. Many mall developers are choosing to include less small-shop space to aid in leasing. "The fallout of smaller specialty tenants is a problem," Maccardini says.

Another trend in 1999 will be the ongoing push for urban retail development. "Many municipalities are joining with developers to bring retail back downtown," Gunning says. "Besides, there are fewer and fewer viable cornfield sites available."

Multi-use projects with residential, retail and office are popping up in many cities. For example, at Post Properties' Addison Circle in Chicago, retail shops line the streetfront with the residential component above in four- and five-story buildings and the office complex nearby.

"It is really attractive to urban professionals," Gunning says. "The idea is to be able to work, shop and live without ever having to get into a car." He foresees increasing numbers of traditional residential developers such as Post Properties joining retail projects on a regular basis.

Entertaining options There doesn't seem to be much argument concerning the value of entertainment in retail projects. The consensus is that it boosts traffic counts and prolongs shopping trips. The real question is: What, exactly, constitutes entertainment?

While destination entertainment such as virtual reality and motion-simulation theaters continues to appear in malls, the trend is toward making the entire mall part of the entertainment.

Freibaum says General Growth has stayed away from elaborate destination entertainment concepts, believing them to be "just a fad."

In SCW's Industry Forecast, music stores and cinemas are the most frequently mentioned form of entertainment included in centers.

"Entertainment should be a combination of the tenant mix and the atmosphere that the mall creates for the shopper," explains Maccardini.

Maccardini cites the Somerset Collection in Troy, Mich., as an example. "It has restaurants, but no traditional entertainment concepts such as a theater or gameroom," she says. "Yet most shoppers would say it is an entertaining mall because of the mix of stores and its design."

Even so, Gunning maintains that multi-screen movie theaters will remain a mall mainstay, though he warns they could be reaching saturation in some markets.

Outlet adding concepts Last year, sales in outlet shopping centers reached $13 billion, a figure that could rise considerably as centers add home furnishings to tenant rosters. Stiffel Lamps, Baldwin Brass, The Bombay Company and Crate & Barrel have all opened outlet concepts.

"Home furnishings should be a significant part of outlet growth in the future," says Abraham Rosenthal, CEO of Baltimore-based Prime Retail. "Considering the size of that retail business, we could eventually see as much as a 60% increase in outlet sales."

Overall, outlet growth will be based on expanding the existing chains as opposed to adding new formats. "The industry is reflected by the fashion side of the business," he says. "The vast majority of fashion retailers already have outlet concepts, so substantial growth can't be expected from existing formats."

The outlet industry seems to be leaning toward smaller, more productive stores. It's also watching the potential for taking the outlet concept outside the United States. Prime Retail recently opened an outlet mall in Puerto Rico, and the company has its eye on European expansion.

Foreign expansion is likely to increase with traditional retail as well. Gunning says numerous American development companies have approached RTKL to design projects in Europe, Japan and South America.

Internet not seen as a threat Retail executives don't take Internet shopping lightly, but most feel any significant threat is still much farther away than 1999.

Additionally, many believe the Internet will complement rather than replace traditional shopping centers. "We are experimenting with Internet kiosks at our malls," says Freibaum. "These allow shoppers to sit and travel through a virtual mall."

Regardless of the convenience the Internet offers, many retail executives say the shopping experience is more than just purchasing goods. "People are social animals, and that will help maintain shopping centers," Burke contends. "They need the activity shopping centers provide as much as they need the goods that are sold."

Adds Freibaum, "[The Internet] is not going to make malls obsolete."

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