COVER STORY, MAY 2008

RETAIL DEVELOPERS CONVERGE ON THE CAROLINAS
The development of Coastal communities, mixed-use projects, highlight second annual Carolinas Roundtable.
Moderated by Randall Shearin, Chris Thorn and Mark Rowell

Southeast Real Estate Business recently held a retail roundtable in Charlotte, North Carolina, to discuss the development climate in the Carolinas with a number of developers. The roundtable was hosted by Childress Klein Properties at its headquarters in downtown Charlotte. In attendance this year were: Connell Radcliff, 1st Carolina Properties; Bill Rooney, Hill Partners; Shoffner Allison, Hawthorne Retail Partners; George Dewey, Aston Partners; Brody Glenn, Centennial Partners; Chris Thomas, Childress Klein Properties; Alan Kahn, Kahn Development; Britt Byrne, Faison; Tim Sittema, Crosland; David Hill, JDH Capital; Jeff Wakeman, Centdev Properties. Moderators of the roundtable were Shopping Center Business Editor Randall Shearin, Southeast Real Estate Business Editor Chris Thorn, and Mark Rowell of BridgePointe Advisors.

SREB: Are big box and lifestyle difficult to develop right now?

Kahn: Several of the leading lifestyle tenants have pulled back, and when they pull back it really hurts. We can’t get interest from other retailers because we are relying on them to lead the charge. We are seeing some big box pull back too. I’m not worried about the financing, although I should be, but these tenants are a killer. If we can get the tenants somehow, we’ll get money to get a deal and stack capital on something like that. The big thing is that there is tenant pull back. Some lifestyle tenants are doing very well and expanding. The real question is going to be whether we can get co-tenancies and couple together enough critical mass to lead the charge.

SREB: What’s the interest you are seeing from retailers?

Radcliff:  Raleigh’s saturated, so you don’t see a whole lot activity in that market. In some of the other markets there might be opportunities, but as everybody knows Harris Teeter is pretty far ahead of the curve. We opened a Bi-Lo recently, and we’re doing some more deals with them. Farm Fresh is slowly moving along. They’re coming into the Carolinas. We’re encouraged, but it’s not like it was the last couple of years.

SREB: What do you see with the big box tenants? You’re doing some of the third phase at Alexander Place Crossing.

Glynn, Byrne and Radcliff

Byrne: It’s actually junior anchors, and we’ve done a couple of these deals in the last few years where we’ve been able to put together 150,000 square feet of box, junior boxes and add more with the co-tenancy issues. We’ve got the Brier Creek area [northwest Raleigh] pretty much saturated too. Everybody who wants to be involved is at Brier Creek. But we do have a few folks that pulled back on us at the end of 2007, just as we were kind of kicking things off. In general it was easier for them to pull back, given the economic climate that they foresaw, in addition to company specific issues that affected the site. I don’t want to lay it all on the economy, but the timing could have been better.

SREB: Did anyone else see tenant interest pull back?

Rooney: In lifestyle, there are people out there opening doors. You have to dig a little deeper and find the deals. I think there are some people who see an opportunity, typically more than a lifestyle center, and try to get in, but I think there are a lot of tenants that we haven’t seen in these markets that will start coming around. You have new brands that we have typically seen, like Chico’s, Talbots, Ann Taylor, and they’re pulling back. But there are other ones out there that I think we’ll see starting to show up that are not in these markets. We’re optimistic. You have to dig a little deeper, and explore every avenue. We are trying to locate some people who are typically in other regions of the country and get them down here to look at the Southeast.

Sittema: This is not specific to lifestyle, but to some of the larger format retailers. I think it’s pretty much across the board for them as well.

SREB: How is the investment climate in the Carolinas?

Rowell: BridgePointe has four partners who are on the investment sales side. Right now they are working on a Publix-anchored shopping center. I know that’s small because it’s a sub-seven cap. The buyers are still out there. The banks are active, but it’s funny when you talk to banks. The only money that’s still really available, that’s still originating really well is construction financing. But as far as acquisition financing and refinancing that’s jamming up the system right now. Obviously, one of the questions to all of you is about the pressure on cap rates. A lot of it is being driven by the financing market, by acquisition financing in the takeout market. Over the last few years we’ve had a return on the cost of development and had pressure from the retailers. Your return on costs has shrunk. You have cap rates starting to go down. Retailers are pulling back; you have cap rates, and everything else losing the other way, so it kind of causes a stall out here for a little while. Everything kind of reformulates, and everybody tries to get a new page.

Dewey, Thomas

Thomas: I think it will raise some discipline in our industry, and maybe we need it at this point in time. I think we are going to see a period where, as in the early 1990s projects, that might have happened in previous years will no longer happen. There is a reason for that. The projects that will happen are those projects that we have all looked at and said, ‘Well, gee, if we can’t sell this are we going to be comfortable in 5, 7 or 10 years?’ If the answer is yes, then that project will kind of be out on its own merits and not just because its convenient to build a project we know that we can flip out of in a few years, which has been so prevalent in our history recently.

Rowell: There are a lot of vacant unanchored strips out there along the roadway.

SREB: Has your development mentality changed?

Wakeman: Well, you always have to have a dual exit strategy. We do, and that’s part of the discipline that Chris [Thomas] was talking about. You look at both strategies. Where am I going to end up on a permanent financing side of the project, as well as is there a demand in the market place for what I am doing? You have to have the ability and the flexibility to use either exit strategy on your properties. Like Chris said, people in the last few years have gotten so enamored with cap rates that we’re out there because the market was heated. It really wasn’t healthy for our market. It really wasn’t.

Byrne, Radcliff and Dewey

Radcliff: We’ve all got to focus on sticking with the issue anyway. Some of the smaller tenants were probably under capitalized. We made some decisions to put some people in business that we probably shouldn’t have. Our focus now is to maintain stabilization of the properties. To do that, we are going to have to work with some tenants on the small side and struggle through sometimes. Not do what we used to do all the time. We need to keep a good tenant. If it’s not a good tenant, then you have to find a replacement. Our leasing efforts are getting more aggressive and we’re trying to find the quality tenants that will be better for the long-term.

SREB: Is anybody seeing insurance company or institutional capital coming back to the market here?

Rowell: Yes. There are just a lot of distractions in the market with other opportunities. There are a lot of securities out there that you can buy that have age on them and are really good quality paper. And you can earn 15 to 20 percent returns buying paper. There is a lot of distraction in the market. Whole loans going at big discounts. There is a lot of money pooling out there. I think at some point there is going to be big movement, and hopefully it will cut the bottom off of this downward spiral. A lot of people out there are ready to jump. Somebody’s going to jump first instead buying the stuff. Wachovia and Merrill Lynch are sitting on a lot of fixed rates. They need to get rid of those.

Dewey: I agree with some of what Alan [Kahn] said earlier. I mean the money is there. We priced two deals in the last 2 weeks to start construction on, and the pricing on our construction came in the same as it was before the CMBS fallout. So on the private side, we’ve never done business other than with life companies. We own our centers for several years, so we’ve wanted a relationship with the lender and we’ve never left that market. So we’ve got those relationships, and they’re pricing them at 6.25 or 6.50, but I mean that’s better than it was 10 years ago. I think the bigger issue is the tenants and making sure that you are pursuing really good quality locations that you can deliver on and have a story to tell with the tenants. Make sure that you are leased up when you’re finished and not half vacant.

Radcliff:  There is a good sign we are starting to see. On our Park West Village project, we’ve had contractors come back in and re-price. We’ve started to see significantly that the trades are getting pretty hungry. We are starting to see substantial savings. We hope that continues obviously.

Sittema: I would be curious to hear: are the rest of you seeing that as well, across all the markets?

Dewey: We just priced a deal that came in 20 percent less than it would have last summer.

Wakeman: We just had the same case. We’ve gotten a couple of quotes that are cheaper than what we were looking at last year. I think it’s because of the competition that’s taking place as well. Dirt that used to cost us $12 per yard last year, now it’s been working at $6 per yard. It’s availability. They’ve got their overhead, and they’ve got to pay. So they are willing to go out there and just put their people to work.

SREB: Do you think the hunger from construction companies is coming from the lessening of the demand for retail or lessening from some other sector?

Kahn

Kahn: Maybe residential. We’re running a commercial business, and 2006 was the best year we ever had. I thought it was an anomaly, but 2007 was better and 2008 is going to be very good. So we are pumped. Now we’re commercial, but the residential business is taking a hit – devastated. There are people looking for work that you haven’t seen in the last 10 years. A lot of people are referring employees looking for work. I don’t know about the residential construction side, but it’s got to be hurting and that’s got to have some impact, especially the kind of material we use, like wall board. But, as you know, the steel and oil is going straight up. I’ve been meeting about capacity problems, and they’re going to continue. We are in a world market. There is a lot of demand in the world, and we are not going to see that subside apparently. So we are not seeing a whole lot of pull back in prices in general, but I notice some pockets of it. I think that’s good, but it won’t last.

Sittema: I’ll add to that too. We’re not seeing the construction prices fall, but there are pockets; we started seeing some savings a few months back, but then we just bid another project last week and it was much higher than we expected. So, we are hoping to see more of the deflation in construction pricing.

Rowell: Since last summer, the weaker developers who couldn’t get deals done before are having a hard time obviously in creditor climates. The lenders were really making sure that they really run their developers through the ringer and understood all the projects and cash flows to make sure the deal is sponsored and is going to be around for awhile. We are actually seeing a lot of weaker developments with good sites, good business plans, some tenants in tow, who can’t get the deals done. They are coming to us to ask to for a stronger partner. They want to generate a joint venture with somebody. What are your thoughts on joint venturing deals with someone who has a good site? Is that something that you would consider or would you want to take it over, give them a little piece?

Byrne: We’re doing it with land owners. We’re doing it with other developers or smaller developers who felt that they got more than they wanted to bite off. Felt like they needed to bring in capital muscle. We absolutely do it, and you can structure it any number of ways. How involved do they want to be? Some are fully vital, but generally speaking they are not, but in some cases they are. In that case, you really are starting out a little bit ahead of the game.

Radcliff: We are a classic example of that at Park Village West. We are partnered with Casto and JP Morgan. The pieces fit together well. It’s a good relationship. We get the entitlements. Casto is involved in the construction and leasing components along with our help from JP Morgan, who wrote a big check for the land, and we couldn’t have done that. It’s a great site, but without that equity partner, a key component of it we wouldn’t be able to do. As I look around the room and everyone talks about what they are doing, almost everyone says we are doing this with somebody else. I think you are seeing that quite a bit. I don’t think there is a person in this room who wouldn’t want to do something prudently. If you get the right partner, if the discipline’s working, it’s a different area.

SREB: Chris, you mentioned a project with a big developer: General Growth.

Thomas: The Bridges of Mint Hill. That’s really more a marriage for the fact we got a 215-acre site, and it’s going to have different retail components. Some of those, our partner General Growth is the best at, such as the department store and high-end retail. Certainly that’s a business that we are not in. We are keeping the part of the project that is more of what our track record has been in that last few years, which is more of the junior anchors, and it works out well. Our philosophy is about being patient, and putting up with 6 years of going through entitlements. We’ve got a ways to go as far as the amount of work we’ve got to do. The key to partnership is to find someone who can understand complimentary abilities, and is a good fit for your organization and the way that you guys can stay together through what could be a rocky road.

Glenn: And I don’t think it’s just small developers looking for bigger developers. You see a lot of bigger developers that are working together, and I think that’s got a lot to do with the tenants. There is only so many deals that can get done. For two sites that are competing, the big guys are coming together and saying, ‘Let’s do this together,’ instead playing against each other.

Wakeman: We are seeing an adjustment in land prices that has to take place right now. We have to become rational about what the land prices are. One of the solutions from our perspective is to bring that person in and say you are going to get a back end piece of this deal, so you can realize what you think should be the profit on this project. Also, it exposes them to just what the entitlement process is and trying to get the tenants and that type of thing. Usually by the end of the day, they just want out. It’s a way to bring that seller to the table and say, ‘Okay, you are not going to realize what you did 2 years ago, but you can certainly leverage your profit right now if you want to stay in the deal.’ It’s just another solution.

SREB: Last year we discussed at length the town center phenomenon that’s occurring. Every town in North and South Carolina wanted one. Many of you have developed one. Where is the demand for these projects? Is it still there? Are they still being developed?

Sittema: I would say the demand is stronger now than it was last year. In virtually every market, that’s the one product type that a lot of municipalities seem to be attracted to. At the same time, the work required, the risks associated are all exponentially greater than a single-level, single product type of project and the margins for the other brand on those deals. I think there is going to have be some backward changes going forward for those deals to be viable. It’s going to have to have more public participation on the financing side for some of those deals. Clearly, there needs to be some reduction in the land prices, and we haven’t really seen that substantially. Many of us were involved in the ‘80s in this business when the banks took over sites, that’s when the free fall for land prices hit. I certainly don’t expect to have anything of that magnitude here, but I do expect to see some further softening in the land side.

Allison

Allison: The demand is there for what we’re working on. I think we have to be a little bit more creative than in the past. We are thinking outside the box on retailers and uses. A couple of our sites we’re working on, the sites are in such bad shape, the existing shopping centers are so stressed that the communities have embraced what we’re doing. We’ve been working with the neighborhood associations and solving for their needs. It’s  what we have been paying attention to, and not just bringing in the standard line of retailers, but really listening to the community and interacting with the community very far in advance and solving their needs.

Rooney: I was going to mention that I think there is opportunity in some of the bigger markets. They may have one or two town centers. There is opportunity in secondary markets for them. From the customer side of things, people love to go to that environment to shop, and it’s strong in all those markets. And so the idea of town center is attractive to customers, and I know it’s difficult to put together a lot of the issues on our side of it, but in general, if you talk to retailers and listen to their customers, the customers are saying that I prefer to shop in a town center. We have the town center plan, and now we have interest from hotels and some residential.

SREB: How is the tenant interest for those types of projects?

Rooney

Rooney: We see some tenants that are in the market. Some may be in a regional mall let’s say, and they want to pull out of that. They will if there is an attractive town center coming online, and that’s what they think the customer might like. It’s a little more luxurious, a little more upscale. They prefer to shop where it’s convenient, close to home and a better environment. We’re seeing some tenants that see an opportunity to come out of the old tired regional mall.

SREB: Where are you looking for development opportunities in North Carolina today?

Dewey: We’re slowing down. Two years ago, we were looking at everything that came our way. Today we are looking at every deal very carefully, and we don’t have the capital that a company like Childress Klein has, so we’re looking to have 10 deals and have $500,000 on each deal in the hopes that we can catch the mouse in the trap. We’re going after the really good properties, spending the time to get them zoned and then deliver on those. It’s time to look forward a little bit and let some of the average ones go off to the side. That’s what we’re doing.

Kahn: There is some pull back going on in our industry. A number of the major lifestyle developers are cutting their development pipelines. Not through any weakness, but just through a deliberate desire to downsize. We are getting hammered somewhat by construction costs going up. I realize some of you have experienced some reductions, but I’ve just seen it going up. And rents are not even higher than they were 3 or 4 years ago. Sure, we made out with a little bit lower cap rates, but if the cap rates rise a little bit and rents don’t rise, lifestyle centers are going to become increasingly difficult to build on the retail side. Now you know making money from apartments is another way to do it. Making money on the restaurant side and the outparcel side. I mean there are some other elements that are possibly better. I’m not so sure about apartments because that’s a thin thing too and that could slow down. Right now we are getting this rush because it is difficult for some people to apply for a residential loan. And so some of those people are forced into apartments. I just think that lifestyle is going to be extremely tough because of the rising costs and flat rents or declining rents. Declining rents are just a killer to me because they force you to take bigger chances, and that’s why I’m concerned. I’m not cutting back yet, but I am very careful about getting hung out on projects. I haven’t seen much give from the landowners. They don’t understand our process or time, and they are looking for a buyer. If you don’t take it, then someone else behind you is promising a quick close. Sometimes, it just isn’t going to happen.

Sittema: It’s gets back to what we said earlier. It’s a return to discipline in this market, which I think right now is a good thing. I think all of us are being careful. It’s a return to quality. It used to be you’d go build in a growth area. Well, there aren’t any growth areas anymore, so it’s high growth areas of the level that we’ve seen in the past number of years. There is more focus on the infill side. There is more focus on quality real estate and that discipline about making sure we are not doing deals for the fun of it, but doing them for the economic sense. I think that’s a good thing in the industry.

Wakeman and Sittema

Wakeman: I think on a macro level though, we’re all pretty lucky. We’re in the Southeast, and it has experienced the least impact of pretty much anywhere in the country. So if you have to be somewhere in this business right now, this is where you want to be. But I don’t think it’s a panacea. None of us are sitting here saying everyone is coming to the Carolinas, and we’re going to continue the growth that we’ve had. It’s certainly moderate at this point.

Byrne: One thing that’s got a lot of potential is the military growth in North Carolina. It creates a number of jobs, not just military jobs, but civilian jobs. We’ve benefited from the base realignment and closure act (BRAC) for a number of years. It’s going to continue to accelerate. What I was surprised to see was how many of those jobs are paying big dollars. I mean this isn’t just private first class; it’s generals coming to North Carolina. A large concentration from the Pentagon. So I think there’s some areas like that around the large bases. Our company’s been active in those areas for 30 years, so it’s really not a surprise to us. That’s one area that’s continually benefiting by something very specific happening.

Radcliff: We’ve got going, for example, a number of projects near Goldsboro [North Carolina], and they had an increase of about 350 jobs. What’s followed that sector has been the jobs in the private sector that support that base, so you’re are going to see two or three other companies come to support Seymour Johnson Air Force Base.

SREB: What about some of the retirement areas? Are they still growing too? Like Wilmington, Asheville and Charleston?

Kahn: Well we were looking in Bluffton. In South Carolina, we’re getting some people moving halfway back from Florida. People are kind of sick of Florida, and they are not moving all the way down there. So we are getting some of that, and I’m sure it’s happening at the beaches of North Carolina as well. Although right now, they are pretty far down in terms of their absorption and existing housing.

Rooney: We had just a small project in Litchfield, South Carolina. It’s local specialty shops. They are all doing well. It’s fairly insulated from recession. There is a lot of disposable income. It’s all independents, but they all have good sales.

SREB: Any hope that the retirees may extend into the cities as well? There was some discussion last year of people from the Florida area moving into the Charlotte and Asheville.

Thomas: In every city, you can probably see it. Probably in Iredell County, north of Charlotte. South of Raleigh, people are moving to Johnston County. I don’t know if this fits necessarily more with high taxes and the other baggage the comes with living in the city.

SREB: Are there still some attractive markets? Is someone trying to get you to come to town to build a center?

Dewey: The tenants. There are lots of small markets trying to attract Harris Teeter, Target, Food Lion or a Wal-Mart. Getting the tenants to go is the issue. If you’re going to be able to get a deal done, it’s going to be in a metro market where there are still some strong demographics and some growth.

Rooney: We’re doing a couple little infill projects in Biltmore Village in Asheville and see strong sales coming out of there. J. Crew is coming in for a first store there. Williams-Sonoma is excited about coming. I think it’s a little jewel.

SREB: Is that market different than the normal demographic that appeals to these retailers? Is it a little bit smaller market than they would normally go into?

Rooney: It’s smaller. You have to do some explaining to them, and show them on paper. Maybe from 600 miles away they say, ‘No, that doesn’t work,’ but when you get them there you show them the neighborhoods and Biltmore Estates and show them the Tiger Woods development and what’s going there. Guys lighten up, and they can do the business. There are people doing business there today that have strong sales. Chico’s is a great store there. There are little independent shops, restaurants doing strong numbers there. You have to get people to sites like that, and show them what’s going on in the market.

Rowell: In the major metros in the Carolinas — Raleigh, Charlotte — I know the Atlanta area is still seeing a lot of the suburban markets looking for identities still and asking developers to come in and redo the downtown area. You’ve got this huge list of all this pedestrian walkways and fountains and all this stuff to make your numbers work and you usually throw in a bunch of condos and so forth. Are you seeing in the major areas around here — the little suburban towns trying to regain their identity and redo their downtowns — those numbers work anymore? Are you having issues with retailers and also issues with residential? Is that something that’s going to continue?

Thomas: It’s probably up to us to give them some tough love. I went out to the foothills of North Carolina 2 weeks ago and spent one morning with a town. They had a big industry announcement for their town and said, ‘We’re ready now to have some retail that we don’t have.’ I’m showing them the demographics for the market and they just don’t work for what the town wants. So, it’s not popular to go talk to someone about what they can’t achieve. Hopefully, you can find something that they can achieve. There are some real fundamental issues out there. People have been told things can happen.

Rowell: There are two tax areas for retail projects: the sales tax obviously can benefit the project, and also the real estate tax. I know in Georgia with the TADs (tax allocation districts) we’ve been trying to set up around Atlanta, there is some strong backlash from the school systems. TADs are a great idea, but there is a lot of pressure.

Byrne: We talked about some of the incremental sales tax generated by our projects and we’ve run into a lot of confusion even on the part of the local folks in North Carolina. I think it is population, not what’s actually generated within that jurisdiction. It’s doled out on the county level, not the township level. We’d talk about a project and say it’s going to bring X number of dollars. Show me how you do that because this is coming from town managers and folks on the city council not understanding how it’s done. When you really generate those numbers and you go through them, we were given these formulas and they are not very big. This may be a very small town with a very big project in a larger county, and the county is getting most of the benefit, not the town itself.

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