FEATURE ARTICLE, OCTOBER 2005

ANCHORED RETAIL:
Secure investment or fool's gold?
Martin Forster

Forster

When my family settled in Stuart, Florida, in 1986, one of the town's most prominent retail centers buzzed daily with high traffic as the townspeople came and went, for groceries, jewelry and china, clothing, glasses, haircuts and meals.

Located at the intersection with Monterey Road, the center had long frontage along U.S. Highway 1, the town's major north-south artery. It was anchored at the north end by Albertsons, co-anchored at the south end by Zayre's Department Store, and in the middle by Service Merchandise. While all was well with the landlord, stirrings of unrest came less than a lease term later as Albertsons decided to move to a new center across the street, later making the decision to leave the area altogether. Meanwhile, in the much less important (though much higher rent) local space, the printer kept printing, the hairdresser kept snipping, the optician kept making glasses while the restaurant continued to serve.

Life was a little tougher for the landlord once Albertsons had gone, but he still had two anchors left, didn't he? The Albertsons space was used briefly as a covered flea market, and later for the White Doves Christmas project. But fortune favored the landlord; after reconfiguration, Scotty's moved in to take on a new Home Depot a few miles to the north. And then came the trouble with Zayre's… They became uncompetitive, and after the usual, dismal procession through the bankruptcy courts, went dark. And lo, the landlord again had trouble sleeping — but he still had two anchors, didn't he? Meanwhile, in the much less important (though much higher rent) local space, the printer kept printing, the hairdresser kept snipping, the optician kept making glasses and the restaurant continued to serve.

This 20-year saga could continue for pages, but there's no value to belaboring the point. You already know that there was no happy ending: Scotty's went out of business, as did Service Merchandise and several others that occupied space in this hapless center. Today, like many other formerly glorious anchored centers, some left behind in town centers when an area's demographic focus shifted, the center limps along with significant vacancy and fleeting, underpaying occupants in some of its large spaces; it is hardly the investment-grade property its owners and mortgagees once believed it to be!

The point is that “Big Name” tenants don't necessarily equal security for the property owner or the lender. One only has to look around small towns in Florida to see the burgeoning numbers of Tractor Supply stores whose business model seems to be to occupy empty Wal-Mart stores as they vacate to create a Wal-Mart Supercenter nearby. Or perhaps to recall fondly those days when Winn-Dixie was strong, regularly triggering development financing with every new lease it signed, then contrast those days with recent months as Winn-Dixie closed 326 stores, following the 156 it closed in 2004. Every one of these closures impacted a retail property, its owner and its lender. Then consider the statistic reported by Business Week in October 2003: for every Wal-Mart Supercenter that opens, two nearby traditional grocery stores will soon close. An oft-stated corporate truism is that growth and strong income can mask many problems. In real estate the same can be said of low interest rates. But when rates finally turn, as they must, and Supercenters continue their march, like kudzu over the retail landscape, it will be interesting to see how many 20-year anchor leases run full term.

Meanwhile the local tenants keep on keeping on with their businesses. Sure, those businesses may be sold from time to time, and Joe may retire, but Joe's Vacuum Repair still fixes vacuums because people still need to have their vacuums fixed — and to get their hair cut, their nails polished and their flyers printed.

It can be argued that while their presence causes the low cap rates that investors currently reap from grocery-anchored centers, those anchors, while critical to triggering the necessary financing for developers, actually make such investments riskier later on than the more pedestrian, unanchored centers bordering Main Street in the nation's towns and cities. One might also contend that, with cap rates currently at 5.75 to 6.25 percent on newer grocery-anchored centers, compared to 7.5 to 8.5 percent on unanchored centers, the investor in anchored centers is not being compensated adequately for the risk.

How do we love unanchored centers? Let us count the ways… They are easy to acquire and to finance. There is a plentiful supply and broad choice, with some 900,000 around the nation. They typically offer significantly higher returns than anchored centers. Their short-term leases enable landlords to capture increased rental levels more quickly than anchored centers, resulting in faster appreciation. The departure of one tenant rarely has any impact on others, and doesn't cause mass tenant migration or the downward adjustments in rents that co-tenancy agreements cause. Unanchored centers typically enjoy high levels of occupancy, and vacancies normally are refilled quickly. Their neighborhood character means that they more durably retain their customer base, particularly as gas prices head skyward. The market for them is inefficient, resulting in good investment opportunities for astute investors. That is why they have been at the foundation of many family fortunes.

For institutional buyers, acquiring four unanchored centers at $5 million each is far more time consuming than buying one center for $20 million. This makes larger grocery-anchored centers completely appropriate for investors whose main focus is on deploying large amounts of capital, particularly those who hold many such centers and can spread the risk across their portfolio. But for the individual investor or family office, the unanchored center continues to represent an accessible, effective investment, easily managed and financed, that, unlike stock market investments, benefits from the remarkable opportunities offered by tax deferral through Section 1031 of the IRS code. Bottom line: for private investors seeking above-average returns in real estate with acceptable levels of risk, the unanchored strip is still the investment of choice.

Martin Forster, CCIM, is a partner in the Pocklington, Pocklington & Forster Retail Investment Group of Advantis Real Estate Services Company in Orlando, Florida.

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