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OUTLET WARS: Retailers, Developers Compete Against Malls and Each Other in Battle for Shopping Dollars

Scrapping Once-Sacred Agreements Restricting Same-Store Openings Within Retail Trade Areas Leads to Increase in Outlet Stores, Level of Competition
December 11, 2013
If it seems like retailers are opening a lot more outlet stores lately, you're right.

While almost no new regional malls have been built over the past 10 years, development and expansion of retail outlet centers has blossomed as growth-minded store chains sought to open new discount locations in order to attract more value-conscious shoppers.

One important and often overlooked reason why outlet center development has taken off, even within markets already heavily served by retail space, is that retailers have won their battle with shopping center owners and gotten them to relax or abandon former radius restrictions -- agreements with landlords preventing retailers from opening outlets within the same trade area as stores carrying full-price merchandise.

The capitulation resulted from the realization that, since the recession, outlet centers are one of the few brick-and-mortar retail locations still able to draw shoppers in strong numbers.

While only a pair of outlet centers opened per year from 2009 through 2011, the number of new outlet centers quadrupled to eight last year -- and in 2013, another 11 have opened or are set to open before the end of December, according to a report on outlet center and mall competition by Standard & Poor's Rating Services.

Over the past year, real estate services firm Cassidy Turley has tracked roughly 4.5 million square feet of new specialty center product delivered to the marketplace, nearly all of it located in outlet centers.

"Demand remains white-hot for outlet center space," according to Cassidy Turley's Garrick Brown and chief economist Kevin Thorpe, who co-authored the firm's 2014 Retail Forecast. "This is one of the few product types where we have seen developers build speculatively. In general, most of these projects lease up before construction is done."

Large developers like Tanger Factory Outlet Centers, Inc. (NYSE: SKT) and Simon Property Group, Inc. (NYSE: SPG) have upped the ante even higher, opening or proposing large outlet centers sometimes within just a few miles from malls or even other outlet centers. Most famously, Simon's St. Louis Premium Outlets and Taubman's Prestige Outlets both opened in August within a mile of each other in Chesterfield, MO.

In the St. Louis market and elsewhere, these outlet vs. outlet vs. mall battles for shoppers may result in casualties as competing platforms target and cannibalize each other's trade area and market share.

Rescinding the Unwritten Pact Between Retailers and Mall Owners

"The unwritten pact between retailers and mall owners is gone and radius restrictions have almost disappeared," said Gerard Mason, executive managing director of Savills US, which has brokered the sale of more than 30 outlet center in recent years. "If you were a retailer, you once promised the mall owner that you wouldn’t cannibalize their market share by opening an outlet store in their trade area. Those types of promises are now gone."

Such radius agreements were common when shopping malls ruled the retail landscape. Back in those days, most outlet centers were located in rural areas or on the outer fringes of major metro areas. Today, the new crop of outlet developments -- typically much larger, more walkable and more rich with restaurants and other amenities than their predecessors -- are often being built within the trade areas of both malls and even other outlet centers.

"The newer outlets, with their larger size and scale upwards of 800,000 to 1 million square feet built in a village type format, have the advantage over smaller and older competitors. Just as in all retail, there will be winners and losers," Mason said.

"We expect there could be operating casualties and principal write-downs in oversaturated retail markets," said S&P analyst Larry Kay. "There are just so many retail slices an existing trade area pie can be cut up into."

Today, profit-minded developers are lured by strong outlet sales and lower development and operating costs than traditional enclosed malls. Many developers also reason that outlets might be somewhat less sensitive to competition from e-commerce than full-price stores, since retailers typically don't sell their "made-for-outlet" goods online.

Bigger Outlets Are Better

In addition to increasing their numbers of properties, outlet centers are also growing larger. Older centers were as small as 20,000 square feet, but the current trend is to go big. The average gross leasable area of an outlet center increased by 40% to over 383,000 square feet at the end of 2012 from about 271,000 square feet in 2009, according to S&P. Over the last five years, the number of retail stores with an outlet presence has also grown by about 14% to 14,793.

Outlets are also more efficient than malls in terms of sales efficiency and performance. Tanger Outlets -- which S&P used as a proxy for the outlet mall industry at large because it's the largest publicly traded, stand-alone operator of factory outlets and the second-largest owner of outlets after Simon -- reported $384 in sales per square foot at the end of second-quarter 2013, an increase of about 20% from year-end 2005, according to the International Council of Shopping Centers (ICSC) and Tanger data.

By comparison, traditional mall sales saw a 13% increase from 2005 to $460 per square foot as of mid-year 2013. During the 2007-2009 downturn period, outlet center sales declined by less than 1%, compared with a drop of 12% in sales at malls.

Outlets also did not suffer as much of a vacancy hit as regular malls during the downturn. According to CoStar Group data, existing U.S. regional and super-regional malls sized at 400,000 square feet or larger had an occupancy rate of 94.8% in third-quarter 2013, compared to 96.1% in fourth-quarter 2008. Outlet centers in the same size range were 98.2% occupied in third quarter 2013 -- the same as five years ago.

Having gotten store owners to drop their store radius restrictions, retailers have become more aggressive in opening multiple locations within major population centers.

Mall Sales Leak to Outlets

Meanwhile, retailers have grown more sophisticated in in the outlet store merchandise strategies. Many retailers have developed specific goods and product lines for outlet centers, no longer limiting their offerings to leftover items or goods damaged or returned at full-price stores at the malls. As retailers have shifted their product mix between their outlet and mall stores, they have far less compulsion to opening stores in new outlet developments.

As a result, outlet centers have invaded trade areas once dominated by malls. Major department store retailers such as Nordstrom, Bloomingdales and Saks Fifth Ave. have expanded their outlet store operations as they look to draw a new customer base and expand their multichannel efforts.

Discount and outlet concepts are one of the few areas where apparel companies, that are otherwise in no-growth or slow-growth mode, are looking to expand. Nordstrom will likely build no more than one full-service department store over the next year, for example. However, the retailer is looking to expand its off-price Nordstrom Rack concept by as many as 60 stores over the next two years.

Likewise, the recent $6 billion acquisition of Neiman Marcus by the Canada Pension Plan Investment Board and Ares Management private equity firm will probably result in increased expansion -- not necessarily for the chain’s namesake mall-based department stores, but for its off-price Last Call stores.

"[Retailers] seem to have overcome the issue of having their brands sold in locations in the immediate vicinity of where they have full-priced stores," Kay said.

Colliers International estimates that about 64% of Nordstrom Rack stores are located within five miles of a full-line Nordstrom, and 42% are within one mile. At the same time, there have been more instances of outlet centers popping up in competing markets and targeting the same shoppers, S&P said.

While retailers may have successfully managed to balafind a working strategy for selling in both outlet and full-price mall stores, the new rules have proven more challenging to store owners.

Examples of outlet centers cutting into mall profits date back to at least 2009, when the Cincinnati Premium Outlets opened 14 miles from the financially distressed Tri-County Mall in Cincinnati. That same year, the mall was transferred by its lender to a special servicer, an apparent casualty of the outlet development.

In the St. Louis metro, another competitor to Simon's St. Louis Premium Outlets and Taubman's Prestige Outlets is the former St. Louis Mills, an REO property now called the St. Louis Outlet Mall.

"It is our belief that the St. Louis market will likely not be able to support all of this retail," concluded S&P. "With limited population growth and a market that appears to be over-retailed, there could be additional victims."

In addition to the dueling St. Louis projects, new outlet retail developments are planned to open in Chicago, Louisville, KY, and Baltimore.

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