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SHOPPING CENTERS HITTING MIDDLE AGE Past Their Prime or Getting

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									SHOPPING CENTERS – HITTING MIDDLE AGE Past Their Prime or Getting A Second Wind?

I.

INTRODUCTION

Traditional shopping malls in the United States have hit, or in some instances passed, middle age. Their lives are changing – partners (department stores) have died or found new loves (power centers), and children (specialty retailers) have moved in other directions (lifestyle centers). Centers are looking old and tired, and some are desperately in need of a facelift, if not an entire body makeover. Shopping mall owners have had to learn new strategies (internet sales, entertainment uses, other mixed uses, increased hours, etc.) to stay current and competitive. New challenges and threats, like terrorism, have changed the way they act. Hurricanes and global warming have taken on new meaning and reality. Old economic standbys that developers have taken for granted, like expense pass-throughs, are going the way of Betamax. Developers need to determine how to revitalize existing centers. What about just building new shopping centers? Some would argue that the United States is simply over-malled. Between 1970 and 2002, mall center space increased at a rate of over 4% annually, compared to a 1.1% annual increase in U.S. population. In 1970, there were approximately seven square feet of retail space for every person in the U.S. By 2002, that number almost tripled to 21 square feet. See Exhibits 1 and 2 attached for further data on the growth of all types of shopping venues, not just malls. Through the early 1990s, much of this growth was through new mall development, anchored by traditional and mass merchant department stores. These new malls provided an opportunity for department stores and specialty retail companies to grow their store base. Decline of Traditional Malls During the late 1990s, new mall development declined. Why was there such a decline? A convergence of events contributed, including: -creation of Real Estate Investment Trusts (REITs); -growth of power centers; and -lack of new specialty tenants and anchors. How did the creation of REITs affect new mall development? The REIT market demands continued growth of funds from operations (“FFO”). Acquisition of other centers and other developers’ portfolios is the most effective way of increasing FFO. REITs that build new malls, rather than acquire existing centers, have the lowest FFO increase. So, the growth of REITs made acquisitions of centers more desirable than building new ones. Note that REITs also influenced the economics of lease transactions. The need to grow FFO has pushed rents higher and contributed to the establishment of fixed CAM and the presence of more kiosks and carts in malls.

Even to the extent that a developer wanted to build new malls, most markets that could support a regional mall had already been developed. Other factors also influenced the shift from almost 50 new malls annually in the late 1970s to only four annually in the early 2000s. Growth of Power and Lifestyle Centers Power centers, which bring together popular big box retailers, and lifestyle centers, which bring together mixed uses, including specialty retail, restaurants and entertainment, in an architecturally enhanced setting, became more popular. People changed how they shopped, and such centers are cheaper and easier to build and create opportunities for non-traditional anchors, such as discount stores and so-called “category killers.” In the 12-year period from 1990-2002, 850 new power centers were built as compared to only 67 new enclosed malls in that same time period. Some argue the lifestyle or town centers may be positioned to drive the traditional mall to extinction. Power centers may be more in tune with shoppers’ preferences today for convenience and amenities. Parking is available at storefronts, and open-air centers tend to be more festive. There is also some thought that power and lifestyle centers take the baby boomers back to their pasts. According to recent ICSC reports, from now through 2008 no regional enclosed malls are planned for construction. By contrast, approximately 60 lifestyle centers are planned. There is also an expectation in the industry that many traditional malls will have added lifestyle center wings or components. In support of this, Simon Property Group reportedly has over 30 projects where it plans to add upscale retailers and restaurants as components of traditional mall properties. Further, power and lifestyle centers are not only growing in number, but in size. Until fairly recently, lifestyle centers rarely exceeded 300,000 sq. ft. There are a number of retail projects today approaching 1 million sq. ft., and which include uses such as office space, hotels and housing. The focus of these centers is not just to create a place for a shopping environment, but a true downtown or “Main Street” atmosphere. Easton Town Center, located in Columbus, Ohio, is a prime example of an innovative lifestyle center, which currently has over 1.5 million square feet of mixed use space, including a wide variety of indoor and outdoor retail, restaurant, and entertainment venues. The entertainment component of any shopping venue is a critical draw to both luring and retaining customers because it provides customers with a social outlet -- a connection and experience beyond merely purchasing goods. Some developers believe that people stay longer at lifestyle centers because of the entertainment component; the longer the shoppers stay, the more money that is spent. Lifestyle centers are attractive to consumers not only because of the variety of specialty stores in an “urban” setting, but because they offer diverse entertainment, such as theaters, restaurants, and high-end ambiance in the common areas. Traditional mall developers recognize the importance of lifestyle components and renovations often attempt to add lifestyle and entertainment components. Malls must adapt to the public’s desire for more entertainment and restaurants to remain relevant.

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Other Causes of Changes to Shopping Centers and the Landlord, Anchor and Smaller Tenant Relationships What other factors have contributed to changes in shopping centers? Department store consolidation has had a huge impact on development. Department stores are not necessarily the draw they once were; they have lost market share. The definition of “department store” has changed. Perhaps most importantly, there are fewer department store chains. The last new “department stores,” actually were the discounters, Target, Wal-Mart and K-mart who first appeared on the scene in 1962. In 1963, Nordstrom entered the ranks of department stores by beginning to sell apparel. No new department stores have been created since then. In 1970, there were almost 170 department store "nameplates,” including May, Federated, Sears, Penney and a number of regional chains. By 2002, through consolidation and bankruptcies, the number of traditional department nameplates has dropped to 45. Even since then, there have been a number of other purchases and closures (e.g., Federated acquired May, Kmart bought Sears, and Target sold Marshall Field’s). Sears and other major brands have not opened new stores in years. Today, only the following traditional department store names remain: Belk, Lord & Taylor, Boscov’s, Dillard’s, Federated (Macy’s and Bloomingdale’s), Gottschalks, JC Penney, Mervyns, Neiman Marcus, Nordstrom, Saks Group, Sears/Kmart, The Bon Ton, and Von Maur. Traditional department stores have continued to lose market share to discount department stores, and big box retailers have taken the place of department stores not only in power centers but also in traditional malls. A new group of sub-anchors have expanded in or entered the market, greatly changing shopping patterns. These sub-anchors include sporting good stores, bath stores, book stores, and new concepts such as Steve & Barry’s. There has also been tremendous consolidation among developers, the biggest of which was General Growth Properties’ acquisition of Homart Development in late 1995 and, in 2004, The Rouse Company. In some instances, developers have gained power as they gained square footage; in other instances, their power has lessened as they struggle to fill more space. The specialty store sector has not experienced the same consolidation as the developers and department stores. Many have simply disappeared. Limited Brands and Gap are the only specialty retail companies that have been in operation for over 30 years and maintained their original focus as specialty retail companies. Many of the specialty retailers from the 1970s and 1980s have either closed (e.g., Petrie and Merry-Go-Round), or changed their focus from specialty retailing. Historically, specialty retail companies used real estate growth (i.e., more stores, larger stores) to generate continued revenue increases. Operating margins and return on invested capital declined as real estate growth reached a point of diminishing returns. To continue revenue growth, some of these retail companies became highly leveraged, which sometimes resulted in bankruptcy. Many of today's specialty retail companies did not exist 10 – 15 years ago (e.g., Williams-Sonoma, Pottery Barn, and Pac Sun). Having quickly saturated top malls, many of these retail companies have turned to second tier malls to sustain growth, although sales and profit growth have been disappointing.

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Both department stores and specialty chains such as Lord & Taylor, Michaels Stores, Burlington Coat Factory, Tommy Hillfiger, and Goody’s, are sought-after targets of capital markets, rising from $9.6 billion in 2002, to $17.5 billion in 2003, to over $50 billion in the last two years. 1 Other changes in the market: shopping at malls has become more purposeful with consumers coming to buy single items, rather than browse; consumer traffic in malls is generally down, with shoppers spending less time in malls and visiting fewer stores per trip; aging baby boomers are seen as a new and separate market with specialty retailers catering to them for the first time (e.g., Gap’s Forth & Towne, Chico’s), while still primarily chasing “tweens” and the 20s crowd (e.g., Express, American Eagle, Abercrombie & Fitch, and Banana Republic); European stores are coming to the U.S. (H & M, Zaras), while U.S. companies continue to explore, sometimes disastrously or tentatively, European and Canadian markets.

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Redevelopment of Older Shopping Centers Across the country, the trend to update old and tired retail shopping centers and malls continues through creative revitalization and redevelopment. Redevelopment may involve “demalling” all or part of an existing center as well as relocating existing anchors and in-line tenants (i.e., non-anchor retailers). The process is costly and time consuming; the results, however, can yield tremendous benefits for landlords/developers, tenants and ultimately consumers. Numerous legal and business obstacles arise during the redevelopment process. Legal issues involving rezoning, re-platting and re-subdividing are commonplace, as well as practical and community issues related to utilities, signage and overall concerns from neighbors and the local community. In connection with redevelopment and expansion, at least one developer has used condemnation as a strategy to acquire premises and lease rights. Existing landlords of retail shopping centers and malls continue with revitalization and redevelopment in order to attract a stronger customer base as well as ensure that the property remains financially strong. As part of de-malling, the traditional regional mall consisting of three to five department store anchors, numerous in-line small shop tenants and a food court, is
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“Players Predict More Mergers,” Shopping Centers Today, by Donna Mitchell, June 2004. See also, “Merger Mania,” Retail Traffic, May 1, 2006, and “Barbarians at the Mall,” Retail Traffic, by Elaine Misonzhnik, September 1, 2006; (“Since January 2005, there have been 94 deals in which private-equity partners bought retail chains. The total value is $54.8 billion .….”)

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changing. Part of the impetus for redevelopment is based upon long-term sustainability and the need to give consumers what they want. Redevelopment projects involve various uses such as: movie theaters; big box retailers as anchors; lifestyle open air mall and strip centers; and mixed-use centers, including offices and residential uses. Redevelopment projects that involve de-malling require landlords to focus upon four major areas of concern: (1) local community and governmental issues; (2) anchors; (3) inline tenant concerns; and (4) financing and lender issues. Within each of these categories, attention must be given to the appropriate parties and issues in order to ensure a successful redevelopment. Poor planning and lack of communication can create costly delays. Local community and governmental concerns, including infrastructure issues, may arise in the rezoning, re-platting and re-subdividing of the project. Problems can arise with relocation of transmission lines, underground sewer and water lines, storm drainage lines; and abandonment of old roads and railroad tracks. These types of issues can be very expensive and time consuming to resolve. The level of support or opposition to a project within a given community will also directly impact the project timeline. Local government officials will be politically motivated and will take into account the opinions of neighbors and the community at large. Landlord communication and involvement of these groups early in the redevelopment process is extremely important. Existing anchors present unique issues to a landlord when contemplating a redevelopment project. Recorded reciprocal easement agreements already in place and perhaps outdated contain specific rights, including no-build areas, that will need to be negotiated and addressed. Land owned by some anchor tenants may need to be re-conveyed in order for the landlord’s redevelopment project to move forward. Infrastructure issues related to parking, signage and traffic flow will all need to be addressed with anchor tenants. In most situations, existing agreements require anchor consent to alterations or changes to the permitted build areas, common areas, roads, and other elements. Anchor tenants traditionally carry much more leverage than in-line tenants, and a landlord must gain the cooperation of the anchors to successfully redevelop. Anchors often use these situations to obtain benefits and further leverage with the developer. In-line tenant leases traditionally provide a certain degree of flexibility to a landlord when contemplating redevelopment. It is important for the landlord to review carefully each inline tenant lease to ensure that no express prohibitions or restraints exist that might impede the redevelopment project. Reviewing in-line leases and coordinating communication is time consuming and tedious. Certain in-line tenants may be impacted directly by the redevelopment project as it relates to the possible relocation of their space within the shopping center or to an exterior location. Other key concepts related to in-line tenants such as co-tenancy rights and exclusives must be reviewed carefully and addressed by the landlord in order to avoid alternate rent or termination situations.

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