Micky bombed out for me

Several months ago I mentioned that we (TKO) were going to exhibit at the Home Builders Show in Orlando, FL in January. The thinking behind this decision was that there would be over 100,000 professionals involved in the residential business attending, with many of them acquiring 100 to 200-acre sites that use the front 10 to 20 acres to develop retail and therefore might require our services. In theory, my thinking was brilliant. In reality it bombed. I was half right; there were 100,000 professionals in attendance and some "do" need our services. The problem came down to that there were too many people in attendance and only 1% or 2% were directly involved in retail real estate, a percentage way too small to reach with a 10 by 10 booth. We spent three days smiling as tons of people walked by. But less than one in 100 had any interest in us (should I take that personally?) I did learn a few things however. First, while never good, the food at an ICSC event is better than what we were served at the Home Builders event. Second, you get more bang for your buck at an ICSC show than at the builders' event and third, I think I'm going to try exhibiting at a local (northeast) Home Builders show instead of their national show, since it might be more productive. I "know" the concept is correct, it's the execution I'm having problems with. We did have 10 or 20 people drop by that are subscribers to Dealmakers and that was "rewarding," and a few dozen more who were members of our e-mail forums, so "some" of "our" people were there but I had no conversation at the show that showed promise to bring in business for the coming year.

I did have an interesting conversation with one builder who's looking to acquire dilapidated shopping centers or ones with surplus land so they could either demolish the center to build residential or build residential on the surplus property. For years, many retail developers bought land that was substantially more than they needed for their center and flipped or JV'd the rear portion of the property to a residential developer. Now the worm has turned and residential wants the commercial site to redevelop. Most of the home builders I spoke to said that business has slowed a little bit, but not much. The low-end homes ($150,000) were still going strong but the $400,000 and up housing was down 10 to 15%. I believe them more than newspaper reports, so residential is slowing, which is not a good sign. Several of the larger condo developers expressed concern that with higher interest rates and a slowdown appearing in residential, speculators might drop out of the market and they "guessed" that speculators account for 15 to 25% of sales, so they could really be hurt. While I don't believe speculators represent a large portion of our industry, I do believe we'll see a lot of "opportunists" dropping out this year.

If Ann buys everything she liked at the show (from a consumers point of view it was great, you got to see the latest gadgets, appliances and home improvements available), I may have to declare personal bankruptcy. But if I ever, in a moment of insanity, decide to build instead of buy a home, it did provide great ideas. The show, from a consumer viewpoint, was fantastic. The trip wasn't a total waste as Josh and his girlfriend Mindy joined us for the week and we did have an excellent family adventure.

Anyway, back to business. I'm writing this in the middle of January and, while business isn't poor, we (TKO) haven't experienced our normal rebound after the New Year. Hopefully this is just an aberration and not a trend for the year, but what does concern me is that retailing seems to be slowing down but development doesn't, which means there could be a lot more product available than companies needing space. That doesn't mean the world is coming to an end (if it does, what difference does retail real estate make) but it does mean we might have to hustle more to produce less. The true stars of leasing, sales and acquisitions will not be affected, since they always produce. But the second and third-string players could have a bad year or two coming up. Now even if the economy drops, it won't be a total tailspin. But because business has been relatively good for the last 10 to 15 years, the slowdown becomes a shock to our system whether it's a deep slowdown or not, and most don't know how to handle a slowdown since it's been over a decade that they had a problem like what I think is coming. This is the time to get your house in order; lower costs, improve personnel and do upgrading (but don't get carried away) at your centers.

Changing subjects, I keep hearing a lot about Sears and Kmart and their plans to improve sales. Well, if they don't get their act together this year, I'm willing to bet they will not be in business that much longer. Their asset, as we all know, is their real estate and that's going to be cherry picked by all the big box retailers. As I said before, Sears Essentials seems to be bombing, their traditional Sears store is going downhill and Kmart seems to want to mimic National Wholesale Liquidators in appearance but with lower sales. Their problem, as is the problem of most retailers today, is that they don't have merchants in charge, just bean counters. Here's a company with major problems.

I recently read that Kmart intends to lay off thousands of employees this year. My question is: "How, they don't have enough now to service the store." Yes, I understand they lack customers so they want to lower costs to reflect lower sales, but if they lay off that many people, who is going to open the door or work the cash register. I've been in convenience stores with more personnel than in Kmarts. Oh well, ranting on...while brick and mortar stores may see a slowdown this year, retailer's web sites are going strong. JCPenney just broke the BILLION dollar mark online and most of the web's retail business is going to conventional retailers with brick and mortar stores, not just an online presence. Just a few years ago, the fear was that online would kill offline business. It's hasn't done that yet, but the growth is tremendous and the stores that had name recognition as conventional stores are now attracting customers to their web site. Nearly 94% of our national and regional retailers have a web presence, making them a little less dependant on developers. I'm willing to bet that in 10 years, 50% of most larger chains' sales will come from online sales.

Here's a couple of observations I've noticed lately. In the January issue of Shopping Centers Today, the theme of the issue appeared to be about master developers and mixed-use projects abounding everywhere. Long story short, the buzz in the industry is about 100 to 500-acre sites combining residential, condos, office and retail or, on smaller scales, just office and retail with perhaps a touch of condos. James Rouse did that four decades ago with Columbia, MD, the Levittown complexes were built 60 years ago and, as I said at the beginning of this story, I went to the home builders show to find the residential developer that has surplus land for retail development; a group that's been combining retail with residential for 100 years. The only difference today is it's quite often built today by a single organization instead of specialists handling each segment. The costs of these projects can run into the billions, which means it's not a segment of the industry for the "little guy." Yes, there's more sophistication today than in the past, but the world is more sophisticated today than in the past. But it's only an old concept that's been updated; nothing new. I think these complexes have a place, but they are not the future of retail real estate, just another niche. I for one have no desire to live in a community with retail and offices next door. I try to live in areas which limit growth, not promote it (developers hate me). I read that currently 20% of all residential sales currently are in master/mixed-use complexes. I don't believe that trend will continue. Oh, in the same issue of Shopping Centers Today, it was reported that the Related Cos. was acquiring Equinox Holdings, operator of 25 fitness clubs. They intend to use Equinox gyms as an anchor in many of their mixed-use projects. IMHO, this is a disaster looking for a place to happen. If you're old like me, you'll remember Arlen (now CBL) acquiring Korvettes, Crown buying Hess, LJ Hooker buying a bunch of retailers or Bob Campeau, who bought and bankrupted Federated Department Stores. All these developers and their retailers went bankrupt because they (the developer) have no idea how to be a merchant. I'm not saying Related is going "11" but the past usually tells the future.

My last observation is on "creative" acquisitions. We're in the process of selling a center to a REIT. It took about a month to agree to the price and I thought the hard part was over but it wasn't. We're creatively lowering the management fee, reserves for roof and structure replacement so that the 6.5% CAP rate turns to a 7% (on paper) return based on these "inappropriate" numbers. What's the expression? Figures don't lie, but liars do figure? I guess it's a problem of being public. Everyone knows what you're doing.

It's Up; It's Down; It's Happy New Year

Read the New Year's predictions and news for the last few weeks and it's extremely confusing. Inflation is up, inflation is tame, interest rates are going up, interest rates are stable, unemployment is going up, unemployment is going down. Consumer confidence is up, consumer confidence is down. Leasing activity is great, leasing activity is showing signs of slowing. About the only constant is that the sale of centers is booming. The record trade deficits will hurt the economy (Democrats are the ones saying this). The enormous budget deficits will not hurt the economy (Republication are saying this). High gas prices will hurt retailing, the high gas prices are having no impact on consumer spending. The world is upside down and no one knows where it's going and I'm not going to claim I'm smarter than the rest and make a prediction; the only thing I know for sure is that we live in interesting times. The good news is that almost every retailer I've spoken to had a decent to good Christmas, so retailers should continue to expand in 2006.

There's a good chance that the new fed chairman will stop raising interest rates and if that occurs, interest in real estate will continue, but I don't think lease rates will increase enough to justify the higher acquisition prices that centers are commanding, The higher prices of construction materials are also having a negative impact on developers' profitability and shortages will prevent construction schedules from being on time (and therefore over budget). Not a good sign for a profitable 2006. Only a small percentage of developers have the skill required to realistically do a budget/proforma that's accurate; the rest just guess and they usually screw up.

The popularity of acquiring centers is so high that it's keeping the inefficient and unknowledgeable developers alive. I recently was hired to review the acquisition of three centers being acquired by one developer from a builder. All three centers will be completed within the next six months and all are over budget by millions, with slightly lower income than originally projected (a winning combination). The builder is a relative newbie and screwed up enough times that in a normal time period he would have either lost the projects or, if lucky, broke even. But when new projects can command 6% to 7% CAP rates, he'll make lots of money. Hopefully for his sake (but I doubt it) he'll stop building right before CAP rates start their climb.

Besides all these confusing reports on the state of the economy, brokerage, at least for us, has been rather slow for the last few weeks. But that's normal for the period between Thanksgiving and New Year's. Hopefully we'll get back to status quo by the middle of January. Everyone I speak to had a banner or record year so even if the market is down, the retail real estate industry is optimistic about its future.

One thing I'm sure of is that there will be an abundance of announcements on store closings from all sorts of retailers over the next few months as retailers start closing their underperforming locations. While it won't compensate for the closures and addition of vacant space to the retail real estate world, what will help out somewhat is the announcements on new concepts opening as merchants try and determine what the consumer really wants (see Ann's editorial). Of course, in my humble opinion, it's primarily service that the consumer wants from the merchant, something most retailers have no grasp of, which is why the Internet is doing so well. Your computer is a lot smarter and more polite than the clerk that usually waits on you.

I recently received a phone call from a friend telling me to read the blog on deadmalls.com, which I did and it made me feel real old. Not the blog aspect of the site but they list all the "dead malls" of America and when I went through the list I realized I worked on a high percentage of the centers mentioned, a scary thought. Now if I look at this with the understanding that I worked on 'em over a 30-year period it isn't that bad. We (TKO) specialize in turnarounds, so of course we have experienced a higher level of duds than most, but "seeing" all my losers in print still hurt the ego. I admit, when we started to work on the malls, they already had one foot in the grave, but I really believe, in most cases, that the center could have "worked" (never a success but could have been made to have a positive cash flow for the long run IF we had a knowledgeable client who understood the process and was willing to put cash into the deal; most wouldn't). Unfortunately, deadmalls.com will be adding more malls this year.

As I was rereading deadmalls.com, it dawned on me how much hasn't changed over the last 10 years. The vast majority of these dead malls have been sold over the last ten years and, in most cases, to inexperienced buyers who looked at the replacement cost ($100 psf to $200 psf) and their low acquisition cost ($10 psf to $25 psf) and also saw a positive cash flow and decided that they had a home run that no one else was intelligent enough to spot (yeah, right. If it's too good to be true, it usually is). Today's buyers of some strip centers are repeating the same mistake. They see high replacement costs, low acquisition costs and positive cash flow. Remember, when someone sells a center they've decided it's the highest price the property can command and the buyer always sees an upside. Yes, the center you're acquiring at a 10% to 13% CAP rate has positive cash flow, BUT for how long? Usually we find it for a one-year period or, at most, a two-year period; then it goes negative. The reason, in most cases, is the regional and national tenants who signed a lease eight or nine years ago and are doing poorly are just waiting for the lease to expire. The locals stay alive by paying rent every other month, it's a discount the tenant takes without the landlord's approval. Once the "big boy's" lease expires and they leave, traffic dries up and the locals only pay rent every third or fourth month. The new landlord figured the center could be turned around in a year or less, so they never contacted the nationals to see if there was anything he could do to keep 'em past their lease term. And it's only as they start to move out that he attempts to start a conversation to keep 'em, which by that time is too late. They usually believe that lowering rent a few bucks is all that's required to change the retailer's position. If they had started conversations a year or two earlier, they might have had a chance, but once the decision is made there's no going back.

Parting thoughts...In the last few weeks, I must have gotten a dozen phone calls from owners wanting us to sell their property. In all cases it was at insane CAPs that make no sense to me. Now I have to decide if it pays to try and market a "C" center at a "B+" price. I'm hesitating because I don't want to waste my time or theirs trying to sell an unsellable product. The only reason I might is because I've seen too many centers sell that have no upside, so maybe I'll be able to find that greater fool. Leasing is taking a change in direction; I'm talking locations with more low-end/urban retailers today on potential sites than any other period I can think of. Some of the dollar stores and blue collar chains were hurt in 2005, but I think their problems were more with over expansion than the actual concept. Anyway, we have 12 months to see how 2006 will be. Here's wishing you a healthy New Year.

P.S. I spent a few hours over the weekend going over all of the deals we leased in 2005. What I found interesting is how we leased 'em. What I mean by that is we market via phone, direct mail, the Internet, ads in trade publications, faxing, attending trade shows and leasing signs on the property. The number one lead generate was the old-fashioned leasing sign by 2 to 1. Sometimes the old ways are the best ways.