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Industry Confronts Economic Fallout

Retailers and developers seek to sharpen operations and strategies during slowdown.

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WWD ICSC Preview issue 05/05/2008

Retailers and developers seek to sharpen operations and strategies during slowdown.

This story first appeared in the May 5, 2008 issue of WWD.  Subscribe Today.

As economic turbulence shakes the industry, retailers and developers at the International Council of Shopping Centers convention in Las Vegas this month will confront immediate challenges with long-term repercussions.

Against that backdrop, whether convention goers will get in the mood to party amid the glitz of Sin City is another matter.

The event, from May 18 to 21, had been called the ICSC Spring Convention and has been rechristened RECon, signifying reconnaissance or information gathering. It’s also short for real estate conference. A subheading, The Global Retail Real Estate Convention, is indicative of the growing international nature of the gathering.

The goal of the name switch is to reflect the dynamics of the convention, particularly the leasing activity and the abundance of new projects that get unveiled to prospective tenants, said Michael Kercheval, president of the ICSC.

“We found the old name didn’t mean anything to those who lived south of the equator,” said Kercheval. “We hired a branding firm, which pointed out that for people in Brazil, this is not their spring. It’s fall.”

Previous conventions drew relatively few people from outside North America, but this year the ICSC expects a major presence from Asia, Latin America, the Middle East and Eastern Europe.

Registration for the conference surpassed 50,000 in the final week of April, and was tracking 10 percent higher than last year. About 5,000 registrants were from outside North America, about double the count of just a few years ago. It’s a sign that retailers, developers, brokers, consultants, architects and marketers are coming together to discuss problems and solutions in a troubling time.

Along with the economy, top priorities will include: globalization, tax rebates, sustainability, the continued evolution of the lifestyle center, new entertainment and interactive formats to replace tired mall tenants and emerging markets.

Amid all the difficult issues, industry leaders see positives.

“Typically during a slowdown, everybody does things better,” said Mary Lou Fiala, president and chief operating officer of Regency Centers, who will be installed as chairman of the ICSC during RECon, succeeding Renee Tremblay of Ivanhoe Cambridge.

Although retailers may sell less merchandise and slow the rate of store openings, they learn to sharpen their operations as a matter of necessity. “Retailers are more selective with their new stores and developers do less green fill, and more in fill or redevelopment,” Fiala said.

She has two primary agendas. The first is to educate “the younger folks in our organization to think a little bit differently and operate differently,” Fiala said. “The fact is everybody needs to hunker down and become a little more frugal in terms of expenses.”

The second is sustainability. At Regency, which operates grocery-anchored neighborhood and service-oriented centers averaging 160,000 to 400,000 square feet, Fiala said there is a 20-year plan in the works to have as many properties LEED certified as possible. Initiatives range from replacing roofs and lighting to becoming more energy efficient, along with landscaping that doesn’t drain the environment, but beautifies it, and how to handle waste management to limit pollution.

Fiala said during this economic downturn the industry is perceived as monolithic. “Everybody lumps all retail together,” she said. “But you have to look at neighborhood centers, groceries and service retailers, dry cleaners, nail and hair salons, drugstores and even businesses like ice cream and coffee. People will still treat themselves, but they won’t spend as much money. They’ll go for a movie or an ice cream, but maybe not a big vacation.

“The businesses that are hurting and really overshadowing the rest of the industry are department stores,” she said. “Any home business is difficult, as is the majority of soft goods. The teen business is still very strong. For that customer, the mall is their entertainment.”

She added that grocery, drugstores and discount department stores are currently among the strongest retailers and, in the future, “experience or interactive retail is going to be even bigger and better” with brands like Build-A-Bear, where she’s a board member, or Blue Tulip, a stationery/gift store, where products and gifts can be personalized with signatures and messages.

She also cited IPic, a new concept that offers multiple entertainment options under one roof, including screening rooms, bowling, a bar and a restaurant. IPic has a strategy to roll out these “dining and entertainment centers” to large and midsize metropolitan markets and their suburbs.

The first IPic opened at the Bayshore Town Center in the Milwaukee suburb of Glendale, Wis., last December. IPics are also slated for Texas, Illinois, Ohio, California and Florida through 2010, according to IPic Entertainment, the parent company.

“People want to go places where they feel they are part of it, where there is some interactivity, where there is personalization,” Fiala said.

Another concept she’s bullish on: Stir Crazy, an Asian restaurant with a dozen locations and a plan to go national. Dinners can be customized with vegetables and sauces of a diner’s choice at the market bar, and it’s possible to eat completely vegetarian, she noted.

Despite the weak U.S. economy, rents charged to retail tenants continue to be fairly strong, Fiala said. “We know that will temper. We are not going to get the rent growth. Mall rents are more difficult than those in neighborhood centers.”

At Regency, a company with more than 450 centers representing almost 60 million square feet, Fiala said leases have rolled over with rate increases in excess of 10 percent for the past six years. However, Regency has provided Wall Street with guidance of 7 to 9 percent for this year.

Among the biggest trends in development is a “blending of formats,” Fiala observed, citing St. Johns Town Center, a 1.5 million-square-foot hybrid center in Jacksonville, Fla., built by Simon Property Group, the largest U.S. developer of shopping centers. The open-air retail project includes a 608,000-square-foot retail village as well as a 450,000-square-foot power retail center and a town center with a Main Street design and a community center.

However, people still seek the convenience of the single-purpose shopping center, Fiala noted. “I still think people want to get in and get out of the grocery store” because of time pressures. “I do think there is still a need for neighborhood centers,” though some think the single-purpose center, particularly traditional malls, are a dying breed.

With future development, “If you are a developer with a strong balance sheet, there are a lot of opportunities,” she said. It boils down to buying land at the right price, assuming a reasonable amount of debt on the project, and then being able to sell at a reasonable profit margin. Developers can still do well, though profit margins may not be quite so high.

At Regency, “We don’t do any developments without anchors already signed,” Fiala said. “We are 70 to 80 percent committed before we actually start.

“The challenge is leasing that last 10 percent of your development,” she continued. “It’s just going to take a bit longer. Typically, that last 10 percent is leased more to local retailers, who I believe will be hesitant to expand or relocate. They are tightening down.”

Developers are more apt to favor phase-in projects, for instance, putting in a grocery first, flanked by smaller retail stores, and a then second phase that could involve big boxes. The point is to be careful and methodical and not rush the leasing, and wait for the right tenant to sign up at the right rate.

Fiala sees potential growth in Mexico and South America, and in the U.S., in New Orleans, Alabama and Texas because of post-Hurricane Katrina redevelopment and the oil industry. The East Coast continues to be relatively strong, though areas of California, the Midwest and Florida are weak.

Around the world “there are three areas, in particular, where there is a real boom happening right now — India, Eastern Europe and the Middle East outside of Dubai,” added Kercheval. “Dubai is happening, but the boom is slowing. The easy win opportunities are outside of Dubai. The projects in Dubai being built now are incredibly high-quality and significantly high-cost. It’s harder to make a huge profit in Dubai than it was five years ago.

“Developers are looking for Abu Dhabi, Bahrain and the Kingdom of Saudi Arabia as markets where the demand is significantly in excess of the current supply and the cost of building is less than the Emirate of Dubai,” he said. “India is just an enormous growth area driven by demand due to a virtual absence of supply.”

There are “a couple dozen terrific shopping centers that have sprung up, including In Orbit in Mumbai, which is about four years old and marked by ‘first world’ design, merchandise and management,” Kercheval said. While there are bureaucratic challenges in India, “the demand is so great, the villages and cities are encouraging redevelopment with modern retail often in the form of enclosed malls, and the government has been generally supportive. It sees it as a generator of jobs, tax revenues and raising the standard of living.”

Eastern Europe, Kercheval said, is “kind of a cross between the Middle East and India,” with Russia and Ukraine experiencing significant development of modern shopping centers and attracting retailers from Western Europe, such as Mango and Hennes & Mauritz.

“These retailers see this as a growth opportunity, whereas in Western Europe, the population is flat or declining, and it’s very, very hard to build anything,” Kercheval said. “Controls and restraints are very difficult. Eastern Europe is more convenient than India or the Middle East, and more of a natural next step for a European or a global developer.”

“For the first time in a number of years you will have U.S.-based companies looking [overseas] with a high degree of intensity,” he said. ” In the past, most would say, ‘I don’t need to go to Brazil or the Middle East because there is plenty of opportunity to grow in the U.S.’ With the slowdown, they’re now saying, ‘Let me take a look at what’s happening elsewhere'” and consider partners to diversify geographically.

He cited Taubman Asia, Ivanhoe Cambridge, Cadillac Fairview, General Growth, Westfield, Simon Properties and Developers Diversified, among others, as either heavily invested overseas, or moving in that direction.

“Outside the United States, the leverage is still difficult, but the consumer demand has not shown signs of slowing down,” Kercheval said.

“These developers often serve two masters,” he added. “It takes a long time to develop a project. You need a long-term prospective. You need to be thinking five or 10 years out.

“The second master is the capital markets, which don’t reward you for your long-term visions,” Kercheval continued. “They are very keen on what’s happening quarter to quarter.” However, “Companies showing they have diversified geographically are beginning to be recognized and rewarded in valuations.”

As far the business climate, he said, “Retailers scream doom and gloom, but it isn’t as bad as you would think. Retailers are fundamentally in pretty good shape. They’ve done a good job in supply chain management and how they positioned their portfolios. They are fairly well positioned to endure slowdowns.”

Kercheval believes some retailers publicly talk the economy down, but privately the attitude is different. “They’re saying ‘Lets get a jump on the competition. I want to be the one opening stores because it takes a long [time] to gear up again for expansion’ when the economy turns.

“I am also a big believer in the idea of self-fulfilling prophecies,” he said. “If you continue to talk it down, you will bring it down.”

Asked about the mood of consumers, Kercheval observed, “You have this housing bubble that makes the consumers think their house is worth less than a year ago, even though intellectually they know it’s worth significantly more than what they paid for it. Then you hear about unemployment, which makes you nervous about losing your job, so you cut back further on the spending.

“Then you have three presidential candidates, with two of the three bashing the current administration and constantly telling consumers that it’s bad out there,” he continued. “So you further pull back and as you pull back, you stop spending and when that happens, retailers start laying people off and that trickles down to the manufacturers.”

Kercheval said developers are generally well positioned with cash flows that shouldn’t deteriorate much in the current economy. “Their operations are so good. They can really manage this.”

However, he is concerned that any company that relies heavily on development as its primary business is finding the capital markets situation difficult, with borrowing harder.

“Clearly, it’s not as easy to lease up new projects,” Kercheval said. “Retailers have been less willing to make commitments out in the future. They are saying, ‘Let’s see where things are 12 months from now before I commit to a project that is opening 24 months from now.'” Banks then charge more for financing projects because of the reduced pre-leasing and greater caution.

On the brighter side, ICSC has leased 8 percent more space for the convention’s leasing mall in Las Vegas. “That doesn’t tell me the leasing demand and activity has fallen off,” he said, although retailers are narrowing the time frame for committing to projects.

Kercheval believes retailers should bear in mind that developers are more carefully constructing lifestyle centers, citing a project by The MGHerring Group south of Dallas that brought in parking consultants to determine the proper parking angles and the width of spaces. “That sort of conscientiousness is now being deployed.” Before, “They would put park benches in front of a grocery store and say, ‘Voilà, it’s a lifestyle center.'”

While the lifestyle format may not generate as much buzz as it did five years ago, after some failed projects, several new ones with different approaches will be announced at ICSC. “Developers are learning from their mistakes,” Kercheval said.

“The majority of centers being envisioned and developed in the U.S. would more closely resemble lifestyle centers than anything else,” he said. “I do not know of a single traditional mall…being developed or planned in the U.S. Almost without exception, most of them have more than one use. Developers have been rethinking how families live and operate, and what can serve as magnets for their shopping centers.”

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