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Local talent

Whatever happened to the strip center of yesteryear? Not that long ago, the neighborhood centers that dot the U.S. landscape were filled with local talent. Shoppers could count on folksy banter at Mr. Green's pharmacy, photos of grandchildren decorating Mrs. Jones' flower shop, and Mr. Higgins' uncanny ability to memorize patrons' favorite dishes at his deli/bakery.

The strip centers themselves are still here, and more are online, but shoppers have to look harder to find Mr. Green, Mrs. Jones and Mr. Higgins. New strip centers are sporting a decidedly more corporate uniform.

“Ten years ago, you had travel agencies, hardware stores, ice cream stores, video stores, to name a few examples, that were quite open to mom-and-pop ownership,” says David Schulman, vice president of regional operations in the Atlanta office of Regency Centers. “Now those uses are becoming fewer and farther between in shopping centers.”

With tight capital markets, lenders are reserving their funds for projects populated by national credit tenants. So, giant chains such as CVS, Blockbuster and Subway are edging mom-and-pop shops out of the lineup. But mom-and-pops don't give up easily, and many small business owners are adapting, targeting different consumer needs, and in some cases becoming the star tenants of older, established strip centers.

Lenders not fond of mom and pop

“Stop ‘N Shop, Kroger, those types of tenants still garner five stars,” says Steve Henderson in the Boston office of Tremont investment advisors. Henderson says lenders are willing to stretch underwriting or give more dollars to get neighborhood centers with strong anchors into their portfolios.

But even with a strong anchor, lenders get nervous if the local tenant mix rises above 20%, says Stuart Tanz, president and CEO of San Diego-based Pan Pacific Retail Properties Inc. “Their requirements will tighten. Interest rates will rise, and they will typically provide less leverage, which means more equity.”

Small, independent retailers lease between 18% and 20% of the space in Pan Pacific's overall portfolio of 112 centers and provide approximately 28% of the company's revenue. But the lending climate prohibits inclusion of more mom-and-pop operators in Pan Pacific's tenant mix, especially in new centers.

“We generally like to see a maximum of 40% in small shop space in a traditional grocery-anchored center,” says Bob Cook, a principal and portfolio manager with Chicago-based RREEF, a real estate investment adviser to institutions.

RREEF's 40% figure may move up and down, depending on the size of the property. “Larger community centers with more than one anchor and a number of regional tenants will probably have a lower percentage of smaller shops,” Cook adds.

The new centers in Lewis Retail Center's growing portfolio will include larger anchors and fewer local tenants, says Randall Lewis, president of the Upland, Calif.-based developer. “There's less shop space and more reliance on the anchors because they have more stability. The grocery stores have expanded their products and services so that there is little need for additional shops.”

In some cases, small local retailers are being squeezed out of evolving strip center configurations. “Grocery stores are getting larger and the overall center square footage has gotten smaller,” says J.S. Gulland, COO of Center Trust, a Manhattan Beach, Calif.-based retail REIT.

As new centers shrink, they move toward national and regional tenants with solid credit histories. “The bottom line in a new center is the ratio of non-anchor small space to the anchor,” says Larry Hadley, president of Hadley and Associates in Novi, Mich., a firm that places institutional debt. “Although I've seen no hard and fast rule about small space, it does boil down to getting as many national tenants as you can. The more the better.”

Developers still want ‘em

On the other hand, new centers don't serve the lion's share of retail demand — existing centers do that. “The majority of our industry is already built,” says Gulland. “Now we're figuring out how to re-use that space, and you do see older space being filled by more mom-and-pop retailers.

For example, Gulland points to Center Trust's Rheem Valley Shopping Center in Moraga, Calif. A few years ago, the 150,000-sq.-ft. center lost its grocery anchor. Center Trust renovated the center and brought in a T.J. Maxx and a Long's Drug Store as the new anchors. “Those two retailers filled about 45% of the space in the center,” Gulland says. “Beyond that, we have local retailers, many of whom do extremely well. A new shopping center would never be built and leased in this configuration today.”

Developers wouldn't try it, and lenders wouldn't permit it. On the other hand, if a new center found itself in a struggling market, landlords and lenders might change their tune. “When times get tough, a rent check is a rent check,” Hadley says. “While small tenants may be getting squeezed out of better centers here and there, anyone that can pay rent will be taken very seriously.”

Lacking the negotiating clout of national and regional companies, mom-and-pop retailers pay the highest rents per square foot. Perhaps more important, mom-and-pop firms operate with short-term leases that provide built-in mechanisms for increasing revenues through rent hikes. “Mom-and-pop retailers live in the neighborhood and know their customers personally,” Pan Pacific's Tanz says. “When their business does well, they will never, never leave your center.”

Erika Reade Ltd., a 17-year tenant at Regency Centers' 97,809-sq.-ft. Powers Ferry Square in Atlanta's Buckhead district, is a prime example. Owned and operated by Erika Laughlin, the 5,000-sq.-ft., high-end specialty gifts boutique is nestled near anchors CVS and Harry's-in-a-Hurry — an upscale small-format grocer — in a center that includes an eclectic blend of small shops ranging from a real estate office to Starbucks. During her tenure at the center, native Atlantan Laughlin's business has been so good that she has expanded her shop to three times its original size.

Laughlin, who sat in the center's parking lot monitoring traffic before signing her first lease, exhibits the entrepreneurial skills leasing agents look for in local tenants.

“We know everyone who lives in the area,” she says. Laughlin and her eight employees emphasize customer service, know their affluent female shoppers by name, and have stuck by Powers Ferry Square even during a dark period when many of the center's tenants left for spots in newer centers nearby.

“We've become a destination for our customers and I would not consider leaving this center for one that was dominated by national chains.”

A 17-year veteran mom-and-shop is not that unusual, Regency's Schulman says. “Mom-and-pop tenants don't have a real estate department. It's a little bit more difficult for them to find alternative locations because they have a business to run.”

Schulman says larger mom-and-pop shops such as Erika Reade Ltd. can also act as mini- anchors by virtue of their familiarity with the trade area, the advertising they do and their longevity.

“They also serve as a marketing tool, because tenants talk and smart tenants will speak to other tenants in the center to get references,” Schulman says.

“A tenant like Erika Reade Ltd. could probably have as much leverage in that center as almost any national tenant.” While successful mom and pops may cling to their center, untested small independents may find it increasingly difficult to get into new centers.

But distinguishing winners from losers among non-credit tenants is no easy task. Increasingly aware of this problem, landlords vet mom-and-pop firms ever more carefully before offering leases.

Pan Pacific studies financials submitted by prospective mom-and-pop tenants. “Most of the time, the financials are weak,” says Tanz. “More importantly, we physically go to their other locations to make sure they are good operators. This is critical in finding the right local tenants.”

NewQuest Properties, a developer of grocery-anchored strip centers based in Houston, also eyes less-tangible personal qualities. “Does an owner have a positive, warm personality?” asks Jay Sears, a principal with NewQuest. “Are they focused on service? If they don't talk a lot about serving customers, that's a red flag.

“We also look at how the business matches the center. A tanning salon is probably not a good match for a bedroom community with young families. On the other hand, that business might work well in a strip anchored by a fitness center serving a community of young singles.”

As grocery behemoths devour the bakery, floral and pharmacy categories, the mom and pops that previously thrived in these areas have been pushed out.

“There's also a consolidation trend among hardware stores, video stores and other uses that works to the detriment of mom and pops,” Schulman says.

“Locally based restaurants have proven profitable in our centers,” says Lewis, who adds that service-oriented operations such as dry-cleaners are also safe havens for mom and pops.

And the budding expansions of nail salons, cell phone stores and dollar stores are almost all run by mom-and-pop operators, Schulman says. “There are still opportunities for mom and pops, but they are in different retail niches than before.”

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