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Outlets Grow Upscale

To get a sense of just how much the outlet shopping center world has transformed in the past decade, one need look no further than to the radical ups and downs experienced by Prime Retail.

A decade ago Prime Retail, a Baltimore-based owner and developer, bought out competitor Horizon Group for $906.3 million in stock and assumed debt and in the process became the largest owner of outlet centers in the U.S. with 43 properties in 25 states containing nearly 12 million square feet.

Unfortunately, that turned out to be the company's high-water mark for a long time.

The firm struggled to find its footing after the deal. It had trouble digesting the portfolio. It had too many dated properties and a tenant mix that failed to excite shoppers. Ultimately, the mix of centers suffered with lackluster sales and falling occupancies. Throw in the company's heavy debt load and it was too much to bear. Prime Retail began missing payments and defaulted on some of its debts. In 2001, the firm was booted from the New York Stock Exchange. Finally, after years of barely scraping by, the company threw in the towel and in 2003 was sold to New York City-headquartered Lightstone Group LLC for $115 million and the assumption of $523 million in debt.

“They saw a company that was undervalued and in need of investment,” says Nicholas King, executive vice president and COO of outlets at Prime Retail, which operates centers under the Prime Outlets brand. “They invested in the physical facilities as well as the tenancy.”

Lightstone poured millions into the centers, upgrading just about every property in the portfolio. Most importantly, it took advantage of a growing trend spreading throughout the outlet center world. Once seen as low-rent havens for discounted floor samples, last season's clothes, irregular items and other low-cost wares, outlet centers began morphing into higher-class centers where upscale retailers found a new audience for their brands.

Chanel, Gucci, Prada, Salvatore Ferragamo, Roberto Cavalli and Catherine Malandrino and retailers Polo Ralph Lauren, Burberry and Coach are all among the group of luxury goods sellers that have expanded their reach from traditional upscale urban thoroughfares like Rodeo Drive, the Magnificent Mile and Fifth Avenue to the world of outlet shopping centers.

Lightstone jumped on this trend with both feet. It improved the tenant roster at the properties by bringing in a new wave of upscale outposts. For example, with a $25 million renovation at its property in San Marcos, Texas, completed in 2005, the firm brought in Neiman Marcus Last Call, Salvatore Ferragamo Company Store, Hugo Boss and a BCBG/Max Azria Group store called To The Max. Similarly, a $27 million renovation at Queenstown Prime Retail in Maryland brought in Coach, BCBG Max Azria, Calvin Klein, White House Black Market, Chico's and Eddie Bauer, among others.

Although Lightstone, as a private firm, doesn't release financial data, there's clear evidence the firm's moves have been a success. It completed a refinancing of just 10 of the Prime Retail centers worth $631 million — nearly as much as it paid for the entire firm just three years earlier. Further, the firm has kept buying, most notably with its whopping $8 billion acquisition of Extended Stays Hotels from Blackstone Group last year.

Today, Prime Retail operates 21 outlet properties totaling 8 million square feet and has plans to bring on-line another 1.5 million square feet of centers by 2010. This year Prime Retail is scheduled to open Prime Outlets International, a 290,000-square-foot center in Orlando; and in 2009 it will open a pair of 400,000-square-foot-plus centers in Grand Prairie, Texas, and in Livermore, Calif. It also has plans to renovate or expand centers in Puerto Rico, Orlando and St. Augustine, Fla.

Capturing the aspirational dollar

Prime Retail's strategy of recruiting upscale tenants is shared by other industry stalwarts like Tanger Factory Outlet Centers and Chelsea Property Group, which are all growing development pipelines to meet the demand for new space by designers and retailers looking to grow their presence in outlet centers.

“Our growth has been tailored to serve the higher-end upscale brands that are either looking to open their first outlet store or expand,” says Michele Rothstein, senior vice president of marketing for Roseland, N.J.-based Chelsea Property Group. Chelsea, wholly or partially, owns 56 Premium Outlets and other shopping centers in 27 states and abroad totaling almost 19 million square feet.

Last year the market for luxury goods in the Americas was $81 billion, up from $34 billion in 1995 when adjusted for current exchange rates, according to Bain & Co., a Boston-based consulting firm. The United States accounts for 90 percent of the aspirational spending by consumers at luxury retailers and coveted designer brands.

“This is an aspirational business that we're in,” says Prime Retail's King. “We saw that and wanted to take the company in that direction.” And that behavior is a key driver in upscale chains entering outlet centers. Luxury retailers want to reach out to potential new customers who today might be middle class but someday may have more disposable income.

They're looking to capture brand loyalty early with attainable goods at affordable prices and hopefully convert consumers to eventually shop at their full-price stores.

For example, Boulder, Colo.-based Spyder, which sells ski suits and accessories and is the official brand of the U.S. ski team, opened its first two outlet stores last year. At its outlet stores, a Spyder-brand insulated, waterproof jacket sells for $99.99 and its Limited fur-lined jacket goes for $1,600, compared to $300 and $2,000 at full-price retail, respectively.

Previously, it had only sold its sports-oriented performance apparel through its more than 800 accounts with specialty ski and sports shops and U.S. retailers. “Our research shows that having direct retail can strengthen the brand in the marketplace,” says Amy Jacobs, senior retail manager for Spyder. The company plans to open up to four more outlet stores by 2010.

Another driver is the wealth that already exists in the suburban settings where outlet centers are typically located. Chelsea, a subsidiary of Indianapolis-based Simon Property Group, bases its decision to develop by looking at major metro markets whose population base and residents' annual household incomes appeal to designers, luxury brands and high-end retailers. As affluent populations grow in the suburbs surrounding major metropolitan areas, Rothstein says retailers want to locate in close proximity to their suburbanite customers and be clustered with comparable brands.

The move toward a more upscale clientele is also evidenced in how outlet centers are being designed today. Architect Orange partner Darrel Hebenstreit notes that outlet centers have raised the sophistication of their architecture to complement the higher-end tenant mix. For example, store signage no longer consists of non-illuminated letters affixed to buildings. And, to promote continual shopper movement, the outlet's scheme is intended to offer a variety of experiences along its strategically designed pathways.

“If you didn't know that you were going to an outlet center, you would have no way of knowing it was looking at the caliber of the architecture and various amenities offered,'' says Hebenstreit. “We are continually blurring the lines between full-price retail shopping centers and outlets.”

Growth spurt

Over the next two years, Chelsea has more than 3.5 million square feet of new development under construction and in predevelopment; nearly 3 million in the U.S. and almost one million abroad. Scheduled for opening this year are Houston Premium Outlets, in Cypress Texas and Jersey Shore Premium Outlets, inTinton Falls, N.J.; each with more than 430,000 square feet.

According to the developers, retailers have specific criteria when it comes to locating an outlet store. They want the center to be in an established market with a growing population; no more than a 45-minute drive from a major metro area and have an appeal for tourists. Even before the recent decline in the U.S. dollar, international and national tourists comprised a significant percent of an outlet's foot traffic.

Overall, developers are not only boosting their construction of outlet centers, but the square footage of some is approaching one million square feet, rivaling the size of some full-price regional malls. The industry average today for an outlet center is about 500,000 square feet. The total amount of outlet space has risen slightly over the past two years according to CoStar Group Inc. As of the fourth quarter 2007 there were 43.6 million square feet of outlet centers in the United States compared with 42 million square feet at the end of 2005.

The growth spurt came after the industry purged itself of many smaller centers in the early 1990s. ICSC reports a 30 percent decline in the number of outlet centers in the United States to 225 today, from 324 in 1990. Industry analysts said the sector had been overbuilt causing 20 percent of the centers to go dark.

For example, Belz Factory Outlet, a division of Memphis, Tenn.-based Belz Enterprises, divested itself of 3 million square feet of smaller, outdated outlet centers. “Over the past few years we've taken advantage of the attractive cap rates to dispose of the outlet malls to be in a better position to take advantage of future opportunities,” says Andrew Groveman, president of Belz Factory Outlet Division.

Belz, according to Groveman, is still very much interested in outlets for two reasons: manufacturers need to dispose of merchandise in a controlled manner and consumers are increasingly looking for the very best value for their dollar during times of both inflation and recession.

Cheaper rents and fees

Contributing to the increase in the number of outlet centers, industry analyst Jeffrey Spector of UBS notes, are the lower rents and common area maintenance fees paid by tenants leasing space at the centers. However, most owners and developers declined to disclose how big the difference in fees and rents are saying it depends heavily on factors such as the geographic area and the tenant.

According to Simon Property Group's third quarter filing, the average base rent at Chelsea Outlet Centers is $25.45 per square foot in contrast with $36.92 per square foot for Simon's entire regional mall portfolio. That's true even though sales at the Chelsea properties average $499 per square foot versus $491 per square foot at Simon's regional malls. Overall, Simon operates five retail real estate platforms, regional malls, the Mills, community/lifestyle centers, international properties and Premium Outlet Centers. It owns or has interest in 379 properties totaling more than 256 million square feet of gross leasable area in North America, Europe and Asia.

Greensboro, N.C.-based Tanger Factory Outlets, meanwhile, does not publish its rents on a square-foot basis, but the firm did disclose that during the third quarter it executed 77 leases with an average increase of 23 percent in base rental rates over the same period the previous year. For the first nine months of the 2007 Tanger executed 414 leases with an average increase of 22 percent in base rental rates over the previous year. Overall, Tanger owns and operates 30 outlet centers in the U.S. totaling 8.4 million square feet.

Travel plans

One big niche that outlet centers fill adeptly is catering to tourists, especially international tourists. (See story on p. 36).

In Orlando, at its The Shoppes at Prime Outlets International, more than 50 percent of the shoppers are tourists. To compete with the various other shopping venues, not to mention the numerous amusement and theme park attractions located nearby, Chelsea routinely attends travel-oriented trade shows and engages tour operators to promote their centers to tourists.

At Spyder's store in Chelsea's Woodbury Common Premium Outlets outside of New York City, at least 40 percent of the shoppers are foreign tourists, according to Jacobs. And unlike local residents who may frequent the outlet two or three times a year and are searching for a specific item when they're there, tourists spend more time and money. In addition to apparel retailers, outlet mall developers note, it's advantageous to have a luggage store as a tenant so tourists can purchase suitcases to ship or transport their purchases.

Not to miss out on the trend to go upscale, Tanger announced in November it had signed its first lease with Neiman Marcus for a Neiman Marcus Last Call store at its Tanger Outlet Center at the Arches under development on Long Island, N.Y.

The discount chain of the high-end retail department store will help position the Arches as a high-end value retail destination when it opens this summer. Tanger opened two developments in 2006 and two more are scheduled to come on-line in 2008.

In all these cases, the new wave of upscale outlet centers has an improved tenant mix, product offerings and level of service and higher design standards and better amenities that reflect this shift, says Hebenstreit. And that's a healthy direction for the sector to be moving toward. “It's important that their environment be conducive to them becoming a ‘most of the day’ destination,” he says.

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