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U.S. Shopping Center Development, Redevelopment Quietly Ramp Up

As Retailers Battle for Prime Locations, Developers Are Starting to See More Construction Capital for Shopping Center Repositionings As Well As Ground-Up Projects
May 29, 2014
Edward Coury of Starwood Retail Partners and other panelists at RECon 2014 agreed that investors willing to do the hard work of redeveloping a challenged center can generate solid returns.
Edward Coury of Starwood Retail Partners and other panelists at RECon 2014 agreed that investors willing to do the hard work of redeveloping a challenged center can generate solid returns.
One of the main takeaways from last week's ICSC RECon conference for Matt Winn, global retail COO in Atlanta for Cushman & Wakefield, is that retail developers are back in business in the U.S and around the world.

"For the first time in a few years, large scale mixed-use projects seem to be getting traction," according to Winn. "In the U.S., there is no doubt that they are more confined to the smile markets of the East and West Coast as well as the Sun Belt. But they are definitely there."

U.S. shopping center completions increased for the first time since 2007 last year, with nearly 400 new centers totaling more than 129 million square feet delivered, according to Cushman & Wakefield's Global Shopping Center Development Report, issued in Las Vegas last week. Canada also saw a dramatic increase in new shopping center deliveries in 2013 following six straight years of declining construction volume.

Granted, the numbers are low compared to history, with growth in GLA (gross leasable area) at roughly early 1990s levels. However, deliveries constituted a 12.7% increase over 2012, accounting for roughly 18% of total new space put in place since the economic downturn in 2008.

New development and redevelopment were buzz words on panels and in the hallways and exhibition halls of the Las Vegas Convention Center last week. Activity at present is more of a ripple than a wave due to a lack of high-quality assets and construction lenders who remain wary about financing ground-up projects, panelists at the Marcus & Millichap Retail Trends 2014 in Las Vegas agreed.

"The biggest issue a high-growth retailer has lack of available real estate," said Ted Frumkin, senior vice president of business development for Sprouts Farmers Market, one of the sleeper success stories among specialty grocery tenants with 172 stores in eight western states. "We want to grow, but when we've gone out, the build to suit or new development has not been there over the last couple of years."

To date, Sprouts had been able to find second-generation space. But as those locations fill up, the chain has explored a variety of options for growth, including working with smaller preferred developers and major developers such as REITs, Frumkin said. Sprouts is also watching the Safeway-Albertsons merger for opportunities to take store spaces opening up due to consolidation.

The strategy is working, with Sprouts opening 19 new stores this year, including an expansion into Atlanta in June, and a goal of 14% annual growth in new stores and a long-term white space goal of 1,200 units, Frumkin said.

"We're going to have to work a lot harder out in the markets. Even in high vacancy markets like Phoenix, a lot of the space that's empty is not desirable for a lot of tenants. The lenders still are not freeing up the capital to build projects for us."

Michael Phillips, president and CEO of Phillips Edison & Co. LTD, the largest private owner of grocery anchored centers in the U.S., said construction lending is opening up a bit in his company's triple-net business. But Phillips Edison has to look at an entire center holistically, including the in-line tenants.

"The real problem is that to put a project together, you need more than just the grocery store." he said.

Rahul Sehgal, CIO with Inland Private Capital Corp., which has a $3.5 billion portfolio of properties primarily owned by individual groups of investors, said downsizing in the office supply and electronics sectors creating opportunities for redevelopment.

"If enough of those tenants downsize by 10,000 to 15,000 square feet, you can create enough space to bring in a grocery store or another mid-box retailer," he said.

Sehgal said debt structure on CMBS and other types of loans allows for repositioning centers, as long as it's done well in advance of expiring leases. "Working 2-3 years in advance of a set of lease expirations is the best way to go."

Considering that challenged shopping centers are available at much higher capitalization rates than trophy assets, returns on such assets can be considerable for owners willing to do the hard work of revitalization, said Edward Coury, senior vice president and director of leasing at Starwood Retail Partners.

"You have to be daring, aggressive, but the rewards are out there," said Coury during a RECon panel titled Acquiring and Revitalizing a Challenged Center.

Leon Capital Group bought and backfilled some of the Albertsons boxes, in many cases with specialty grocers, said Fernando De Leon, managing partner. "It's not easy. We have to get grocers to pay a little bit more rent and we have to invest money in roofs, HVACV and big [tenant improvements."

Frumkin has seen projects stall because lenders required higher leasing rates then in the past.

"Sometimes we have to wait for a project to be 75% leased before lenders will let shovels in the ground. When you're trying to open 25 stores a year, that makes it difficult to do that," Frumkin added.

That said, an additional 758 centers totaling 120.5 million square feet will be added to U.S. inventory over the next three years, with more than two-thirds expected to be completed this year alone, according to C&W, citing CoStar Group data and other sources.

"These new projects are all positioned as either luxury, mixed-use or value retail and outlet centers - the physical embodiment of the barbell of prosperity we have been tracking since 2009," Winn noted.

These new shopping centers will be small to modest sized, averaging just under 160,000 square feet, with just under one-third of the construction in California, Texas and Florida, according to Cushman.

But a number of larger U.S. centers are also under construction or in planning, including American Dream at Meadowlands in New Jersey, nearly 2.66 million square feet of retail, dining and attractions; Shops at Summerlin Centre in Summerlin, NV, 1.6 million square feet; and the 550,000-square-foot Crosstrail Shopping Center in Leesburg, VA.

Competition for retailers among shopping center developer will be keen between continents, global gateway cities, towns and cities and urban high streets and suburban centers all competing for new projects and tenants. Online and mobile shopping will influence not only how shopping centers adapt and position themselves, but also how retailers use their stores as part of their global supply chain.

The case for new development is strengthening as supply dwindles, rents increase and store chains expand and reposition in the improving economy. Chatter at the ICSC conference confirmed that leasing fundamentals continue to improve and concern over the impact of e-commerce on shopping centers appears to be overstated.

Many publicly traded retail REITs are now being priced out of the marketplace, however, amid competition from private and foreign capital in the increasingly frothy investment market. Landlords cited redevelopment as among the most attractive growth opportunities for publicly traded REITs, according to Cantor Fitzgerald analysts.

"Select redevelopment in our view allows landlords to better align portfolios with ever-evolving consumer shopping habits and tenant demands, while providing for a return that can be in the high-single to low-double digits," according to the Cantor team headed by David Toti, Evan Smith and Patrick Ewane.

Until new retail concepts move into the pipeline, growth levels could finally start to slow by next year even as limited new construction returns to the marketplace. That could be unwelcome news for Class B and C shopping center landlords who have been waiting for, and in some stronger markets, experiencing some relief from spill over demand from Class A centers, said Garrick Brown, research director for Terranomics Retail Services, a Cassidy Turley company.

Class A malls and well-located strips are seeing most of the pricing gains, agreed Citi analyst Michael Bilerman.

However, rising land costs, little available construction financing and inability to push rents high enough to make most developments pencil out are largely keeping the lid on new supply, Bilerman said.

"Retailers are hungry for space in existing centers and proven locations, and will ultimately drive an increase in new construction, but that isn’t happening yet," Bilerman said.

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