Growth Mode

By Paul Rosta, Senior Editor

The retail real estate landscape has evolved greatly in only a few years. Reduced building footprints, the rapid growth of online sales and the disappearance of major national retailers present new challenges for owners and managers. But all in all, when it comes to factors that influence tenant recruitment, capital upgrades and other management tasks, the outlook for 2013 is primarily positive.

“I think that from an investment/development standpoint and from a tenant standpoint, more often than not, you’re probably in a good position to take advantage of the improving economy and the improving mood of retailers,” said Mark Hunter, Jones Lang LaSalle Inc.’s retail market lead for the Midwest.

A variety of indicators support Hunter’s statement. A survey of some 1,000 retail properties by the International Council of Shopping Centers and the National Council of Real Estate Investment Fiduciaries concluded that net operating income rose 3.6 percent nationwide in 2012. Meanwhile, gross income rose 2.3 percent, and owners and managers trimmed expenses 0.1 percent. And 55 million square feet of new retail product is scheduled to come online this year in 44 major markets, up from 32 million square feet in 2012, according to Marcus & Millichap Real Estate Investment Services Inc.’s annual retail outlook. (Which markets will have the least vacancy and the most new product in 2013? To find out, click on “Scare Space, Full Pipelines” on page 36.)

So far, at least, the recession appears to have had little long-term effect on owners’ preferences for in-house versus third-party property management. Outside service providers continue to thrive. For instance, John Sebring, director of property management for The Shopping Center Group, a diversified Atlanta-based retail consulting and advisory firm, reports that the company added about 1 million square feet to its portfolio of assets under management, and he expects a similar uptick this year.

On the other side of the coin, a sizeable group of investors argue persuasively in favor of self-managing retail properties. To begin with, “it’s one of the tougher types of properties to manage,” contended Steven Grimes, president & CEO of Retail Properties of America Inc., which handles a portfolio of 252 lifestyle centers, power centers and strip malls encompassing 34 million square feet in 35 states. He prefers to keep a tight leash on what he calls a three-legged stool: property management, asset management and leasing. All functions are overseen at the regional level, Grimes added.

While the retail sector of the economy may be slowly improving, its dynamics remain mixed. The National Retail Federation’s projected retail sales growth for 2013 declined to 3.4 percent from 4.2 percent last year, not counting restaurants, gas stations and automobiles. One corporate move on the radar this year is the proposed $1.2 billion merger of Office Depot and Office Max. At a minimum, the merger is likely to create at least some vacancies in the 2,600 locations operated by the retailers.

Developers Diversified Realty Corp., which owns 65 stores encompassing 1.6 million square feet occupied by Office Depot and Office Max, expresses confidence that it can find tenants for any spaces that become available after the merger’s closing, expected by the end of the year. If the deal unfolds as planned, it “will enable us to realize positive rental increases by backfilling the newly available space with a variety of today’s fastest-growing, high-credit-quality retailers,” predicted Developers Diversified Realty senior executive vice president Paul Freddo in late February.

Retailers are also mindful of the rapid rise of online shopping. During the third quarter of last year, Internet sales grew 17.3 percent compared to the previous year, far outpacing the 4.6 percent uptick registered by retail sales as a whole. But technology is also changing retail real estate management in other ways. Tools like smartphones and tablets give managers the freedom to spend less time behind their desks and more time talking shop with tenants.

As a result, property managers can take on a new role. “You’re really more of a small-business consultant,” said Sebring. He encourages on-site managers for The Shopping Center Group’s 10 million-square-foot retail portfolio to serve as an informal but consistent resource to tenants on cost-saving strategies, improving customer traffic and marketing fundamentals. 

One constituency that can benefit from property managers’ counsel includes smaller, less experienced retailers that were hit particularly hard by the recession. “You’d be surprised at how few small retailers really understand their business,” Sebring said. Getting to know a tenant and helping them improve their business not only helps that retailer’s bottom line, it can also give them a better shot at survival, thus decreasing turnover.

He cites as one example a butcher shop that had occupied about 3,500 square feet in an Atlanta neighborhood center for a decade. The butcher’s business was shaky after several years of recession, and its ability to stay in place was in doubt. But some brainstorming sessions with the property manager recharged the tenant’s batteries with some fresh marketing ideas that boosted foot traffic and kept the store open.

On another front, curtailed financing took a heavy toll on local mom-and-pop stores that lacked the brand identity or deep pockets to ride out the downturn. Rather than attempting to buck the odds and invent store ideas from scratch, a larger number of new entrepreneurs appear to be taking the more secure route of opening a franchise, reported Rob Nadler, president of Kimco Realty Corp.’s central U.S. region.

Recognizing this surge of interest, Kimco offers retailers and prospective tenants a new twist on its leasing strategy. “We’ve instituted a program where we pre-qualify spaces at our shopping centers,” Nadler said. Kimco invites popular franchisors to tour properties and identify spaces that meet their requirements. The initiative is a logical extension of an owner’s continuing assessment of its centers and search for the right tenant to fill the space, Nadler added.

Although owners and managers remain as vigilant about expenses as ever, the partial thawing of the capital markets combined with renewed consumer confidence adds up to a new mindset. “We’re not really the hero anymore for cutting. That’s already been done,”added Sebring.

Trimming common-area expenses by installing more efficient lighting fixtures and looking closely at certain maintenance expenses is standard practice. Challenging property tax assessments continues to reward both owners and tenants, reducing overhead and pass-throughs. As prospects for retail brighten, owners are also more confident about putting money into the property. A priority is warding off bigger maintenance-related problems. “Our job is to put out small fires. We don’t like big fires,” quipped Robert Leahy, senior vice president of property management for Inland American Management L.L.C.

The Art of Investment
In a transitional economy, however, projecting return on capital investment remains an art as well as a science. “Some ROIs are much easier to discern than others—either they’re accretive or dilutive,” noted Kirk Williams, managing director for Cypress Equities, the development and management affiliate of SRS Real Estate Partners. “Other ROIs, you’re not going to know right off the bat. They’re more subjective in their analysis.” As Williams observed, intangibles can influence consumers’ shopping decisions as much as economic indicators. In that vein, experience and intuition, no less than number-crunching, must guide decisions by owners and managers.
The impact of another Great Recession legacy, empty big boxes, continues to ease as a steady stream of retailers lease vacant space. Grimes reported that anchor occupancy at Retail Properties of America’s 252 retail properties has hit 96 percent. Backfilling big-box vacancies sometimes requires alternative solutions; a recent favorite is subdividing old anchor stores and leasing them at higher prices than they would command if a single tenant occupied them.

As the retail sector improves, real estate managers are also taking a fresh look at strategies that make their properties competitive. For many executives, the recession underscored the long-term value of creating the right lineup for a center. The principle, as Grimes sums it up: “Let’s make sure you have the right tenants so you can mitigate the impact of any future recession.” At many Retail Properties of America assets, that means courting solid national brands with a reputation for value and broad-based appeal, among them TJ Maxx, Target, Kohl’s and Bed, Bath & Beyond.

Taken as a whole, retail real estate continues to present managers with rapid, often unpredictable change. Consumer preferences, the capital markets, technology and other issues will reward owners and managers able to read the market and adapt quickly. For all the innovation ahead, however, some facts of retail real estate will remain.

“We just have to understand the shopping center model and the effect it’s going to have on shopping patterns,” said Grimes. “We are the landlord; we are responsible for bringing the consumer to our retailer’s front door.”