Friends Don't Let Friends Buy Centers At 5 1/2% Caps
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.
Ted Kraus ( ted@dealmakers.nethttp://www.dealmakers.net ) is publisher of the Dealmakers, a national newsletter on retailing and real estate in addition to leasing and managing centers nationwide.
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