Leading Shopping Center Buyers Discuss Retail's Hot Topics
Shopping Center Business and Trammell Crow Co.'s East Coast Investment Team hold a roundtable of leading shopping center owners to discuss the topics.
Roundtable moderated by Randall Shearin and Whitney Knoll

Participants of the Trammell Crow/ Shopping Center Business investment roundtable, held in New York City recently.

Attendees of the panel were: Tom Caputo, executive vice president, Kimco Realty; David Craine, managing director of acquisitions, LaSalle Investment Management; George Fryer, principal, AEW Capital Management; Adam Ifshin, president, DLC Management; Tom McAuley, president, Inland Capital Markets Group; Glenn Rufrano, chief executive officer, New Plan Excel Realty Trust; and Jim Thompson, managing director, Regency Centers.

Shearin: Let's talk about the geography of your centers, in terms of where you are now, and where you are looking. Most of you are active nationally. What are the markets that you find attractive? We hear a lot about the Sunbelt stretching from Florida and the Southeast all the way to California.

David Craine, LaSalle Investment Management.

Thompson: California is our strongest market from a   development standpoint. It's obviously the most populated state in the country, and has the highest growth. I think we have about 20 percent of our total portfolio in California. The barriers to entry are very strong, entitlements are difficult to come by, but our development teams have been very successful adding new ground up product to our portfolio. We view the Mid-Atlantic region as a very strong market for us as well. We recently closed on the CalPERS/First Washington portfolio that included over 50 assets in this region. The demographic profile of the portfolio was extremely compelling, with average densities exceeding 100,000 people and AHHI in excess of $95,000. We have found these types of demos to be key success factors for our predominately grocery-anchored portfolio, as we tend to compete well against the discount formats in these market conditions. We continue to see good growth and performance in the Carolinas, and of course Florida is obviously a solid, strong growth market.

George Fryer, AEW Capital Management.

Knoll: Adam [Ifshin], I'm curious as to what your parameters have been over the last few years with your tremendous growth.

Ifshin: Our look at geography, David [Craine] and I look at almost entirely different universes of property. What's the quality of the real estate in a specific market, what's going on from a supply issue in the market and the demographic side from a demand issue in the market. As you know, we're rarely in the markets that all these guys have been talking about, unless we're in infill, multi-ethnic, older suburban communities. We've never chased Phoenix, Las Vegas, Dallas and South Florida. Our focus has been parts of the Midwest that have basically been left for dead from an investment perspective. But there's job growth, there's some population growth. They are more complicated deals but the retailers we deal with need to access customers they don't access now. Marshalls has the market in Charlotte covered, for instance. Our ability to add value means bringing retailers to space currently we can re-engineer. Those value tenants are looking at those markets, and those are the places we're going.

Tom McAuley, Inland Capital Markets Group.

Knoll: Since you all do so many different types of purchasing you can buy the best product on the street. Where are you focused now?

Thomas Caputo, Kimco Realty Corp.

Shearin: With so much competition these days to buy centers, especially in those areas like Los Angeles, Dallas, Atlanta and Chicago, are you looking at smaller areas, going to the secondary and tertiary markets? We've heard a lot of talk in Atlanta about markets like Montgomery and Macon; are these investment grade properties for you? Are you interested in going there either as developers or owners?

Ifshin: Developers have gone to those markets because tenants like big boxes are finished with expansion in most primary markets. So all of sudden, you say hello to a power center developer, and he's got 850,000 feet going up in Waco, Texas, with names that won't move to the neighborhood I live in. From my perspective, where are the tenants going to drive development? It may not be a traditional market that David [Craine] would look at. The developers that traditionally the institutional grade investors are comfortable with are clearly now increasingly going into secondary markets because that's where the tenants are going. From our perspective, whenever we go to small town, there's got to be a buffer. We own five assets in small towns that are quintessential college towns where the college or university is the dominant economic driver. It probably is dropping in as many non-census counted transients — people who are living there (i.e. students) — as people in the census count. We know the census numbers aren't right, and we're more comfortable if we go to a small market where there's a college or university. Sometimes you find a small market that has a true institution in the American industrial society that is going to stay there and defend it. Racine, Wisconsin, for example, is where SC Johnson Wax is located, and they're never leaving. It creates stability in that market that otherwise wouldn't exist.

Caputo: We agree with Adam, there has to be a hook. We recently purchased a property in Laredo, Texas. Many investors wouldn't even consider going to a market like Laredo. It's right on the New Mexico border, there were 10 acres of extra land in the back of a very deep site and there was expansion potential in addition to that. The sales for some of the tenants were over the moon, $460 a foot for some, which we thought was pretty darn good. Before we closed on the deal, we had a letter of intent from Kohl's to buy the 9 acres that we purchased in the rear. In the meantime, we're expanding the rest of the center, so the real hook was there. We own a center in Norman, Oklahoma, which we purchased for exactly the same reason: it's a college town.

Craine: To go to some of the smaller markets, the price point is also a consideration as well. Are you getting paid to go to a smaller market, recognizing that the world to sell it to, whether if its 5 years from now, 7 years from now, or 10 years from now, will be a smaller universe? There are a couple small reasons behind this: the pricing on the transaction, good tenants, and a growing area and there were a number of positive things about the market. But in this world today, to get national prominence plus cap rate is not easy to find.

McAuley: With the REIT that I used to run, probably 60 percent of the property I owned was in secondary and tertiary markets. [Editor's note: McAuley used to be chairman and CEO of IRT Property Trust, which was acquired by Equity One in 2003]. In almost every case there was no to negative growth in those markets from shopping space. Where cap rates are trading today and with negative growth in the secondary and tertiary markets, it would be a crapshoot in my opinion to go in those markets, but there are always exceptions.

(left to right) James Thompson, George Fryer, Glenn Rufrano and Whitney Knoll.

Caputo: We have a five-property venture with one of David's clients which includes a center in a small town in Pennsylvania. There's an expansion opportunity for the supermarket, and our intention, once we get the supermarket expanded, is to exit that market because we've accomplished our goal. We had an expansion hook on this site and once the expansion is complete, we have in effect landed the fish.

Glenn Rufrano, New Plan Excel Realty Trust.

Ifshin: The hook could be just a very good price, but the reality is guys like this [the owners at the table] don't let us get a very good price today. So we need to find a way to get there and if you can't get there on prices in the secondary market you have to have some of those reasons. There is no price hook anymore in the market. I think one of the concerns of the smaller markets going forward is that there is no risk premium right now for smaller markets. We've increasingly taken the position that you're buying a location and you're buying bricks. We've done a number of deals this year where there are limited lease terms on the pages but the rent's low enough and we're taking the position that if they are dumb enough to leave it for whatever reason we can replace it in a multiple. That's the hook, that's the protection.

(left to right) George Fryer, Glenn Rufrano, and Whitney Knoll.

Shearin: A few small owners commented at our Atlanta roundtable on the predicament they are getting into if they sell their assets. Their concern is what do they do with the money. They are the small guy and they don't have the institutional capital behind them. They want to get rid of the centers but they don't know what to do with the capital they will have as a result.

Knoll: Along the same lines, with competition so strong, what are you guys doing with your companies to increase operating profits, now you've got to look internally as well as externally? What are the different things you're doing to create the value of your existing portfolio because it might be difficult to add to that portfolio?

McAuley: Tearing down and redeveloping, even properties that are 5 and 6 years old. In Inland Retail, which is the southeast REIT, we've got $200 million of redevelopment going on within that REIT. Some of it is tearing down big boxes and rebuilding for other tenants. It's cheaper to do that than it is to go out and buy new properties.

Fryer: We're systematically looking through our portfolio to consider adding mid-rise residential sites or a combination of mixed-use where we can. The other thing we're doing across our portfolio is examining those strategic initiatives that 1 year or more ago did not look economic because the returns on cost were below the market cap rates at the time. Now, with today's lower cap rates, you can make those expenditures and position defensively for the long term, perhaps through anchor repositionings and more major redevelopments.

James Thompson, Regency Centers.

Craine: A lot of municipalities are pushing for that too.

Caputo: We're combing through our entire portfolio and looking at residential and office opportunities. The office opportunities are obviously closer in and we've identified several. We are expanding our redevelopment team fairly quickly and examining those redevelopment opportunities within in the portfolio. I received a call on the way in today from one of our developers who was out looking at a property we will be purchasing soon. He was calling to say he believes there is a strong opportunity to add a residential component to the site.

Rufrano: I'd agree, but the only thing I'd add is, this whole portfolio management trend, is an exercise in maximizing value. The old time guys — none of us — would buy assets, put them in the background, forget about them and go on to the next deal. That whole era of real estate operating companies is all but gone. You clearly can't operate that way in the public market, and I don't think a private guy can do it either. So the concept of redevelopment, exploring   residential, converting to office, are asset management elements providing the highest and best use of our properties.

Randall Shearin, Shopping Center Business.

Rufrano: It's clear that Wall Street is the asset allocator, not the operator. The operator provides the expertise and Wall Street determines who is the best apartment guy, who's the best office operator, who's the best residential or retail player and so forth. It's been that way for 10 years and we have conformed with that model in general. Vornado's business model is a change from this theory. They are a public opportunity fund and they have made a great deal of money for their investors. We couldn't get away with it if New Plan was to buy a set of office buildings in Manhattan. We'd be strung, hung up, beat up, and that'd be it. I think some companies may morph into that model; Kimco has also made a great deal of money for its investors over a long period of time and has a unique infrastructure. Otherwise it's very hard to move away from your business model. This is a fair concept because you have set expectations and strategy with your investors which should not be changed without proper rationale.

Adam Ifshin, DLC Management.

Rufrano: I think the residential guys would argue with you on that Adam. If you look at Avalon Bay or Archstone, they've got huge development projects and the construction debt is drawn from the revolver. As long as they create a spread between the debt and equity they will be successful developers. The levels of debt are generally 50 or 55 percent, and those ratios represent market influence. It's a question whether investors will increase equity value of companies that have a conservative balance sheet and relative safety. We will find that out as our business matures.

McAuley: Inland's fourth REIT is called Inland America and it is a diversified REIT that will buy any property type. The reason for it being diversified is that you can't find the retail anymore. They've got tremendous demand to the tune of approximately $300 million a month in new capital coming in from investors that are buying into that product through a financial planning network.

Thompson: One of things we've tried to accomplish in the short run, when we have an opportunity to do alternative, non-retail use within one of our centers, is to find the best residential or office guy to come in and partner with us to leverage their expertise. We have found success through air rights and ground lease scenarios where we can maintain control of our asset while enhancing the overall value of the property. We can stick to our core competencies while enhancing value in the real estate, which I find   to be a pretty good way around changing our direction.

Caputo: Kimco has a multiple business platform and we not only own and operate and build shopping centers and manage and lease them, we also have a very active retailers solutions group that handles lots of bankruptcies, works with troubled retailers and helps them recapitalize. We have a preferred equity program, we have a small opportunity fund, and when you throw all those together in the mix, some people wonder if you just own and operate real estate. That's what our retail REIT needs to do including development. We have a different business platform and as a result the analysts tend to ask more questions about our business strategy.

Rufrano: It's one thing to go out and buy office buildings. It's another to take a property you have, for instance an empty Kmart, and build a 100,000-square-foot office building for BP. I think that's an okay way to diversify because you're creating value from existing inventory and its far different than just buying different product types.

Whitney Knoll, Trammell Crow Co.

Rufrano: You constantly search for the lowest cost of funds. One reason I suggest exploring outside as well as inside the USA is to try and obtain capital de-linked from our economy; so that if you have domestic capital and you have international capital, you can invest both. At any given time you can choose and arbitrage the lower cost. Over periods of time alternatives will change. I don't think there's any one source you could count onto be the lowest capital source forever. Why Australia versus somewhere else? When we did our transaction we spoke to investors in Europe, the Middle East, and in Australia.   We were selling 20 percent of the assets in our company in a joint venture, a large proportion. We had a strategic reason for this execution and wanted a long-term arrangement whomever we were going to invest with. The Australian public market is different from private investor alternatives. Our [Australian] partner is a corporation in perpetuity. There's no concept of an unwind; it doesn't exist. The only way it could unwind is a change in control. That could happen, it just hasn't happened before. Second, we have a management contract that gives us   management, leasing, development, acquisition, disposition and finance for 20 years. Basically, the only way we can get fired is gross negligence a standard we will surpass. We have an asset management fee which in perpetuity as it relates to our interest in the partnership. The Australian source, all things being equal, provides for an optimum long-term joint venture arrangement.

Thompson: We have two domestic partners as well as an offshore partner for the same reasons. In Australia, citizens have a mandatory retirement savings program, which has created a significant amount of capital in search of public securities in which to invest. So there's a tremendous amount of capital over there, with limited amount of real estate product. Our Australian partners own grocery-anchored   real estate in Australia, so they are of like mind on the product type and operations of the assets. They are very savvy investors, and they have been fantastic partners. In today's cap rate environment, the only way we can play competitively in the acquisition game   is through this JV program, as the fees that we earn enhance the overall returns.

Rufrano: We have two partners, JP Morgan and AEW. It has been reported that Australians purchase real estate in the U.S. at high prices. This is not true. The Australian capital is derived from funds that represent the social security system of the nation and invested in public securities. They desire high yielding, lower risk, investments. There is no public bond market in Australia, and therefore real estate is the bond equivalent. There is a compatibility of risk and return between the United States and Australia, and the corresponding pricing. They are very astute investors and implement diligence procedures that is equivalent to any institution in the United States.

Ifshin: You have a huge change there structurally. They've essentially gone back 4 or 5 years ago and dealt with what was going to be their social security crisis, what this country has not yet dealt with, and the outflow of that was a privatization with a huge government mandated forced savings component. There was no product in Australia to satisfy what was suddenly a dramatic level of demand, so they're out trotting the globe, looking for a product to meet that demand and they see a large transparent market, relatively safe, highly developed in the U.S. It's predominantly retail, but its not exclusively retail, they're now in office and there will be more sectors added.

Knoll: Ten or 15 years ago there weren't that many partnerships, as all of you know. Now there have been big ones.

Craine: We've done a number of transactions, not only do we have our quintessential Kimco, but on the industrial side, representing CalPERS and now called Cal East, we've done a number of ventures including one with Center Point, which is an industrial REIT based in Chicago. We look to get hooked up with these people because you hear about new deals. You have better expertise to run these properties. Relying on your partner is very different than relying on a third party.

Fryer: AEW is probably a bit different among the advisors. It's first investment back in 1981 led to a joint venture with the Westcor Companies from Phoenix. It was a relationship and partnership that actually lasted 22 years. Venture and relationship management have always been in our DNA. Our opportunity fund has done ventures across the spectrum, in all product types, in all strategies, internationally as well, and we continue that today both through our commingled funds and direct separate accounts. Our venture platforms, the one with New Plan for example [nods to Glenn Rufrano], permit us to invest in more value-added deals with a higher return profile, not to mention our numerous joint ventures of single assets as well. Since we have no internal leasing and property management, we rely on the traditional third party construct only for solid, core properties. The venture approach allows us to invest in much more active properties.

Shearin: Are we headed for a bubble that is going to burst? There has been talk now for 2 or 3 years with interest rates rising. I don't think we really see that happening as much as people have speculated it would. Are there any speculations from this group?

Ifshin: Bubbles are micro things, the same way you decide to buy a property or not based on an individual market. Bubbles can turn out, in retrospect, to look like a macro event because a market can take down an entire real estate cycle. I think the fundamental risk is that the condo market takes the rest of us down. I was born and raised here in New York City, I grew up with a father who was a real estate broker, he's my partner now, and I've seen it happen since the time I was a little kid three or four times. It will happen again, and I don't have any question in my mind that it's going to start there. What will happen is the liquidity will dry up and then short term exit strategies are in jeopardy because the end user buyers won't have access to the kind of liquidity that they need to make those deals.

McAuley: I think high interest rates, energy is probably going to be a problem and that's why I think mid-market centers will stay in high demand because people are going to be close to their goods, necessities and services that they need. But I don't think there is a bubble, but I think we've got some things we've got to watch, primarily interest rates. I know most of you are not as old as I am in here, but I can remember the prime rate being 21 percent.

Shearin: What about lifestyle centers: are they the shopping center of the future? You're now seeing things like grocery anchors mixed in and some hotel components. How are you looking at these properties?

Fryer: Each one is an individual animal. Of course, you could say that about every piece of retail real estate, but these certainly take it to the next step. We have been involved in the development and repositioning of about four of them to date and we'd like to do more, but again preferably on the front end of a repositioning or development. For us to acquire a rack-rented, fully leased stabilized lifestyle or town center project, it would have to stand up to a pretty long checklist. The trade area would have to look like the Crate & Barrel demographic requirements. There's no question they are proven to stay, they are very successful, and they can impact regional malls when they sneak up against the highest income neighborhood pockets. I do have some concerns that they are going to be over done. I toured a site in the Upper Midwest last week that absolutely made no sense. It was sponsored by a local residential developer, has a grocery store, some local tenants and no other nationals. I see more of that happening because communities want these projects in their towns so desperately that they're going to drive development without the proper fundamentals.

Fryer: For the future, retail concepts tend to cycle like everything else. They start off as pure, independent, highly targeted centers, and then they become more hybrid as the different, pure formats tend to merge together. That's what we're seeing now, the non-discount big boxes are being incorporated into the lifestyle centers. Ultimately, when the centers are no longer special enough, when they are trying to appeal just to the broad middle, the upper-end customers will no longer find them compelling and will drive the next new form of development. It's a cliché at this point, but the saying, ‘Food, Fashion, Fun and Function,' really does need to be incorporated into these hybrid projects. The terms ‘omni-mall' or ‘power village' are being thrown about to try to define these, but they are and can be regional mall replacements that better serve the American family life.

Caputo: We have built two lifestyle centers. We sold one a few years ago, we have one that's still in final lease up in the Woodlands in Houston. So far, we have not purchased any lifestyle centers. We were asked by a large investor to take over a lifestyle center in the Pacific Northwest and on the surface it looked very attractive, had a really good rent roll, and it was about 4 years old. We pulled the demographics, looked at the income levels, the tenant roster and said, ‘gee, this doesn't look so great.' We were looking at a significant amount of near term lease rollover and we thought a lot of tenants would not be renewing based on the sales levels they were achieving compared to their occupancy costs. We have shied away from lifestyle centers on the acquisition side because of the short term nature of the leases, the high TI allowances that the tenants demand, the high rents and therefore the high price per foot. That said, they are definitely a factor and certainly intriguing but something we haven't done much with yet.

Thompson: I think there is certainly a place for the lifestyle center, as evidenced by our Cameron Village in Raleigh that was developed over 50 years ago. It has obviously changed over time, but it continues as the city center. We will be adding a residential component to it in the near future as well.

Ifshin: The tenant determines what kind of format really gets created and it's a form of distribution. The tenants need to grow. At the September ICSC, The Container Store got up and spoke and they are going to be in community shopping centers, in malls and in lifestyle centers and it's because they have to grow. Have you sold many lifestyle centers, Whitney?

Knoll: I have not.

Ifshin: What do your colleagues in the business say about selling them?

Knoll: That they are obviously in demand right now, the good ones and we have Cousins who have done their successful Avenues. You've got Sembler who has taken this multi-use and lifestyle center to the next level in my opinion. I think they are in the right areas.

Fryer: All four that we were involved with were successful. For example, we provided much of the seed equity for The Market Common, Clarendon, (Virginia). Perhaps the most successful transaction I've ever been associated with was our investment in the Bell Tower Shops of Fort Myers, Florida, when it appeared troubled, with its Jacobson's having just closed. We were able to replace it with a gourmet grocer, Jos. A. Banks and Ulta Cosmetics. We acquired it at a cap rate that would appear as distressed and which was applied to only income in place. We added significant additional income and subsequently sold the property at a cap rate 200 basis points lower.

Shearin: We hear a lot about tenants shifting here and there to different property types. You see tenants leaving the malls to go into lifestyle centers, and tenants like Dollar Tree stores locating into malls now. What's going on in your centers? Who are some of the new tenants you are seeing, and what attracts them to your properties?

McAuley: We are dealing with the same tenants we've always dealt with, probably a little more food coming into them than most. There's a Panda Express on every corner, there's Mama Fu's on every corner. There is more food, more service, and less pure retail.

Rufrano: In most retail markets there are two winners in most categories and maybe there is a third. You can go down each category, find the appropriate players and position your property. It's a very tenant oriented market situation. We're seeing a lot of food uses, everybody's looking at the last possible outparcel that can be created.

Caputo: Justice is a new concept rolling out.

Ifshin: It's younger, it's targeted at teens. It is a bridge for the kid who is desperate to not let her mother take her in Kohl's or Marshalls, but who can't afford Abercrombie. It's a bridge product, the same way they did Limited Too in the malls. For us, we have the most boring set of tenants in the world because they are all value guys. There's no question, Dollar Tree has figured out how to do a slightly more upscale market and we've done probably close to 10 deals with them in the last 18 months. It's clear that TJ Maxx in all its formats understands their customer as a whole. They went through a period of time when they were not on hold but they weren't as sure of themselves to press the accelerator with store openings. They're really pressing the accelerator now pretty hard and we are doing a number of deals with them. We're working on our second Marshalls within a year and they're clearly hitting on all cylinders with our customers. Their sales numbers are very good, and they are reinvesting in their concepts and in their stores very hard. Our spaces are admittedly more working class than most of the rest of yours.

Rufrano: Anna's Linens and Pei Wei are other relatively new retailers. We have grocers who we think are far better than the big, publicized grocers, so we're positioning the correct grocer at the right price point in the market.

Ifshin: Those private grocers have much more in depth levels and those families that have control will reinvest in gross margin. They don't have to answer to the street. Jim [Thompson], have you readjusted who you are doing business with? Are you trying to work more with Kroger, less with some of the other guys?

Thompson: We continue to like the traditional grocers that have market dominance and presence. Clearly there is a sector of specialty grocers that appeal to us as well — the Whole Foods, Fresh Markets, Trader Joes, and Earth Fares — the niche players that are more aggressively expanding today to service that higher demographic market. You've kind of got these upper end   players on one end of the spectrum with the discounters like Wal-Mart at the other end, and your typical normal grocers are trying to sort out what they are supposed to be in that hunt. Kroger has become very competitive and appears to have a solid strategy. The strong regional guys, like Publix and HEB, continue to do very well in their core markets.

Ifshin: Target is doing an amazing job facing unbelievable competition. We are working now on our second deal with them and they are amazingly wired in to what their customer is all about and they are coming to markets like ours willing to pay to work on assemblages, to get in the right place and they are really on their game.

Thompson: They go across the board to draw clientele, they get the low demographic, the high demographic. Everyone shops at Target.

Knoll: Quickly, what's the biggest challenge in the next 12 months for retail real estate?

Ifshin: Tenants ability to pay their rents in the rising cost environment.

McAuley: Discretionary income with energy prices.

Caputo: Finding investment opportunities that make sense.

Craine: Will rates go up, causing prices to decline.

Rufrano: Understanding balance sheet implications for retailers repositioning stores.

Fryer: Rising interest rates in tandem with high energy costs laying the foundation for stagflation.

Thompson: Retailers are up against increasingly higher rents, and I don't see sales growing at the rate that rent has grown in the past and there will become a point where you can't do it.


©2005 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.