Monterey here we went

Ann and I went to the Monterey ICSC dealmaking, where attendance increased nearly 25% from last year's 1,200 dealmakers, so no one can complain about "the action." The show was active all day Wednesday, the day before the actual dealmaking, with leasing plans, cell phones and computers spread on every flat surface while everyone attempted to do a deal (some even did). The cocktail party was also active on Wednesday evening with most attendees going out to wine and dine afterwards and, topping it off, the actual dealmaking on Thursday was busy until the closing bell, which is unusual for a dealmaking event. That's the good news. The bad news is that I kept hearing of a leasing slowdown from many (if not most) of the attendees, not a drastic one but a slowdown. Reports of this slowdown started six to nine months ago and it seems to be gathering steam. Those working on new projects or ones approved a year or two ago are still active troopers, but many of the brokers and smaller developers complained that 1) There's very little space to lease; the excellent economy for the last few years has rid the industry of almost all its semi-decent vacancies 2) Retailers are slowing down in their expansion plans (again, not drastically but slowing down) 3) Land costs are so high it's a substantially bigger risk than normal to do new development and the majority of "owners" that got into retail real estate in the last decade are not developers, but are either flippers or owners so they have no idea how to develop 4) With CAP rates being insane (in California people were complaining of CAP rates of 4% to 6%) it makes more sense to put your money in CDs and 5) Retailers, especially big box users, complained that even if they wanted to expand there's little vacancy around except for new development which few can afford. None of these problems means the end of the world is near (but based on how the environment has been acting lately, the end may come sooner than we thought) but it means that if the trend continues we'll all be working a lot harder and hopefully smarter to make a deal than we have in the past. The "easy" decade of leasing and sales may be coming to an end.

Over the years I've noticed our (TKO) leasing business does well when the economy does well. When the economy does fair, we do poorly but when the economy is doing poorly our leasing department does well (two out of three ain't bad). Never made total sense to me, but after 35 years I can accept the facts, whether or not they make sense. Of course, we do better and work less in a booming economy over a failing one but money is money. I only hope for all our sakes that my business starts doing better because of an improving economy, not because of a slowing one.

In a conversation with three leasing guys from three different REITs, they all brought up that their companies were considering selling their "C" and lower grade properties (for one REIT that's almost half of its portfolio). The last few years have been excellent for REITs and they're flush with cash and buying power. What they've learned is that it's easier to lease "quality" centers than tired workhorses (it took 'em a decade to learn that), so they intend to eliminate their problems, spend more per property on acquisitions and try to upgrade. That's excellent news for entrepreneurs, since they're the only logical candidate to acquire and turnaround some of these dogs the REITs will be selling. One of the problems is even though the REIT can't lease the problem center, they still want top dollar for their product and their economics don't work, which is why it's taking so long to do the sell-offs. The entire real estate industry has gotten fat and somewhat lazy over the last five years sending everyone to want to acquire "better" property that's easier to lease. REITs want to go the upscale route (it's easier), as do many companies that were originally formed to either do urban development or turnarounds but are no longer in that business since they decided they had to work too hard to make the projects profitable and did not get a great return. With raising money so easy right now, they've taken the road most traveled, meaning they borrow more to "upgrade their acquisitions," leaving the dogs for others.

Everywhere we went there was talk about the Vegas show. And while most, or many, admit there's a slowdown going on, they're all optimistic about Vegas and there's no doubt in my mind that another attendance record will be reached. There will be lots of bodies in Vegas this year, but I'm willing to bet that most will be gone by Tuesday. And only the exhibitors and workaholics will be around on Wednesday. The show, because of the low vacancy factor that the industry currently has, will be highlighting new developments, more so than in the past with "lifestyle" centers leading the pack. Of course, with over 40,000 +++ in attendance, there will be millions of sq.ft. of existing space being offered but that's down from year's past. The economy totally confuses me. Forgetting the stock market, which makes absolutely no sense, retail is doing decent for the most part. Employment is high (retailers are having a tough time finding help), rents are rising and prices of centers are commanding record highs. But something is wrong. I'm not sure what, but something is wrong. I can't put my finger on it, but there's a problem brewing. Maybe Vegas will bring it to the forefront.

As I said, most developers and retailers today want to go upscale, and to some extent I understand why. By changing from popular price offprice/outlet retailers to more upscale tenants, outlet centers are beginning to change years of declining sales in their outlet centers to improving sales per sq.ft. Lifestyle centers can only survive in an upscale settings and Nordstrom is having a banner year. BUT, and I repeat BUT, that's not where America shops. Retailers like Foreman Mills and Shoppers World, which cater to blue collar and urban customers, are doing great also. Too many retailers and developers don't believe there's money to be made catering to the blue collar, lower middle class market, and they're wrong. One of the reasons for this disbelief is Kmart's sales, which keep declining; but they're declining not because of the market they sell to, but they're just plain bad merchants who, IMHO will not exist in five years or less. However, Kmart is still Kmart and is No. 3 in the discount industry. Target, No. 2, is considered "upscale," with Kohl's being middle class. Only Kmart caters to the blue of the blue and they're a rotten merchant. Stores like Dollar Tree, Family Dollar and K&G Clothing are expanding and profitable, but they're just not sexy and we're an industry that loves sexy. (Remember, never make a pretty woman your wife if you want to be happy the rest of your life).

Changing subjects, I had an interesting conversation last week with a gentlemen by the name of David Tepper (847-919-8162) who is coming out with an interesting and I believe new approach to doing brokerage (for disclosure purposes, I am NOT involved with his business and have no idea if the concept will work but it sounds interesting and worth a try. I don't even know David). The idea is relatively straightforward. He acts like the "back office" for developers and brokers. He does a demographic study of the market and property (the demographics are substantially more then a one, three or five-mile radius), and then he divides the market into segments and determines what retailers make sense to pursue based on this study, and more importantly what retailers are doing well in the market. (Oh, I forgot to mention that there's NO exclusive required and you only pay him based on results). The reason for a detailed study of the market and center is to promote the retailer's probability of success and the center's interest in their success. It also helps identify those retailers who actually understand the market. The leasing process itself, once the targets are identified, is as old as time. Phone calls, emails, letters and follow ups. The warm leads are then turned over to the broker or owner (he goes both ways). He does NOT close; the agent or landlord does, so his telemarketing approach works nationwide and he's paid a "finder's fee," not a full commission. Again, remember, this is done on a contingency basis; they only get paid on signing. Ten or 15 years ago, we (TKO) set up a telemarketing department to offer a similar service (but we did the actual close). While the idea produced deals, we found we couldn't make enough money promoting it. David's approach of just providing leads may make the concept workable. If you have space that isn't leasing that quick, give David a call. What do you have to lose?

Friends Don't Let Friends Buy Centers at a 5% CAP

It's Vegas time again (God, time goes fast when you're making money) and 40,000 +++ of our closest friends will be congregating to wheel, deal and have a great time eating, drinking and being merry. What a fantastic business we're in; being paid to eat, drink and gamble (whether it's on your property or at the tables).

I "think" this is my 35th convention (I'm VERY old), and while the current shows aren't as much fun or as wild as the conventions 30 years ago (but then again, I'm not as much fun or wild as I was 30 years ago) they're more productive; we all know what we're doing or at least think we do; 30 years ago we winged it. Most of you will arrive on the scene on either Sunday or Monday morning and leave sometime on Tuesday, a waste in my opinion, since staying until Wednesday can make the show more productive for all involved and increase the probability of making a deal. I write this every year and every year the show is desolate on Wednesday after 11, so some things never change.

Either way, 2006, so far, has been an excellent year for all those involved. In addition, the regional dealmaking shows have been growing even faster than in the past, with attendance increases of ten percent or more not uncommon (I'd guesstimate a 7% to 10% increase for Vegas, and considering there were 40,000 attendees last year that's a big increase) and some shows have had a 25% increase. The only negative on the horizon is the apparent slowdown in leasing.

This is a make-or-break show for retailers and developers needing additional stores opened for Christmas 2006. If you can't get on the fast track by the end of this month the odds are that no store will open until 2007. In reality, the vast majority of 2006 deals are already done, with few retailers having an open to buy for the remainder of the year. But there's always a few stragglers who either NEED, or want, another deal for this year, so if you have vacancies (and there's not a lot around) this is the time and place to hustle, otherwise the deals started here will be opening in 2007.

I have to give leasing agents credit for being aggressive when it comes to scheduling meetings for the show. For the last month, I've been bombarded with e-mails and phone calls trying to set up meetings. In the vast majority of cases, I declined, since the projects offered were of no interest to our clients. Everyone is trying hard to fill up their dance cards so they can impress the boss, but meeting for the sake of a meeting makes no sense to me. Of course, if they were really smart they'd leave a few hours every day to just walk the show, do basic networking and see what's new instead of wasting unnecessary time on unproductive meetings. This year will be easier than next, when the convention floor will be doubled in size and most of the exhibitors or attendees will be lost or confused by the vast size of the exhibit hall. Yes, having a larger exhibit area will benefit all, but I personally prefer to shop Ace Hardware over Home Depot because the size is easier to maneuver. Of course I'm not getting as good of a selection, but sometimes I'm lazy.

Ranting on...I'm not going to go into the details of the Mills Company and their problems since we've all heard and read what's happening with that REIT (and probably more will come out by the time this is published), but I will comment on Mill's desire to mix entertainment with retailing, which doesn't appear to be working or at least profitable (and in a capitalistic business, if it isn't profitable it isn't working). If you look at the history of entertainment in shopping centers, it's a checkered past, mixed with lots of failures, whether it be Discovery Zone, Jeepers, indoor skate parks, roller coasters, or whatever, or the fact that movie theaters have been in and out of retail projects for over 20 years. One year, developers think theaters should be included in a center's mix; the next year they're buried in the back with no viability (the only way theaters could become profitable was by going bankrupt a few years ago).

Few entertainment complexes combined with conventional retailing work and I don't believe that will change in the near future. The difference today from when I put roller rinks into centers 30 years ago is that the costs and risks are substantially higher. When I did a roller rink deal 30 years ago, the rent was usually under $4 GROSS and that was for a vanilla box. Today, the Mill's project in North Jersey will cost billion$ to develop and no one knows if the entertainment aspect will be the attraction and profitable as projected. Today it's not uncommon to develop entertainment beside mixed-use and baseball parks, where the costs will run into the hundreds of million$, and again I don't think it will work. (Of course, if you can convince some foolish city to provide millions of taxpayers' money to the project, it does improve the probability of success). Entertainment is NOT a high sales per sq.ft. generator and you don't have to be Einstein to understand that if your development costs are high, your rents have to be in the same league. Overall, entertainment retailers can't afford high rents and that's where the problem lies. I also think the industry is getting itself into trouble with many of the high-end, mixed-use projects, especially ones promoting residential housing in a cooling housing market. (Somehow I can't justify spending $500,000 for a condo located in a retail/office complex. I don't want to live where I shop). One of the industry's current problems is that money is so easy to raise today; developers who sign non-recourse mortgages are willing to try any idea THAT MIGHT work (it's not their money, so who cares because they get leasing, development and management fees no matter what).

Changing topics...friends don't let friends buy centers at a 5% or 6% CAP rate. Even with leasing activity slowing, the market for acquiring centers is still hot (why is another question) and while I predict a slowdown in sales (or an increase in CAP rates in the near future) a few select centers are being sold at 5% to 5.5% CAPs. And CAPs of 6% to 6.5% are not uncommon. Yes, millions have been made in the last five years by "flippers" who kept a center for six to 12 months and then flipped (with no increase in income) for millions more than they acquired the center for. But with a slowdown in leasing and rising interest rates, acquiring centers based on these numbers makes no sense. Remember the dot.com boom, it BUSTED really fast. I believe the same can be true for retail real estate. Pricing of property has gotten so bad that some sellers that normally would have elected to do a 1031 exchange now elect to pay the taxes instead of buying a Walgreens at a 5% CAP, and when you're willing to pay taxes over acquiring real estate there's a problem.

Of course, the other end of the spectrum isn't that rosy either, since I hear a lot of developers complain that with costs so high they're only getting a 10% to 11% return on NEW development. High risk for low reward. The only reason 10% looks good is because of the 6% CAP on existing property. Either way, the leasing mall will be pounded by thousands of buyers and brokers wanting to know if you have a center for sale.

Oh, as I mentioned in the last MyWay, the amount of available space is down substantially over prior years because of the robust economy. But the amount of new construction, especially lifestyle centers and urban redevelopment, is up (we're even involved in an urban redevelopment in Chicago) substantially over last year (merchant developers keep the economy moving whether we need more centers or not) so I highly recommend you walk the leasing mall to see what the current trends are, where they're happening and who the anchors are. It's a good education and will provide ideas for your project.

On a different note, I had dinner with two friends the other day, both of whom are directors of real estate for their development companies. That's where their similarities end. One complained that even though his company has over 12 million sq.ft. of retail, he gets no support from the company's executives; they look at leasing as an expense, not the prime income generator for the company. Whenever he proposes mass mailings, advertising, e-mail blasts or going to local dealmaking shows, they turn him down because of the cost and their belief that "marketing" doesn't work. The other company does their own mailings to ALL their existing tenants, plus the ones in their corporate database (they promote heavily to brokers) and uses outside mailing services to reach "ma&pas," sends thousands of e-mail blasts to promote vacancies and goes to almost as many local dealmaking shows as I do. His company has over 20 million sq.ft. with a vacancy factor of 4%. The other company runs a 6% to 7% vacancy factor consistently. Which company would you rather be? Oh, the "smart" company looks at vacancies as a "cost," and the longer the vacancy the higher the cost, so they're willing to make sweetheart deals on property vacant for a long time while the "other" company says "this is our rent, pay it or don't go into our center."

Have a great and productive show.



P.S. Don't forget to drop by the RD/TKO/KIN booth at 667 Sixth Avenue on Monday after 4 p.m. for our annual Beer Blast. Booze, fun and friends, what more can you want? Oh, I almost forgot, drop by and let me introduce you to my son Josh, who's entering the industry.