Shopping Center Appraisal and Analysis

CHAPTE
R

2
Shopping Center Investment
Markets

Because appraisers forecast investor behavior, they need to understand not

only local investor behavior that affects the property being appraised,
but also trends that are operating in national and regional markets. The
nature of real estate investments in shopping centers can be analyzed
from both historical and prospective standpoints.

Shopping Centers as Investments

The shopping center investment market is continually changing as this
mar- ket competes directly with other capital markets for the attention of
inves- tors. These other capital markets are dynamic and continually
changing, especially as the global investment marketplace has become
more united and demonstrated its ability to impact financial markets in
the United States.
The overall shopping center investment market has changed substantially
over the last quarter of a century; however, this sector of the larger real
estate investment market is itself quite large and consists of many
segments repre- senting various types of shopping centers and geographic
locations. Some of these submarkets have outperformed others. It is
important for the practitio- ner to recognize these differences and be aware
that just as each property is unique, so is its market.
Retail properties have continued to attract buyers. Retail properties are
known for outperforming other property types during this cycle and
look comparatively stable during recessionary periods. Grocery-anchored
cen-
ters are unusually popular and in many cases prices have been driven
above replacement costs.
Shopping centers in general, and regional and superregional malls in par-
ticular, have traditionally been considered very desirable investments.
Their desirability is due in part to the discipline and stability that an
anchor tenant brings to a shopping center. Historically, the most sought-
after anchor ten- ants have been department stores. Department stores
were considered to be highly sophisticated retailers, and these retailers
would know which markets would support their stores based on extensive
market research. Their draw- ing power meant that owners would offer
relatively low rents or free pads and other inducements to bring them into
a center.
Because a developer is unlikely to begin construction of a new shopping
center without a commitment from a construction lender and construction
financing is rarely available without a commitment from an anchor tenant,
unwarranted construction of shopping centers is substantially reduced.
An- chor tenants also ensure financial security because they lease a large
block of space, which constitutes a substantial portion of the shopping
center for an extended period of time. Moreover, once an anchor tenant
locates in an area, it is not likely to dilute its market share by opening
another location nearby. When successful, a regional shopping center
enjoys a real monopoly in its market and is resistant to competition from
other regional centers.
Another advantage of shopping centers as investments is that they are
typi- cally rented on a net-lease basis. As a result, increases in operating
expenses are usually passed through to tenants and the owner/operator is
assured of
a reasonably stable real income stream. Most leases also include overage
clauses which allow the owner/operator to share in the sales growth of
ten- ants. An overage clause also provides a hedge against inflation.
A third factor contributing to shopping centers’ attractiveness is the oppor-
tunity to renew the retailing space periodically. By renovating space and
re- leasing it to new tenants, a shopping center generates additional rental
rev- enue, improves its image in the market, and increases its value. When
there is a substantial oversupply of space, the ability to renovate and
renew space provides a major opportunity for investors and developers.
This recycling trend may be reinforced by the lack of acceptable alternative
investments available to investors who might prefer the outright
disposition of their retail properties. Renovation and renewal is cheaper
and safer than the construc- tion of a new shopping center that must
prove itself in the marketplace.
Rehabilitation and renovation is feasible when a center is well-located and
has good retailing fundamentals but languishes because of a curable
problem with its management, financing, or retailing operations. Physical
enhance- ment may be accomplished by adding a new facade or
landscaping, upgrad- ing the common areas, increasing the size of store
windows, or adding food courts. Rehabilitating a mall sometimes means
downsizing some of the space
 Shopping Center Appraisal and Analysis
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to attract smaller tenants. Specialty stores may be added or the space
between anchors may be enclosed and modified to provide additional space.
The objective is to enhance the shopping and entertainment experience for
those visiting the center. In some cases, the tenant mix can be upgraded
by adding more space or replacing one or more of the mall tenants;
manage- ment may even buy out a tenant’s remaining lease when
necessary. Expan- sion makes sense when a center is already attracting
traffic and its location has proven to be successful. Expansion programs
may be driven by the pres- ence of sites available for construction by
competitors.

Risk
Successful investors in shopping centers must identify and manage the
fol- lowing real estate investment risks:
• The purchase or construction of a shopping center is frequently
financed
with too much mortgage indebtedness.
• During periods of excess competition, a center's operating income may
be in- sufficient to cover debt obligations and still provide an acceptable
equity yield.
• Location is critical. A shopping center must receive the support of a
trade area with sufficient purchasing power and not be burdened by
excessive competition.
• A center must have adequate ingress, egress, and visibility. (Other
impor- tant site factors and many locational factors such as access
are discussed elsewhere.)
The quality of management and proper merchandising are critical to a
shopping center's success. Shopping centers foster relationships among
the retailers who rent the space. A shopping center is operated like a retail
store with accounting, insurance, and merchandising responsibilities.
Merchan- dising a shopping center means selecting the right mix of
tenants rather than accepting the first rent-paying applicant and conducting
periodic promotions to maintain community interest in the center.
Management and merchan- dising require supervision of landscaping,
active concern for the visibility and accessibility of the center, and
maintenance of the parking lot, lighting, security, functional common
areas, and service areas.
Through the leasing process and the lease instruments used, manage-
ment can control the risks of shopping center operations. A rent
abatement or offset clause may allow a major tenant to offset some or all of
its overage rent payments against its prorated share of some expense item,
such as taxes. Tenants may also have a contractual right to carry out one
of the landlord's obligations such as maintenance or insurance if the
landlord fails as well as to offset this expenditure against their pro rata
obligation. A major tenant's
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right to rent abatement can seriously affect the landlord's cash flows. It is
important to determine whether there is operating harmony between all
ten- ants, but especially between the anchor tenants and the center's
owner/op- erator. Tenant lease provisions are discussed later in this text.
Other risks to shopping center investors include eminent domain proceed-
ings to acquire part or all of the site, government controls, environmental
condi- tions, and excessive competition from nearby sites. As shopping
habits change, shopping center owner/operators must periodically renovate
and update their space to maintain their merchandising ability and keep
functional obsolescence in check. Other forms of retailing such as lifestyle
centers accelerate functional obsolescence and create external obsolescence
for shopping centers.
With some exceptions such as auto care malls and theme malls, shopping
centers must fulfill the purchasing power needs of the population within
their trade areas. Buying power cannot be created. Shopping centers with
substantial vacancies must be analyzed very carefully to determine where
re- tail purchasing activity will originate. Communities with excessive
shopping center development and no opportunity for additional residential
growth face a long period of maladjustment.

Occupancy-Cost Ratio
One important measure of credit risk and the potential to increase rents in
a regional mall is the occupancy-cost ratio. This is an important tool for
credit- rating agencies as they evaluate commercial mortgage-backed
securities and other financing transactions. This ratio is defined as
follows:

Total Annual Occupancy Expenses

Occupancy-Cost
Total Annual Sales Ratio 

As used by Moody’s Investors Service, the numerator includes the aggregate

occupancy costs for all comparable mall tenants including minimum rent,
per- centage rent, and expense recoveries, but excluding tenant-specific
utility charg- es. The comparable shop tenants include all tenants occupying
up to 10,000 square feet of GLA, which have been in occupancy for 12
months. Department stores, junior anchors, movie theaters, and kiosk
tenants are excluded.1
The purpose of the exercise is to judge how sustainable the rental income
is to the mall. Above-normal occupancy cost levels will lead the Moody’s
analysts to lower the projections for income. Below-normal occupancy
cost ratios may signal the potential for rent growth and likelihood for
lease renewals. Malls have some of the highest operating costs in the field
of retail formats because of the climate-controlled common area, large
parking areas and decks, security, and interior landscaping, so
monitoring the continu-

1. Andrea Daniels with Patricia McDonnell,“CMBS Occupancy-Cost Ratio is Key to Analysis of Mall Credit Risk,”
Moody’s Investors Service special report, December 9, 2002.

Shopping Center Appraisal and Analysis

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26
ing ability of the tenants to support these costs is important. The presence
of anchor department stores in the mall aggravates the cost burden;
Moody’s reports that mall anchors typically comprise 55% to 65% of a
mall’s GLA, but their share of the gross income is only about 5% of
revenues.
Moody’s experience with this measure leads them to observe that some
landlords are sufficiently astute to be able to extract higher-than-normal
occupancy costs. In December of 2002, Moody’s published a special report
in which they noted that typical cost ratios depend on the level of sales per
square foot for the comparable mall shop tenants with the normal
occupancy cost-to-sales ratios ranging from 9% to 16%, as shown in
Exhibit 2.1.
Moody’s also has other experience-based guidelines for occupancy-cost
ratios for movie theatres, arcades, and fast-food operators (up to 20% and
even 25%) as well as restaurants and some national specialty apparel
chains (ranging between 8% and 13%).
In addition to the occupancy-cost ratio, a qualitative judgment about a
mall also considers factors such as comparative sales levels, occupancy
lev- els, market dominance, trade area profile, and sponsorship.
Appraisers can also use these as elements of comparison in the sales
comparison approach and in concluding capitalization or discount rates.

Exhibit
2.1 Occupancy-Cost Guidelines
Comparable Mall Shop Sales per Square Foot Occupancy Cost-to-Sales Ratio

Less than $250 9%-11%

$250-$300 11%-13%
$300-$350 13%-14%
Greater than $350 14%-16%
Source: Moody’s Investors Service at www.Moodys.com.

Ownership and Financing

Retail properties appeal as investments to a number of entity forms,
including real estate investment trusts (REITs), pension funds and related
institutions, opportunity funds, private investor groups, high net worth
individuals, and 1031 exchangers.2 Recently, there has been a consolidation
of retail space own- ership. Appraisers should be sensitive to the types of
buyers operating in a sub- ject market and strive to learn their investment
criteria and analytical methods.
REITs are now well capitalized because they have benefitted from the rela-
tive uncertainty in the earnings of other non-REIT common stocks, lower-
yielding bond markets, and the Employee Retirement Income Security Act

2. NewBridge Retail Advisors, “Capital Market Review,” Shopping Center Business (May 2003). Note that current
capital market updates are available at http://www.shoppingcenterbusiness.com/capitalmarketsupdate.shtml.

Shopping Center Investment Markets27

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(ERISA) law change that allows for greater participation in real estate.
This has led them to be aggressive in their acquisitions of properties and
grow through mergers. Because many REITs are relatively large, they have
an appetite for large projects and multi-asset transactions. They
frequently have both the capital and the talent to reposition troubled
properties and can be tough in bargaining with tenants.
Pension funds and related institutions are frequently “all-cash” buyers
and have some difficulty competing with leveraged buyers. They have a
compara- tively low tolerance for risk.
Opportunity funds are investment companies that traditionally seek high
risk/high yield opportunities, use leverage, and seek partnerships with quali-
fied operators.
Leverage is the use of borrowed capital to increase the returns to the owner.
Leverage is judged as favorable (or positive) or unfavorable (or negative). It
can be measured by comparing returns for a property to the returns to the
lender, where returns are measured either as rates of capitalization or the
internal rate of return. Capitalization rate measurements have been
popular for their simplicity but can produce conflicting results from the
internal rate of return (IRR). Either way, the necessary condition for
favorable leverage is for the return rate to the lender to be below the
corresponding rate to the property.
Appraisers need to be aware of lender preferences and underwriting proce-
dures in order to judge the quality of leverage available to the subject
property as well as the level used at the time of sale for comparable
properties. Lenders typically control their risk through measurement of
the loan-to-value ratio
as well as the debt coverage ratio (DCR). Comparatively higher loan-to-value
ratios and/or lower DCRs will likely result in a higher interest rate or some
other underwriting proscriptions. Appraisers need to be alert to these
condi- tions. Additionally, lenders focus on the spread in their interest rates
compared to comparable maturity Treasury securities. For example, a ten-year,
fixed-rate loan might need to yield 200 basis points over the ten-year
Treasury index (200 basis points equals two percentage points in the
mortgage interest rate).
Capital is traditionally classified as debt, equity, or a hybrid of the two. At
the time of this writing, debt typically provides about 70% to 90% of the
total capital required for an investment and might be structured as
permanent loans (both fixed-rate and floating), construction loans, and
lines of credit. Equity may comprise 10% to 30% of total capital and take
the form of a joint venture, preferred equity, or loan guarantee. Hybrid
positions carry some of the attributes of both equity and debt. They may
typically contribute 10% to 20% and be structured as mezzanine,
convertible, or participating debt. Many commercial loan instruments have
been securitized into commercial mort- gage-backed securities (CMBSs) by
loan packagers called “conduits.”
In all structures for retail deals, capital contributors are risk sensitive to
the identity of the particular retail stores involved. Both individual
retailers
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and CMBSs are rated for credit quality by rating agencies such as
Moody’s or Standard and Poor’s.
The periodical Retail Traffic and corresponding Web site http://retailtraffic-
mag.com/ rank the top managers of retail property by total GLA owned. As of
April 1, 2008, the top ten managers were as follows:3
1. Simon Property
Group Indianapolis,
IN
Total GLA managed: 238,000,000 sq. ft.
2. General Growth
Properties Chicago, IL
Total GLA managed: 200,000,000 sq. ft.
3. Developers Diversified
Realty Beachwood, OH
Total GLA managed: 163,000,000 sq. ft.
4. Kimco Realty
Corp. New Hyde
Park, NY
Total GLA managed: 114,000,000 sq. ft.
5. Centro Properties Group
New York, NY
Total GLA managed: 107,236,079 sq.ft.
6. CBL & Associates Properties, Inc.
Chattanooga, TN
Total GLA managed: 81,800,000 sq. ft.
7. The Macerich
Co. Santa
Monica, CA
Total GLA managed: 76,000,000 sq. ft.
8. The Inland Real Estate Group of Companies,
Inc. Oak Brook, IL
Total GLA managed: 71,000,000 sq. ft.
9. Westfield, LLC
Los Angeles,
CA
Total GLA managed: 63,000,000 sq. ft.
10. CB Richard Ellis
Los Angeles, CA
Total GLA managed: 60,000,000 sq. ft.
These figures are likely to change as Simon Property Group has now
acquired Mills Corporation (Ranked No. 9 in 2006 with about 51 million
square feet), De- velopers Diversified has recently acquired Inland, and
Centro Watt’s (Ranked No. 12 in 2007 with about 46.1 million square feet)

has bought out New Plan.

3. http://retailtrafficmag.com/research/rankings/retail_top_managers_0410
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The National Research Bureau Shopping Center 2005 Census reports that
there are now more than 47,800 shopping centers of all sizes in the
United States. Most of these centers are less than 200,000 square feet in
size and anchored by a grocery retailer. The number of new centers varies
somewhat from year to year depending on the investment climate, but a
clear declin- ing trend in the number of new openings is visible from 1996
to 2002, with a growing trend through 2005.
Appraisers should ascertain which benchmarks are tracked by local
market makers and become informed about the current readings for
those benchmarks. Performance benchmarks for malls, centers, and
individual retailers include the following:
• Sales per square foot
• Same-store sales for the current period compared to one year earlier
• GLA per capita
• Consumer confidence levels as revealed by recent, local surveys

The Purchasing Process

Sophisticated investors perform a very thorough investigation before they
purchase major assets. This process, called due diligence by investors and
major financial institutions, should interest appraisers because they contrib-
ute to it and may find the product of the process useful.
The investigation is conducted by a team of experts in accounting,
finance, appraisal, engineering, property management, and law. It may
involve both
in-house staff and special counsel. The accountant reviews the seller’s
operat- ing statements and makes spot-checks of various records. For
example, the team might do a sample audit of the retailer’s sales to confirm
projections for percentage rent payments. To assure that lease escalations are
set according to contract, common area maintenance charges are reviewed.
Accountants exam- ine the quality of center earnings by comparing them to
national and regional averages. Excessive profits are investigated because
they can breed damaging competition and may be hard to maintain.
Accountants also look for one-time, special nonrecurring earnings; such
aberrations are particularly important.
Accountants search for missed opportunities such as the sale of waste
materials, the sale of utilities, or advertising costs that could be
recovered. Appraisers prepare estimates and forecasts to guide investors
in develop- ing bids. Their work may precede other parts of the due
diligence process, but they may also want to consider information
obtained later in the process to revise any important assumptions on
which the appraisal is based. Ap- praisers may perform a continuing role
throughout the process to determine
whether any new facts uncovered or judgments made might cause the
invest-

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ing institution to violate corporate policy or regulatory law. In this way,
the appraiser confirms his or her appraised value.
Engineers evaluate the physical components of the shopping center to
identify needed repairs and estimate their costs. If this information is
avail- able to the appraiser, it can provide the basis for estimates of
obsolescence and costs to cure as well as the adjustments applied in the
sales comparison approach and the expenses considered in the income
capitalization ap- proach. The property managers on the team will
probably want to accompa- ny the engineers on the inspection to help
identify deferred maintenance and extraordinary maintenance costs as
well as help determine whether a center is being undermaintained and
thus generating less cash flow. The property managers and possibly the
appraiser should do follow-up inspections before the closing to ensure
that the property is in acceptable condition, all major tenants are
operating as expected, and there are no problems with the per- sonal
property or equipment to be included in the sale.
Property managers confer with the shopping center tenants during this
investigatory process to hear their complaints and concerns about the
center. Complaints that surface during verbal discussions or in the
estoppel certifi- cates may be routine problems that are present in any
center, or they may be indications of serious and otherwise unknown
deficiencies. Property manag- ers can tell potential purchasers whether or
not the shopping center is an effective synergistic retailing enterprise. If it
is not, the tenants may simply be putting forth a minimal effort to avoid
claims of breach of contract and fulfill their merchandising obligations
under the lease. This situation would be indicated by operating with low
inventory levels and secondary personnel.
The appraiser should study the role of the property manager and investi-
gate his or her motivation to better understand the property and
enterprise being appraised. Because managing a shopping center is a
relationship busi- ness, the appraiser must also understand the behavior
of the tenants and the shoppers in the center. Only by understanding
market behavior in the pres- ent and past can the appraiser make a
reliable forecast.
Legal counsel will review all key documents involved in a shopping center
acquisition. In-house counsel for an institutional investor will probably
have responsibility for monitoring the due diligence process to ensure that
it com- plies with corporate policy as well as the regulatory statutes of the
jurisdic- tion. When an institutional investor undertakes the purchase of a
package of properties, in-house counsel may manage and coordinate the
various indi- viduals and processes within the investigation, often
retaining local counsel to review important documents such as major
leases, reciprocal easement agreements, and existing mortgages. The
leases of nonanchor store tenants are usually reviewed by the appraiser,
and legal counsel is concerned only with the standard store lease form.

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Local counsel will investigate local building and zoning codes for com-
pliance and check for certificates of occupancy as well as compliance with
parking and subdivision regulations, environmental safety and health codes,
and hazardous waste regulations. All appropriate certificates, licenses,
ap- provals, and litigation that affect the subject property must be
reviewed.
Local counsel is consulted concerning the impact of state and local taxes,
including how the property taxes for the subject parcel will be affected by
the price to be paid. The contract document and proposed deed will be
exam- ined, as well as the title insurance policy. Special concerns to be
investigated by local counsel might include, for example, whether an
easement that benefits the subject property will be cut off as a result of
foreclosure on an abutting property or if the center operator can legally
resell electricity to the center’s tenants.
The shopping center appraiser should understand when the due diligence
process is to begin, how his or her duties coordinate with the duties of the
other team members, and what information is available for review in
prepar- ing the appraisal. These items should be discussed when the
contract for the appraisal is negotiated, perhaps in a pre-authorization
data request form.
Before a sale is final, the investor’s underwriters will scrutinize the eco-
nomic representations contained in any promotional materials supplied
by the seller’s investment banker. The appraiser should determine
whether the sales literature and original offering document are available
for inspection.
The due diligence process is concluded when the team members meet to
identify and resolve problems and communicate unresolved issues to the
seller and the seller then provides written responses. Several rounds of
nego- tiations may be required to resolve all the problems uncovered in the
process. Problems may be resolved through price negotiation, sharing of
costs to cure, indemnification to the purchaser for some matters, sharing
of specified risks, or the seller’s promise to perform certain tasks after
closing. The seller may agree to obtain certain approvals, zoning changes,
quit claim deeds, or other documents to clear up ambiguities.

Financing with REITs

Individual investors have found advantages in real estate investment
through publicly traded securities including liquidity, diversification, and
freedom from management of direct holdings. REITs have grown from 58
such traded Equity REIT entities with $5.55 billion dollars in assets in
1990 to 153 with
$275.3 billion in 2004. In addition, real estate mutual funds have also
gar- nered attention and capital investments of $4.77 billion in 2003.4

4. For further discussion, see “More Wires, More Brands, More Owners” in the Wall Street Journal, February 9,
2004, page R7, as well as the www.reit.com Web site (click on “All About REITs”).

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Once seen as mere acquirers of assets, REITs are now credited with
understanding how to manage and market their properties. During their
growth, REITs learned to use debt capital in their acquisitions. This debt
was frequently rated by one of the agencies, leading the REITs to greater
disclo- sures in their financial statements. This sort of “transparency” is
frequently credited with improving the match between supply and demand
for real estate and leveling off the development cycles of prior years.
To the extent that REITs are active in the market area of a subject property
appraisal, the appraiser will need to study their acquisition analytics to see
how values are viewed. Instead of traditional market value targets, the REITs
look for funds from operations (FFO) that are “accretive” to shareholder value.
REITs often do not seek a traditional definition of market value in their
metrics.
Current problems facing REIT investors include terrorism insurance and
a general distrust of financial reporting. But REIT assets are quite
tangible. REIT shares have generally sold well and are seen as stable
assets in a volatile era. Recent years have seen a REIT consolidation. The
Simon Group, Rouse, Macerich, and General Growth Properties have
spent a combined $7 billion recently to acquire the portfolios of Rodamco,
JP Realty, and Westcor.

Mixing Retailing and Real Estate

A shopping center is a co-venture between retailers and developers, so ap-
praisers seeking to understand shopping centers should know something
about the retailing business as well as shopping center development and
man- agement. In the 1960s and 1970s, shopping center developments and
depart- ment stores experienced significant growth. The shopping center
development industry was dominated by several large companies including
The Hahn Company, Melvin Simon & Associates, Homart Development
Corporation, The Edward J. DeBartolo Corporation, and The Rouse
Company. Department stores grew in part through mergers and
acquisitions, and by the end of the 1970s the industry was dominated by a
few large corporations such as May Department Stores, Allied Stores,
Associated Dry Goods, Carter Hawley Hale, Federated Department Stores,
and R. H. Macy & Company. A few department stores joined to undertake
development activities, including May Companies and May Centers,
Federated Department Stores and Federated Stores Realty, Sears and
Homart Development Company, and Dayton Hudson. Passive joint ventures
were undertaken by J. C. Penney’s and R. H. Macy’s Properties.
Overexpansion and turmoil plagued retailers and developers alike in the
1980s. Few development opportunities remained, and by the middle of the de-
cade complaints about excessive retail space arose.5 Profits were declining, and
controlling expenses became management’s paramount objective. Staffing and

5. See, for example, “Merchant’s Woe: Too Many Stores,” Fortune, May 13, 1985.

Shopping Center Investment Markets33

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merchandising were reduced, and retailers focused on profits rather than
sales growth and market share development. Many companies were not
successful in dealing with the changing demographics of their markets. By
the mid-1980s,
many department store companies were attractive targets for leveraged
buyouts, which were popular at the time. This situation was partly the result
of underuti- lized real estate assets. A number of leveraged buyouts and
mergers burdened these companies with large amounts of debt, creating a
need for short-term operating profits and changing the identity of many well-
known retailers.
While the retail industry was restructuring, so was the development
industry. At the beginning of the 1990s, a number of developers sold
shares of stock to the public to raise capital. They soon learned, however,
that stock market investors did not understand the business of
developing shopping centers. Wall Street investors did not appreciate the
high risk, heavy capital needs, high start-up costs, and short-term cash
flow losses involved in these investments. Subsequently, some developers
bought back their stock to go private, and some retailers sold their
shopping center development entities.
Institutional investors did understand the retail real estate business, however,
and they appreciated the inflation hedge and growth potential it offered.
When traditional shopping center and retail development opportunities
waned during the 1990s, developers turned to innovations such as off-
price centers, power malls, specialty centers, and festival or lifestyle
shopping centers. By the end of the decade, a trend appeared in which
large develop- ers were buying department store companies to control
anchor tenants for future shopping centers. For example, L. J. Hooker
purchased Bonwit Teller,
B. Altman, Parisian, and Sakowitz. Campeau Corporation, which later
filed for bankruptcy protection, purchased the Federated and Allied
Department Store chains. This vertical integration of retailing and
shopping center devel- opment caused great concern because it eliminated
an important external check on the overexpansion of anchor stores. It will
probably continue to concern real estate appraisers as their attempts to
assess the ability of a sub- ject shopping center to compete in a trade area
are complicated by entangl- ing alliances between some of the tenants and
competing developers.

Recent Trends in Retailing and Shopping Centers

Since the first edition of this book, several trends have emerged. With a
con- solidation in department stores, many such stores are closing their
locations in malls. Landlords have started to lease space to prime
discounters such as Kohl’s and Target to replace department stores. Not
only does this restore the stores’ function as anchors, but these stores are
usually able to pay more rent than the traditional department stores.
Shopping center space has increased dramatically over the last 10 to 15
years. The National Research Bureau (NRB) Shopping Center Census
reports
 Shopping Center Appraisal and Analysis
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34
on numbers of centers by size. Selected data from this source shows this
growth in Exhibit 2.2.6
Industry watchers like to estimate shopping center space per capita within a
market area. The NRB also reports the GLA per capita, as shown in Exhibit
2.3.
Much of the growth in per capita GLA occurred during the stock market
peak, when low unemployment and surging home equities (and securities
values) made consumers feel a wealth effect. However, most urban
markets now have excess retail supply, and some shopping centers have
problems with design, size, tenant mix, and demographic appeal.
PriceWaterhouse Coopers issued a report in 2001 to the effect that 20% of
the regional malls in the country were in some stage of distress.7 A
Goldman Sachs analyst esti- mates that up to 800 retail mall locations
could become available in the next decade as the present anchors fail or
withdraw, and only 200 to 300 of those could be retenanted by discount
stores.8
Numerous retail companies have gone out of business or reorganized
under bankruptcy protection, including the following major tenants in
the nation’s shopping centers:9
• KB Toys (the country's largest mall-based toy retailer)
• Montgomery Ward

Exhibit
2.2 National Research Bureau Trends
1986 2005 % Change

Under 100,000 sq. ft. GLA 18,230 30,27 66%

0
100,000-400,000 sq. ft. 8,775 16,02 83%
2
400,000-800,000 sq. ft. 918 1,628 77%
Over 800,000 sq. ft. 573 775 35%
Total 28,496 48,69 71%
5

Exhibit
2.3 GLA per Capita
1986 2005 % Change
Number of centers 28,496 48,695 71%
Total GLA 3,522 6,059 72%
GLA per capita 14.74 20.53 39%

6. 2003 CoStar/NRB Shopping Center Census, www.costar.com, information downloaded from www.cluster1.claritas.
com/MyNRB/Default.jsp?ID=43&SubID=40 (February 10, 2005). Information is also available at the International
Council of Shopping Centers Web site, http://www.icsc.org/srch/rsrch/scope/current/UnitedStates06.pdf.
7. Matt Valley, “The Remalling of America,” National Real Estate Investor (May 1, 2002),
http://nreionline.com/ microsites.
8. Mike Duff, “Two-tier Mall-based Wal-Mart Store Lands on Fringe of Dense NYC Market,” DSN Retailing Today
(June 9, 2003).
9. “The Bankruptcies Begin!” Retail Traffic Online vol. 2, no. 53 (January 14, 2004), http://enews.primediabusiness.
com/enews/shoppingcenterworld/v/96.

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 • Service Merchandise
• K-Mart
• Zayre and Ames stores
• Factory 2-U (a 250-store discount apparel chain)
The empty stores left behind provide opportunities for liquidation and
work- out specialists but are also competition for new stock.
Store closures have been announced by Gadzooks, Wet Seal, and Eddie
Bauer. Phillips-Van Heusen Corporation also announced that it will close
28% of its 700 retail stores. Other retailers and restaurants that have
raised credit concerns include Landry’s, Pep Boys, O’Charley’s, Whitehall
Jewelers, Toys R Us, Paper Warehouse, Blockbuster, Harold’s, and Today’s
Man.
Some of the “category killers” that are sought by leasing agents include Wal-
Mart and Target in the discount store sector, Walgreen’s in pharmaceuticals,
Best Buy in consumer electronics, Home Depot and Lowe’s in home
improve- ment centers, Staples in office supplies, and Bed, Bath and Beyond
in soft goods.

Mall Design
Numerous commentators assert that the shopping mall has lost the interest of
the shopper and become a blight on the suburban landscape.10 They decry
its dependence on automobiles, its poor and ubiquitous design, its disregard
for both interior and exterior aesthetics, and its controlled culture of
consump- tion and homogeneity.11 This is seen as the fault of the developers
who care more for the revenues to the mall as a whole than for the
individual retailers.
To better compete with other malls as well as other forms of retailing,
many developers are experimenting with new designs known as “town
cen- ters,” “lifestyle centers,” and “shopper-tainment,” which were
described in Chapter 1.
Appraisers need to observe how some centers use their space for advertis-
ing. Advertising displays make use of walls, kiosks, mall TV networks, and
other media. Some owners, like Simon Property Group and Westfield Inc.,
have invested in leveraging the brands of their tenants into additional
intan- gible value.

New Tenanting
Part of the conventional wisdom in creating a shopping center tenant mix
has been that certain businesses like movie theaters and health spas are
undesir- able tenants because they take up lots of dead parking and the
customers of those businesses do not patronize other merchants. Today,
developers rec-

10. See the article “The Controlled Culture” by Seth Siegel in the January 30, 2004 edition of The Wall Street Jour-
nal, page W9, and the book reviewed in the article, Call of the Mall, by Paco Underhill, Simon and Schuster, 2004.
11. Ibid.

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36
ognize that some of these tenants, such as movie theaters, can be a draw
to bring family business inside the center to other family-themed tenants.
As a result, some center designs now place the theater nearer the inline
space in- stead of on an outparcel, as has commonly been done before.
This is one way in which investors and developers are trying to enhance
the shopping center to differentiate their center from the ordinary.
Drugstores have preferred larger footprints in order to offer more high-
margin merchandise. This has frequently led drugstores to depart from
strip centers and create leasing challenges for center owners.

Department Store Chains

Department stores have been faced with stiff competition from
discounters at the same time shoppers seem to prefer the
merchandising and customer service of the specialty apparel shops.
When anchor department stores were built a generation ago, typical sizes
exceeded 200,000 square feet; today, a typical store may be about 150,000
square feet in area. (Mall inline space has also been downsized.) The
impact of this smaller size is usually higher sales per square foot and
higher valua- tions. Appraisers need to be sensitive to functional
obsolescence in the older designs and sizes. When the department store of
today fails or leaves a center, the management is faced with the challenge
of leasing the large space.

Discounters
Once the competitors of regional mall department store anchors, the
discount stores and other big-space retailers are now becoming mall
anchors them- selves, often taking over the space of a withdrawn
department store. Kohl’s and Target have adopted this as a strategy to
compete with Wal-Mart, while shopping center owners like it because they
see the potential to increase the rental rates above the low rates paid by
the department stores. Wal-Mart is both a major draw for other tenants in
shopping centers that feature the store as well as a feared competitor for
nearby merchants.

Remerchandising
The overexpansion of retail space and shopping centers generally has
lead to a glut of unsuccessful and distressed real estate. Much of it will
not be feasible as retail and will be a candidate for other uses.12 Greyfield
is a new term that has emerged to describe these properties. According
to the Center for Transportation Excellence,
Greyfields are abandoned, obsolete, or underutilized properties such as regional shopping
malls or strip retail developments. Greyfield redevelopment is an opportunity to introduce
new life and infill development in blighted commercial spaces. Declining shopping malls

12. For the latest news on this topic, see www.deadmalls.com.

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and strip commercial streets which often constitute large tracts of land can be converted
into new mixed-use neighborhoods.13

Much of this redevelopment is expected to require public and private

coop- eration and financial support.14 Some malls will be converted to
mixed uses and others to totally non-retail uses.
Some developers are investing large amounts of capital in the redevelop-
ment, renovation, and expansion of existing but obsolete malls. This
remer- chandising of malls requires a deep understanding of the trade
area demog- raphy, the competition, and tenant mixes. These developers
have cultivated close working relationships with local governments and
major tenant chains. Some developers have generated surprisingly good
returns in the process.
Joint ventures are frequently the entity of choice. An investor may
contribute the bulk of the capital while a developer contributes expertise
in the retail redevelopment and management of a property. The investors
include REITs, pension funds, and other institutional investors.

The Grocery Business

Grocery-anchored neighborhood centers are enjoying great popularity with
investors. Driven more by the demand for investment outlets than grocery
fun- damentals, prices are comparatively high and capitalization rates are
between 7% and 8%.15 But competition in the grocery business is ferocious,
with Wal- Mart now the largest volume seller in the country. Wal-Mart
enjoyed 2006 U. S. grocery sales of about $134 billion in 2006, almost
three times that of Kroger, the second-largest volume seller in the country.16
The business has seemed to perform well through the recession and the
weak recovery in business. Large stock gains have been enjoyed by four of
the large companies in the grocery- anchored sector—Regency Centers,
Kimco Realty, Pan Pacific Retail Properties, and Weingarten Realty Investors.
The seven largest publicly traded food retail- ers—including Albertson’s,
Ahold, A&P, Delhaize America, Kroger, Safeway, and Winn-Dixie—are losing
market share to Wal-Mart and other supercenters.
Wal-Mart has become such a juggernaut in all its lines that competitors
struggle to come up with a plan for coping. Some try to reach a higher
price point, leaving Wal-Mart for the moderate-income consumers. Other
investors avoid locations within the shed of influence of a Wal-Mart
location.
Appraisers need to be sensitive to the risks facing investors in grocery-an-
chored neighborhood centers. Some observers think the smart money is
selling out at the top to less-informed investors. Obviously, when a
transaction occurs, some investor sees a value or a future in the asset that
the seller does not.

13. From http://www.cfte.org/glossary/glossarypage.asp?Letter=G

14. Valley, “The Remalling of America.”
15. Matt Valley and Parke Chapman, “The Grocery-Buying Binge,” National Real Estate Investor (August 1, 2003).
16. Information taken from the release of PlanetRetail.com’s ranking of the top 30 grocery retailers worldwide in 2006.
For more information, see www.planetretail.net.

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E-Commerce
In the 1990s, some commentators thought that online shopping would
be- come a serious threat to stores and shopping centers.17 While
demonstrating relatively high growth rates from small sales volume
bases, the impact of Internet purchases has been narrowly limited to
certain lines such as books and music. With exceptions like Amazon.com,
many e-tailers have failed to generate sufficient promise to retain their
investors and have disappeared. The grocery model in particular did not
do well.
Today, the level of sales on the Internet is a significant part of the universe
of retail sales. If governments figure out how to levy sales taxes upon e-
com- merce, some of the competitive edge will be lost. Internet shopping
has al- lowed some retailers to develop another marketing outlet. Shoppers
can now research detailed product information and conduct comparative
evaluation on the Internet before going to the store for the purchase. In this
way, the Internet has encroached more upon catalog sales than upon travel
to store locations.
Finally, the Internet has provided technology for more efficient manage-
ment of retail space. Purchases and inventory can be managed with e-
mail, tenants can place work order requests, and even leasing activities
and pay- ment systems can be facilitated with the Internet.

Retailing in a Shopping Center

There are a number of aspects of the retailing business that appraisers
should be aware of and evaluate. One important consideration is the pre-
ferred store depth within the submarket. There is usually some
particular depth that is considered most desirable by retailers in each
market, despite the fact that a shorter space may generate a higher rate
of rent per square foot. The shorter space does not permit optimal use of
the site. Local leas- ing agents will probably be able to describe the sizes,
locations, and types of retail space that are currently popular.
An appraiser should analyze the overage clause and its breakpoint in the
lease. (The breakpoint is the level of sales at which the percentage clause
is activated.) Some retailers may find it feasible to open another store
nearby even if it diverts some of the trade area’s purchasing power. This
might be an attractive option because increasing sales at the original
location could trig- ger the percentage clause and increase the total
occupancy costs.
Some national retailing companies are increasing their share of local mar-
kets at the expense of local retailers. The appraiser should observe
industry trends for the principal tenants in the mall to forecast their
percentage sales and the probability of lease renewal.

17. Phil Brit, “E-commerce and the Rise of Big Box,” Valuation Insights & Perspectives (Fourth Quarter, 2003).

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Many retailers can be categorized as either “value- or commodity-ori-
ented” or “point-of-view-oriented.” This distinction affects the extent to
which the retailer contributes to the drawing power of the shopping center.
Value- or commodity-oriented retailers feature depth of inventory and
selection and a modest shopping environment; they may have only limited
drawing power for the rest of the center. Home Depot is an example of a
value-oriented re- tailer. Point-of-view retailers offer greater service and
unique merchandise in an expensive environment calculated to draw
shopper traffic.
If mall tenants cater to a fashion market, for example, it would be useful
for the appraiser to determine how well each of these retailers anticipates
the tastes and demands of shoppers and gears their buying and inventory
prac- tices to take advantage of them. Admittedly, this is a very difficult
task, but limited interviews with retailers, sales clerks, customers,
competitors, and mall managers may reveal which retailers are most
successful.
Appraisers should also be aware of normal promotional activities in shop-
ping center submarkets. Many shopping center operators conduct annual
marketing programs or special events to increase shopper interest. These
activities are typically paid for by the manager of the shopping center out
of a marketing fund to which all the shopping center tenants have
contributed. The presence or absence of this kind of promotion on the
part of the shop- ping center operator should be noted by the appraiser.
Internet technology has made it easy for appraisers to gather information
and insights as they start new assignments. Some good data sources for
retail property analysis include
• www.retailmaxim.com
• www.reis.com
• www.icsc.org
• www.businessweek.com
• www.nreionline.com
• www.sconline.com
• www.pwc.com
• www.fitchratings.com
• www.realert.com
• www.plainvanillashell.com
• www.ecommercetimes.com
• www.planetretail.net
• http://retailtrafficmag.com
• www.STDBonline.com (Site To Do Business)

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Summary
Appraisers should understand how investors view shopping centers. Large shopping
centers were attractive in the past because the presence of anchors reduced the market
risk posed by competing centers. At the time of this writ- ing, grocery-anchored
neighborhood and community centers are popular.
The use of net and percentage leases allows owners to pass some increases in operating
expenses on to tenants and to recover part of the value created when the venture works.
Percentage clauses also offer protection against inflation. Growth in the trade area
around a good location may offer profit- able opportunities for expansion on surplus land
or the remodeling of a tired building, even when new retail construction is sluggish.
Shopping centers are not without problems. Some retailers and service tenants
experience comparatively high occupancy costs in their shopping center locations. This is
partly due to high property taxes based on assess- ments keyed to overly optimistic
purchase prices. Investors and appraisers need to be sensitive to how occupancy costs
relate to tenants’ sales revenues.
The risks facing center owner/operators include the construction of sur- plus retail space
and changes in retailing techniques that can cause functional obsolescence. Appraisers of
shopping centers should attempt to stay abreast of conditions in the retailing industry and
the activities of major firms.

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