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.
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.
posted by tedkraus at 8:09 AM
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