By  on April 16, 2007

Six of the savviest retail real estate developers in the country shared their thoughts on how they create room in the industry for their companies to grow. They include some of the largest mall and shopping center owners, as well as small and highly

profitable niche developers. What may be most surprising is not their take on development or profitability — but how their opinions diverge.

What is your single biggest opportunity for growth?

John Bucksbaum: Redevelopment activity. Bringing in alternative uses is the greatest opportunity for us. Urban and inner-city opportunities are also huge. Going into tough environments that have been neglected for many years by retailers and recognizing the purchasing power that is there is a real area of growth as we look ahead.

Arthur Coppola: For our company it's significantly enhancing, expanding and densifying our super regional centers. We're dealing with proven commodities and proven markets, not markets where we're relying on external growth. So you already have huge pent-up demand and there's an opportunity to bring in the highly productive tenants and replace some of the lesser productive ones.

Daniel Hurwitz: The most profitable area of growth is clearly in the development business, where we are manufacturing product at margins that are at historic levels. As a result we have increased our development pipeline substantially to maximize the benefit of the current value creation that's available in the marketplace.

Jimmy Ratner: We have a new development program that is the largest in our history. We think there's significant opportunity on a national basis in selected markets, where there is a significantly underserved population. We are also expanding a number of our major centers to take advantage of centers that are already very profitable.

Richard Sokolov: The single avenue where we're going to grow the most is improving our properties so when leases come up for renewal we can re-lease our properties for higher rents than we're getting today. That's not very exciting but that's the core of our business — re-leasing our space at rent spreads between 17 to 25 percent over expiring rents. Our second biggest opportunity in the portfolio is to grow our existing property market share by redeveloping the properties.Donald Wood: Our number-one prospect comes from properties that are already strong where we have the ability to remerchandise and re-tenant. The most important avenue for growth for us is growing demand for quality retail locations from retailers.

How much are you investing in your portfolio going forward?

Bucksbaum: Over the next five years, billions will be invested.

Coppola: On average for the next five years we'll spend $500 million a year on our portfolio and that will include new ground-up centers, expanding our existing powerhouse centers and smaller remerchandising and lifestyle expansions.

Hurwitz: We have $4 billion in development currently in the pipeline.

Sokolov: Over the next four years we have $1.3 billion earmarked for redevelopment projects in our mall portfolio. We'll invest $500 million in new development over the same period.

Wood:
We will invest $75 [million] to $100 million a year to work on redevelopments. But if we find a $200 million to $300 million acquisition that we like, that's also a possibility.

How focused are you on alternative revenue streams?

Bucksbaum: On the sponsorship side of things, we're working with partners to do more in our malls. Generating revenue outside of our lease line is becoming more important. Our specialty leasing programs, whether the carts or kiosks, also play an important role. In the past, there was so much activity you could be one dimensional in your

approach to growth, but today there's no one area that you can rely on exclusively.

Hurwitz: Our new business development group focuses exclusively on nontraditional revenue at the asset level. When we started the department in 2000 we did $600,000 in revenue. This year it will be $22 million. That covers everything from carts, kiosks, sponsorship deals, cell towers, anything that's nontraditional. Our new business development department continues to have double-digit growth in an annualized basis.

Sokolov: We're very focused on growing the marketing and sponsorship revenue in our business and are optimistic that that will be an increasing source of revenue for us. We're now in the process of installing in 50 of our properties the "on-spot network," which is basically a collection of digital screens that are available to advertisers and marketers in our properties. The gift card program is now in excess of $515 million and we're looking forward to continuing to grow that program both with individual purchases of gift cards and the more corporate purchasers.Wood: We're doing some sponsorship and signage deals at some of our premium properties. We certainly look at exploiting the heavily trafficked, best locations that we own.

What is your single biggest challenge to growth?

Bucksbaum: One of them is the ability to put together the necessary space to accommodate the retailers' expansion plans. It's a good problem from the owner's perspective that we're running at historically high occupancy rates but what that causes is difficulty in accumulating the kind of space that retailers are looking for.

Coppola: We've built up traffic in the markets where we've got these great centers. So when we expand, community activist groups step in. We have to get the local communities to buy into the idea that there is a bigger opportunity there to make the projects more viable and successful for them.

Ratner: People are skeptical of the benefits of development. It's the developer's responsibility and job to convince communities that the development that they're talking about is important to the market. I think it's going to remain as difficult going forward as it is now. Then again, the market is more open to unique and unusual site plans. You have very different attitude and intuition about anchor tenants and that has opened our thinking a great deal on how to develop these centers, what retailers we include, how we use them as anchors.

Sokolov: It's really just working through all of the benchmarks that have to be met to make all of our existing properties as good as they can be, from attracting the right tenants to the existing properties to going through the approval processes with the relevant people.

What are the biggest macroeconomic pressures on your growth?

Bucksbaum: Employment is number one. Are people working? If they have a paycheck, we will continue to see retail sales activity. Fuel costs, consumer confidence, those are all important but they also all play into employment. Consumer confidence generally affects more large-ticket items, like buying second homes or a car, not buying a skirt and going to the movies and a dinner out. And interest rates. Debt is an important component of our financial structure.Coppola: The biggest impact from a macro viewpoint in our business is money. The biggest cost for us on any project is our interest rates. Say debt comprises 60 to 70 percent of a project. If interest rates go up like they have — LIBOR [London Interbank Offered Rate] went up some 300 basis points last year — that has a huge impact on bottom line and pro forma even more so than the costs of steel or labor or lumber or drywall. We're capital-driven companies and that is the macro issue that we deal with. So we consistently try to reduce our debt levels in our companies.

Wood: Clearly higher construction costs and higher interest rates affect our earnings. But in terms of those costs, in the better locations we have the ability to share some of that rising cost with our tenants. We very much look at our relationship with retailers as a partnership and our job is absolutely to provide them with the best location and the best physical plan that they can do their business in. So our tenants are happy to pay as long as their sales are there.

Is the difficult land entitlement process inhibiting your growth?

Coppola: No. Historically Macerich was always a company that would buy a center from somebody else and then put a lot of money into it, so cities would embrace that because we weren't asking them to do anything but allow them to make their center more beautiful for the community — we're not asking them to build new roads, schools, infrastructure for us.

Hurwitz: The biggest challenge we face is the overall complexity that comes for the entitlement process for a typical shopping center today. The demand for space by tenants looking for growth outstrips our ability to deliver the product because of the complexity and time that's involved in getting a typical project entitled, and that has created some limitations on how much product we can deliver in any given year. On a risk-adjusted basis, the returns are lower than they would just appear on paper because we are taking more risk and in many cases we're having to close on unentitled land.Ratner: I think the biggest challenge everywhere in the country is entitlement. Entitlement has always been difficult. It has now become extremely difficult to do. It doesn't affect the bottom line as much as it elongates the time schedule because you face a whole host of issues, many of which end up in contested legal battles. But of course time has an impact on the bottom line itself.

How do rising construction costs, including land prices and labor, effect your growth?

Bucksbaum: Obviously a big spike occurred in the last year or so in the price of most construction materials. That certainly has an effect on our overall returns but it has not stopped us from proceeding ahead. It does make projects more difficult. We've had to adjust some expectations.

Coppola: There's a number of challenges, including rising construction costs. But you can deal with that. Rising construction costs generally end up modifying mildly your final return but they don't make a project a go or no-go. I think there will be softening in those construction cost increases.

Hurwitz: Construction costs have an impact on project level returns but the biggest impact and the biggest pricing pressure that we have on margin are land costs. Land costs have accelerated beyond construction costs and that's put pressure on margins. We are banking land on a more consistent basis than we have in the past because landowners are not giving you the time necessary to secure all your approvals. The risk to our projects today is not leasing, it's entitlements.

Ratner: Land costs have gone up, and more importantly, our entitlement costs have gone up. We all have to contend with those costs as land is a diminishing resource in America. One of the benefits of creating the public/private partnerships on developments is that we mitigate those land costs in a number of major markets.

Sokolov: Happily, with a redevelopment project you already own the land and you have infrastructure. Clearly there are still the incremental costs to obtain appropriate approvals and construction costs clearly have been going up, particularly in Florida in the wake of hurricanes. It's of relevant consideration, but we aren't seeing any slowdown in redevelopment or development because of it. If anything, our redevelopment program is growing because of the Mills portfolio.Wood: Land costs don't affect our growth very much because we don't rely on acquisitions and we don't do ground-up development in large measure. Instead, we redevelop property where our land cost is embedded in Seventies dollars. Therefore when we redevelop those sites we're at an advantage. The only acquisitions we'll do are in locations where we have significant redevelopment opportunities.

Will merger and acquisition activity continue at the same pace?

Coppola: The huge rush of "going private" transactions is clearly going to continue. It's the natural evolution of the industry. In the early 1900s, there were 250 companies making automotives. Today we have 275 public real estate companies, and we probably don't need that many. It really shows a maturation in the industry. From an investor viewpoint it's very comforting because it shows there are multiple exit strategies for an investor's capital and there's a number of different ways for an investor to get liquidity. There's already been a huge consolidation in the mall industry, and there could be more.

Hurwitz: The open-air shopping center business is still somewhat fragmented, with multiple public companies trading within the same sector. I think there still is a significant opportunity for continued consolidation within the open-air shopping center sector, assuming the capital markets maintain their desire for that asset class.

Ratner: The M&A activity is real and is pushed by lots of factors in the market. My hunch is it will go forward. We look at acquisition opportunities and have acquired a number of individual properties but have not done an entity transaction. We're constantly looking at them and if the right opportunity presents itself we'll certainly do it.

Sokolov: It's really impossible to predict in our sector. The activity really comes in clumps, and there's no way to predict when the next wave of activity is going to be triggered.

Wood: Public companies have to grow to survive, and if you don't have growth internally with redevelopment, you have to buy to grow, you just don't have any other choices. There's an enormous amount of capital that's out there for acquisitions. Capital has been and should continue to be pretty available, so you'll continue to see consolidation at the pace that you have seen it.Is the retail market saturated, or is there room for growth?

Bucksbaum: I always worry about being overstored. There are a lot of retail sites that could be demolished. Generally speaking right now we're in good equilibrium and that's due in large part to very few new malls being built in recent years. Retailers have shown great discipline in their expansion approach. I've been more concerned with developers and the access to money. Money is readily available and when money is so available it can create overbuilding problems.

Coppola: The number of traditional retail centers in the U.S. has dropped, but most of those that have gone away have actually been redeveloped into great mixed-use type facilities. The recycling of real estate is not really unique to malls.

Hurwitz: I don't think we're overbuilt at all. I do think we're underdemolished. Right now demand for space is clearly outstripping the ability to deliver that space, which is a positive for the market. That being said, I think we all need to constructively look at our portfolios and acknowledge which assets have outlived their useful life as a retail asset and might be better with an alternate use. As an industry that's part of our job — retailers have to consistently reinvent themselves to grow and thrive and owners of retail properties need to do the same thing.

Ratner: You can't make a blanket statement applying to the whole country. What's more and more true is that the U.S. is very different in very different places. Certainly there are places where it's wildly overstored and some places that are significantly understored.

Sokolov: I wish I could tell you, but I think it is a market by market analysis. And it's very hard to say what point equals saturation. While it may be that on a casual basis you can say there's a lot of retail space, the sales growth would indicate that there's still demand. There are clearly going to be properties that can be put to different and better uses. In some of those instances rather than doing those transformations ourselves we've sold properties to others and have them do the redevelopment because it was not an efficient use of human resources or capital. In the next 12 months we'll have several of those projects that we can announce.Wood: I think when you look macro, it's absolutely true that the market is saturated. But there's nothing macro about real estate. There are areas of any big city that are underretailed, and then there are areas in the more tertiary locations where there is less demand than supply, and that's a very definition of saturation.

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