Shopping Center Business is the leading monthly business magazine for the retail real estate industry.
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INSTITUTIONAL INVESTORS 116 • SHOPPING CENTER BUSINESS • December 2016 There are a lot of everyday goods and services that people need, like groceries and health-and-beauty. When we look at the demographics that we have, which are much more dense than what we had in the past, we view them has having incredible potential. We oftentimes think that we are one of the largest owners of parking lots in the country. Those parking lots have significant upside potential in the future, even if today their highest and best uses are parking lots. Dykstra: All industries are always evolv- ing — including the shopping center busi- ness. The shopping center business and retail has hundreds of years of history — from the open air markets and the grand bazaars of the old world, to main and street retail and town center retail, to the Sears catalog in the early 1900s, to the ear- liest strip retail in the '40s and '50s in the U.S., the department stores and the mall properties, to neighborhood grocery-an- chored retail, category killer tenants and power centers and lifestyle shopping centers. What is a given is that change is always underway, but the best real estate, the best 'dirt' always prevails. I don't be- lieve there is much in the shopping cen- ter business we haven't seen before or we shouldn't have expected. Most of what is happening today in our business is a natural evolution of the 'last mile' equa- tion. We don't see ourselves as being in the shopping center business as much as we are in the real estate business, with our retail properties covering the expense of owning land. When we are considering properties for acquisition, we are focused on the intrinsic value of the real estate and not the noise of evolution. The strongest locations always survive in one form or another. Vittorio: We have done a lot of studies on the real estate business, including those for historical returns. Retail tends to be the least volatile of all property types, next to multifamily. That is one of the reasons we like retail right now. As we look at the generations to come, the demographics are favorable for retail: households are ramping up, at low unemployment, per- sonal income will increase, and consump- tion will continue to drive the business. Fryer: When you are doing your analysis, are you looking at a bucket of retail, or the way an individual asset behaves? Vittorio: I would call it a decent quality bucket. We use our own portfolio as well as data from a variety of sources that con- tains a number of assets. Wheeler: From our perspective, we are a bit of a contrarian. We are acquiring in secondary and tertiary markets. We own in markets like Hawkinsville, Georgia. We are 95 percent leased there. Our rent spreads are 6.9 percent year-over-year; the industry average is 3 percent-plus. Our same-store net operating income was north of 7 percent. People ask how we keep our occupancy so high. We are constantly getting ahead of the leases and renewing, or replacing with better quali- ty tenants. At our center in Tampa, not one tenant is the same tenant as when we purchased the property in August 2000. It is 98 percent leased and occupied. Good real estate, even in a small town, works. If you have the dominant grocery store, it is hard for a competitor to come in. Even though the population may not be as dense, you don't have the competition, so your store is the store. SCB: David [Harvey], as someone who is re-entering the sector with a new entity, what do you see as the positive fundamen- tals for the business? Harvey: We are essentially continuing the model we have been successful with in the past, which is to acquire the largest, most dominant open-air centers in strong markets that are growing. These big open- air centers are comparable to dominant regional malls. These assets contain in their respective markets, the dominant concentration of best-in-class big boxes, restaurants, entertainment and lifestyle retail. Even in smaller markets, the dom- inant asset, with the best quality tenants in each tenant category, will always have a waitlist of tenants who want to fill vacan- cies that may occur. That is the strategy. Ragland: If you looked at the mall ten- ancy line-up 20 years ago at any fortress regional center, you would see that the tenants are completely different today. Owners are consistently remerchandising so as to offer best-in-class brands that are producing at the top of their respective category. As for location, we focus on high income demographic areas where these top brands tend to cluster in dom- inant centers. Harvey: As Joe [Dykstra], was saying, you are trying to buy the best real estate in the markets you are seeking. It doesn't have to be the biggest MSA. Senenman: It is all about the real estate. Tenants do not last forever. Whoever thought that Kmart would be where they are today 20 to 25 years ago? Fryer: Dominance over the trade area is the key. Even if it is a grocery-anchored center, you want the one that customers desire to the point of driving past other grocers to shop. Much of what we have done — including two past deals with Da- vid [Harvey] — has been the acquisition of large power villages that have been the dominant centers in their trade areas due to the breadth of anchor merchandising and sheer scale. SCB: How important are tenants today? Do you expect them to last the full lease term? When you are underwriting new deals, how do you view tenants in the equation? Harvey: For us, the performance of the tenants is the most important consider- ation. We evaluate every tenant based on the tenant's sales performance. If the tenant is important strategically but their health ratio is unsustainable, we deter- mine where their rents need to be to keep them around long enough to redevelop the property. If the tenant is important to the merchandising plan, we may assume a concessionary rent for the entire hold- ing period. In the acquisition process, we underwrite based on a sustainable level of rent not necessarily contractual rents. And then we try buy the property based on the NOI produced at sustainable rents. The question is: Will the tenant survive if it's rent is reduced to where it is sus- tainable? And do we need or want that