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.
Forever 21 is slated to open in six quality General Growth Properties (GGP) regional malls in 2010. The collective size of these units totals nearly 600,000 square feet, thus averaging almost 100,000 sq. ft. per unit for Forever 21. This comes on the heels of Forever 21 taking over leases on Mervyn’s stores in California earlier this year. This typical Mervyn’s box is in the range of 80,000-90,000 sq. ft. Forever 21 has also announced numerous new 30,000-40,000 sq. ft. units at various high quality regional malls across the country, including malls owned by Simon Property Group. This is a dramatic shift upwards for Forever 21 in terms of the size of their stores. (These units are going to increase the total mall space devoted to this juniors segment by as much at 50% in some properties.) Previously, Forever 21 was principally found operating as an in-line tenant in regional malls with units sized in the 7,000-10,000 sq. ft. range. It is also a testament to mall landlord’s willingness to put Forever 21 in very high quality regional malls, in an environment where there are few other opportunities for new retail formats of this size. I would consider a good portion of the malls where these new stores have been announced to be A class properties ($400-$600 PSF+). The same cannot be said for all of the Mervyn’s units which include both B and C class properties.
The aspirations of Forever 21 begs the question, is there a need for ~100,000 sq. ft. of juniors apparel and accessories under one roof in anchor-like positions in regional malls? And secondly, what will be the impact on mall landlords with the introduction of this new format?
My first inclination is to consider previous attempts by Limited Stores/Limited Brands as well as Gap, Inc. to “upsize” their mall offerings to create a department store-like box, marrying their various store concepts under one roof. These operators also went through a period of simply “upsizing” individual store nameplates to a larger format. This was popular particularly in the late 1980s and the early to mid 1990s. Unfortunately, this did not work well for these particular operators. In fact, a few years later they reversed course and proceeded to work on downsizing many store units from Limited to Express to Old Navy as well as others. In short they, found the sales productivity did not justify the store size and costs associated with running the format, including occupancy costs. Occupancy costs typically average 15%-16% of store sales, although the range of occupancy costs can be quite large from the high single digits to over 20% at times. In the case of Limited divisions and Gap divisions, these companies have a long history of being able to negotiate below market rents with mall operators. It would not be uncommon for Gap or Limited divisions to negotiate up to a 50% discount on the market rental rate at a particular regional mall. That said, the larger juniors store format for these companies still could not justify the costs of running it. Overall these larger stores fared unfavorably relative to smaller units, and did not stand the test of time. They never reached the 80,000-100,000 sq. ft. that Forever 21 is envisioning for these new units. The Limited and Gap experience topped out at 40,000-50,000 sq. ft. and those were pretty rare.
Last month I visited the new Forever 21 (Forever XXI) store at Polaris Fashion Place, the newest regional mall in Columbus, Ohio. The store contains the typical trendy merchandise in the so-called “cheap fashions” segment also occupied by competitors Charlotte Russe and H&M. The store occupies roughly 40,000-50,000 sq. ft. on two levels and is an example of Forever 21’s march to larger store formats. It is part of the “lifestyle wing” at Polaris, essentially an outdoor court of shops and restaurants attached to the mall. My first observation was the store was merchandised at a lower level on a sq. ft. basis than the typical in-line mall format. Also when compared to traditional department store operators, such as Macy’s, the store is again merchandised to a lower level on a goods per foot basis. The store also contained a small young mens presentation, occupying a few thousand sq. ft. I have to believe that less merchandise per foot equals lower productivity. And a larger store format always equals lower productivity.
From the mall landlord perspective, this is an idea whose time has come. There are few if any retailers willing to take 30,000-100,000 sq. ft. positions in regional malls these days. While these store are being subsidized at healthy levels with allowances for store build-out provided by the landlord, the rents are by no means dramatically below market. In fact other small formats in juniors apparel are paying less for smaller store units at the same properties. At best the rents are 1/3 off market — and the market would be for a store size in the 7,000-10,000 sq. ft. range. This will likely be a boon to mall landlords in the short run. However, paying fairly high rents for an untested concept that dramatically increases the juniors merchandise, even at quality regional malls is not without risk. In fact, the sales productivity these units can generate will be the key determinant of success for both Forever 21 and the landlord. Given the rent structure, these units will have to be highly productive (~300 $PSF) when compared to other mall anchors and junior anchors. Intuition, observation and past experience suggest this is a low probability outcome. I can’t help but think of Steve & Barry’s which a few years ago was also thought of as an idea whose time had come.
Most department stores are struggling to find a message and an offering that resonates with shoppers. Most department stores are also paying little or no rent in regional mall anchor positions. Will Forever 21 be the answer? Or does Forever 21’s larger format represent an answer to a question that no one is asking?
My analysis strongly suggests the rent structure is out of line with the potential sales productivity to the point where there will be little if any margin for error with this concept. It is also likely to put significant pressure on other juniors stores in regional malls through market share capture by Forever 21 simply due to the critical mass of these larger units (negatively impacting landlords in other areas). And as noted previously, past experience does not favor this transition from in-line mall retailer to junior department store. The future 100,000 sq. ft. units are being rolled out aggressively with no proof of concept, let alone any testing for viability. And then, there is the economy and poor retailing climate. All in all, history, analysis and sentiment do not favor these aspirations.
