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INSTITUTIONAL INVESTORS 100 • SHOPPING CENTER BUSINESS • December 2017 important. We're fundamentally using the same underwriting standards, inflation rates and vacancy factors; tenant improv- ment assumptions have gone up in recent years though. Other than redevelopment potential, we are pretty much in the same spot for underwriting standards. FALATKO : One change is that tenants are modifying their formats, so underwriting is morphing. We have some tenants who would prefer not to do a 10-year deal because they don't know where they're going to be in 10 years. We spend a lot of time educating lenders about what is happening with the retailers and have learned to focus on which categories are evolving. For example, the sporting goods category — we're looking very closely at what is going on in that part of retail and the tenants within those categories who create a shopping experience. Our deci- sions are always tenant-driven. CLARK : We underwrite different scenar- ios, including value-add and redevelop- ment scenarios that we think will work at some point in the future, but I do think we're spending more time on tenant sales and what their health ratios are and talking to the tenants about how their store performs. Even though there's an option and generally at increased rent, we don't always underwrite the contractual obligation. There is a fair amount of push back from tenants at option time, so we're spending a lot of time looking at their health ratios at that particular location, checking to see if they are in their current proto-typical footprint and the proximity to their other locations in the market. It can be very costly to make changes and downsize a tenant and put another tenant in. We're underwriting the up side, but we spend a lot of time underwriting the down side as well. FALATKO : At VEREIT, we've worked through downsizing options with several tenants. We always consider if it's best for a tenant to stay in the same box first. We also think through the cost of down- sizing and the upside of keeping a tenant in place by potentially re-working a lease. We also explore where the opportunity is to grow such as pad sites. You must be flexible, but also committed to what will work. We're finding that some firms are retaining the pads and the developer will buy a new center. With the REA, some- times the center is incorrectly defined, so we've had to go back and recast the REA. In some cases, the shopping center was the whole property at some point, then they sold the pads, they forgot to restrict them, etc. When we are redoing REAs, we assess the potential for other modi- fications like parking counts and other improvements for the future. FRYER : We do two things consistently when we underwrite power centers. Even in our best cases, we always assume that one big box will fail to renew and we suffer attendant down time and re-leasing costs, even if all tenants are creditworthy with good sales. You expect at least one failure amongst the line-up. We don't know ex- actly who or when or what is going to hap- pen, but we reserve anyhow. The other thing we're doing is trying to be a landlord that provides more than just space. We're underwriting non-recoverable expenses for marketing programs where there may not have been one before, social media maintenance, event programming and customer profile research. Even as we get into smaller centers, these actions will be necessary for competitive positioning. MUSSELL : We're taking a harder look at some of the existing tenants in the cen- ters, where do we see them five years from now? Does this retailer have for- ward thinking management? Are they being proactive with the changes that are going on in the world. We're also taking a hard look at the apparel retailers. It can't all be food. SCB : We overview the market, particularly retail, and three years ago we created our conference Entertainment Experience Evolution all about the changing environ- ment in retail. The conference discusses exactly what you're talking about — how do you change your centers to be more inviting for the consumer? You talk about the retailers being more successful, but you also have to get the consumers there. How do you make your centers more exciting that the consumers will come back, they will bring their kids, they will want to spend time there? What are you doing to make your property exciting for consumers? COOPER : In one example, Toys "R" Us is utilizing virtual reality in 25 locations. You go into the store with your phone, and in different sections of the store, you can actually virtually play a game. Lowe's has been very aggressive in virtual reality with virtual show rooms where you can picture what the furniture is going to look like in your own house. HOLDEN : We have changed our leasing strategy in several of our assets. Where historically we had a lot of mom-and-pop shops, the national retailers entered push- ing all the mom-and-pops out. Now, we're back looking for the specialty retailers — the mom and pops, the regional guys that can create that customer experience — to bring some sort of uniqueness to the asset. VALERO : Look at Lincoln Road in Miami as an example. It was a wonderful mom- and-pop outdoor street that local resi- dents used often in the '90s. Now, it has become 100 percent national chains; local residents hardly visit the street anymore; it has basically become a tourist destina- tion. I believe that as some national chains fail and disappear the mom-and-pops will come back to replace them. RAGLAND : There has been a lot of research with various consumer groups. Consum- ers go through the phases of a purchase: discovery, trial, purchase, delivery/pickup and potentially return. Millennials are not using stores that much differently than any of the other demographic groups. If you talk to retailers and you talk about how many store managers are compensat- ed right now, they're compensated based on their store sales as well as online sales in their trade area. I think that retailers are going to help us define how the physical store fits into the omnichannel world. I think it's a combination of consumers and retailers being well informed about each and really being educated by each other in terms of how to transform the experience.