There is a report out on Bloomberg that FDIC bank regulators are in the process of issuing guidelines on commercial real estate loan workouts for banks. Is this the moment we’ve all been waiting for? Probably so, and I am looking for 2010 to be the year of commercial real estate REO as there was a lot of talk about REO in 2009 but it never really materialized, save some of the single and multi-family residential.
Bridgewater Falls in suburban Cincinnati, Ohio may be a shade of things to come. Bridgewater Falls is a 600,000 sq. ft. “power town” originally developed by the now defunct Premier Properties. The center is basically a hybrid, something of a cross between a traditional power center and a lifestyle center. Believe it or not, this center had an $80 million dollar loan on it and entered foreclosure in early 2009. The lender, Wachovia, sold the property to itself for $33 million, or a whopping 59 percent less than the original loan, after no higher bids emerged at an auction back in March of 2009.
Just last week this center traded hands again. The buyer, a distress/opportunity fund operated by Phillips Edison, paid $43 million for the center in an all cash transaction. My sources tell me the cap rate was in the range of 10%-11%, thereby raising the bar for these types of transactions. The tenants are basically a who’s who of retail survivors that you want in a power center project – JC Penney, Target, Dick’s, TJ Maxx, Best Buy, Bed Bath & Beyond and PetSmart. This type of project could have easily traded in the 8%-9% range just a few short years ago. Clearly this sets a new lower level of value for power/big box centers. This segment is where notable distress exists in retail real estate given the rampant overbuilding throughout this decade (almost 50% of new space constructed was in power center/big box retail), and the fallout from the bankruptcies of Circuit City, Linen’s N Things. I look for many more of these opportunities to become available and I strongly feel 10% is the new cap rate floor in these types of transactions. REO buyers take heed.
Here’s a tale of excitement and shoppers flocking to get the goods and services they want amidst this retailing climate plagued by gloom and doom.
Providence Town Center is a “power town” shopping center that recently opened in Collegeville, PA – a Philadelphia suburb. The project is intended to be a hybrid power center/lifestyle center. A 132,000 sq. ft. Wegman’s opened on Sunday to a throng of shoppers, including 1,500 who lined up at the door at 7AM. (Wegman’s is a good story in and of itself. They are quite well known in the mid-Atlantic for high quality stores and a loyal customer following.) The twist is this particular Wegman’s includes The Pub, a full-service restaurant located inside the store’s Market Café.
The enthusiasm and excitement of the shoppers is a bright spot and a testament to delivering what the people want and where they want it.
Providence Town Center also includes Best Buy, LA Fitness, Dick’s Sporting Goods, DSW Shoes, Ulta Cosmetics, Five Below, Staples, PetsMart, Michaels’, Raymour & Flanigan, PNC Bank, PF Chang’s, Eastern Mountain Sport (EMS), and Olive Garden. This is one of the larger retail projects to open this year (about 500,000 sq. ft.). Private developer Brandolini Companies also envisions a lifestyle center as part of the project in the future, adding another 200,000 sq. ft. or so. As one might expect, this component has been delayed for the time being. I have seen many hybrid centers around the country but few with full-line grocery stores. Power center developers, take note.
The reality is that we do have too much space for the given market conditions. Too much or too little space is relative to the demand for this space.
The demand for retail space is highly correlated to population/population growth and income levels. In this decade the industry built retail space that took the per capita shopping center square footage from 21 in 2000 to 23.5 today. This is a compound annual growth rate of 1.3%. Given that, the population was growing at about 1% per year in the U.S. and income/wealth was also growing, this seems appropriate on the surface. However, in the current economy, incomes and wealth are down substantially and we have lost most of the jobs created in this decade. We are now over-stored and retail stores are closing and many shopping centers are in distress as a result. The supply of space now far exceeds demand. Roughly half of the space that was built in this decade was off-mall, big box. We are seeing the direct fallout from this trend with the bankruptcies of Circuit City and Linens ‘N Things and store closings by other box retailers.
Virtually no enclosed malls were built in this decade. Enclosed malls are facing another challenge and that is the slow grinding obsolescence of the department store format–which is largely responsible for decline of some regional malls and the related emergence of the so-called lifestyle center (essentially an open-air mall without department stores). Good quality A & B malls are holding their own in the current environment and will continue to do so. However, poorer quality malls are being impacted across several fronts: by quality malls they compete with, as well as all other formats from off-mall boxes, to lifestyle centers to internet retail. This trend will continue and many C & D malls are going to slowly die as a result of this trend. Retail contraction is underway and it is largely the result of decreased demand. Overactive lending did not help and created some poorly underwritten shopping centers that should not have been built. Regardless, supply now far exceeds demand and this is going to take several years to work itself out.
Most of us are very familiar with the trials and tribulations of the big three U.S. automakers: Chrysler, Ford and GM. The downsizing of the dealer networks of the big three has serious implications for commercial real estate in the coming years. The National Auto Dealers Association (NADA) is projecting a whopping 3,500 car dealerships will close over the next 4-5 years. This will have a negative impact on commercial real estate by flooding the market with a very large number of challenging sites to deal with for owners, brokers and developers. The NADA is projecting only 25% of these dealerships have the potential for car-related reuse. This means roughly 2,600 do not have a car reuse and will fall into the commercial real estate market. At roughly 10 acres per dealership, this means some 26,000 acres across the country will become “available” for redevelopment.
The anatomy of a car dealership is such that these sites are challenging to redevelop:
They are often highly competitive with retail and shopping center sites in the area since dealerships are typically located in high traffic, high visibility retail corridors, down the road from the mall or power center.
Car dealership sites are disjointed with multiple buildings across the entire acreage.
They often have environmental issues.
Existing zoning does not lend itself to redevelopment without changes.
A shuttered dealership suggests a blighted area that does not “show well”.
These and other challenges suggest a long road to redevelopment and recovery. Prices for commercial acreage have already come down substantially in the last two years and adding another 26,000 acres to the supply is only going to depress prices even further. This is especially true for retail sites since car dealerships will prove to be a suitable alternative for some users such as a discount store, home improvement center or warehouse club.
Woodbury Lakes in Woodbury, Minnestota (a suburb of Minneapolis-St. Paul) is headed for foreclosure and possibly a Sheriff’s sale after the owner defaulted on a $65 million first mortgage. The open-air center was originally developed by Opus Northwest and opened in 2005 at the height of the lifestyle center boom. This same site was long thought of as a potential location for the next regional mall in the Twin Cities but never could gain sufficient traction from department stores given the low sales potential. This did not prevent an eager developer from plunging in with an uninspiring design and layout. Unfortunately, many developers with limited experience in shopping center development, as well as lifestyle development, have created projects that lack the necessary appeal with shoppers to make these center’s sustainable over the long haul. Adding insult to injury, Woodbury does not have a single restaurant — and it opened in 2005! Restaurants are a key anchor component of any lifestyle center that create evening traffic flow and appeal to higher income shopper groups. Woodbury Lakes is reportedly 75% occupied and thus was never able to gain enough tenants at high enough rents to service the debt. Given the prevalence of uninspiring lifestyle centers across the country including those in extreme northern climates such as Minneapolis-St. Paul, there is more distress to come in the lifestyle arena.
