COVER STORY, OCTOBER 2010

ATLANTA RETAIL ROUNDTABLE

Recently Southeast Real Estate Business hosted its annual Southeast Retail Roundtable at the offices of Morris, Manning & Martin at the Atlanta Financial Center in Buckhead. Many thanks to them for hosting us. The attendees at the 2010 Southeast Retail Roundtable were Reece Stead, Stead Retail Group; Matt Sours, John Ginley and Homer Lee Walker, Morris, Manning & Martin; Jim Hamilton, Holliday Fenoglio Fowler; Ty Underwood, NAI Brannen Goddard; Ray Uttenhove and Steve Gunning, SRS Real Estate Partners; John Perlman, Adams & Co.; Ricky Novak, Strategic 1031 Exchange Advisors; Whitney Knoll, Newmark Knight Frank; J.R. Connolly, Connolly Realty Services Inc.; Marc Weinberg, Shopping Center Group; Ted Benning, Benning Construction; Scott Shuman, Arnall Golden Gregory; Alan McKeon, Alexander Babbage Inc.; Jackie Wammock, Coro Realty Advisors LLC; Tosh Wolfe, Mimms Enterprises; Bill Read, Developers Diversified Realty; Mike Puline, DLC Management; Julie Solomon, Retail Insight; Christopher Decoufle, CB Richard Ellis; and Michael McMillen, RCG Ventures.

Ray Uttenhove, Steve Gunning, J.R. Connolly, Tosh Wolfe, Scott Shuman, Whitney Knoll, Ricky Novak, John Perlman and Marc Weinberg.

SREB: There are a number of you involved in the investment sales area of the shopping center industry. What is the climate in Atlanta and the Southeast for sales?

Knoll: The Southeast is a strong market for core properties, and that is from South Florida all the way to the Atlanta area. There are some people at the table who have made some sales lately. Atlanta is on everyone’s radar screen. There has been a lot of activity here and there are assets on the market.

Novak: In the last 2 weeks, we have had 10 new 1031 exchanges come in and five of those are in retail. In the last 3 months, we had that many conversations about potential exchanges. Some of our developer clients are looking at how inexpensive dirt is right now. They are looking at selling income producing assets at a stabilized cap rate and rolling that into ground up construction. These deals are $5 million and under. A lot of it is single-tenant, triple-net lease.

Hamilton: The big story this year has been grocery-anchored shopping centers and select power centers. There has been significant demand for grocery-anchored centers. We see demand as strong now compared to the height of the market. Cap rates have compressed anywhere from 100 to 200 basis points from 2008-2009 levels. Underwriting today is much more conservative and realistic than it was at the height of the market. Investors are being very detailed in underwriting.

Decoufle: Grocery-anchored is at the top of the food chain for demand. The story within the story is that the pricing level within the quality rungs; there is a tremendous difference. The thing that will help all of us is that when you go off the top rung pricing, the assets are not being priced as aggressively. Another story is the resurgence of CMBS. We are seeing that come back weekly.

SREB: In California and in the Midwest, we are hearing that there is not a lot of Class A retail coming to market, but what does come to the market trades at a premium.

Decoufle: That’s a very correct statement.

SREB: Mike [McMillen], as a buyer what do you see?

McMillen: We have been very active. We closed a deal earlier this week. We are closing another today. We are buying deals that have a lot of moving parts. We are not buying the stabilized core assets. We are buying deals with upside, perhaps with vacant boxes.

Knoll: There are fewer B and C centers on the market right now; they are a little harder to find.

Novak: On the capital markets side, people are asking who in the world is doing 1031 exchanges in today’s market? You generally have to sell at a gain. Those we are seeing have a very low basis [in the property] and have done exchanges in the past. Because of that historic exchange pattern and the depreciation of the property, it is still is making sense for them. The clients also have a perception on the replacement property side that there is debt financing available.

SREB: How easy is it to identify the product on the replacement side?

Novak: There are people who are willing to sell. You have distressed assets and you have product that is selling at a stabilized cap rate. You have two different buyers in the market. Most of the sellers — if you are able to sell a core asset — you may take advantage of a replacement property that is at a value in the marketplace.

McMillen: Taking deals in all cash allows us the flexibility to jump on them quickly.

Perlman: I have reissues out on three letters of intent that I placed between January and June where other buyers were not able to close. Nothing positive has happened to the properties in the interim. The brokers have come back to me and asked me to take another look. I have not closed on any of those yet, but I’m told financing is available. You do have to show you have the cash at hand.

SREB: Chris [Decoufle], what are you advising your clients to do with regard to financing? What is the norm today?

Decoufle: The norm changes every week. That’s good, because it is changing for the better. It really depends on the asset. For the very best grocery-anchored center, you can get debt that starts in the 4s. If you go down the quality scale, you will see some recourse on some situations for some buyers. That partial recourse is going away. The CMBS loans can get up to 70 percent loan-to-value. It depends on sponsorship and the quality of the property.

Wammock: We are active in acquisitions. We are looking for the Class A, high quality, well located properties. There was a window last year where if you got lucky, you could get something for a low cap rate. That window is closed. It is competitive right now. We can close all cash and act quickly, but there is still competition for the really good grocery-anchored properties right now.

SREB: As all-cash buyers, how does that position you when you go for a bid?

Wammock: The question we get the most is, ‘where is the money coming from?’ They want to know who our equity source is.

McMillen: Over the last 4 or 5 years we’ve built a track record and we have a good reputation for closing. That’s why we continue to get the deals.

Shuman: Not everyone can go and buy broken assets anymore. That is a big difference in the market today. You don’t see less qualified sponsors going out to make these purchases.

SREB: Are you seeing interest in distressed properties?

Knoll: There is interest, but the lenders have not put a lot of them out yet.

McMillen: We have not even hit first base in what is coming.

SREB: We have heard that based on the performance of lenders’ balance sheets, they may beginning to let some of the properties move to market.

McMillen: We are closing a deal today that went into default 11 months ago. It went to a special servicer. We are closing on the note today. That is how long it takes from default to sale.

Walker: The last two center deals that I closed, which was a few months ago, were distressed assets. We had a buyer working with the lender. The original borrower was teetering on bankruptcy and the buyer acquired the note from the lender in a loan-to-own program. They kept the borrower in the deal so they could continue to manage the property and earn fees. If you can get access to the lenders and the people dealing with the special assets, they have more flexibility to deal with the sale of the note than they do with the disposition of REO.

SREB: Bill [Read], as a public company, how does your company look at the market as a buyer and a seller?

Read: We’ve been both, but more of a seller lately. What we did 2 years ago was different than what we will do in 2010. This year is about making sure we have the right portfolio going ahead. We define our core assets as prime properties. That accounts for probably 80 percent of our net operating income. About 200 out of 600 properties we have generate most of our NOI.

SREB: Ray [Uttenhove], what are retailers concerned with?

Uttenhove: The position of the retailer is affecting a lot of decisions. So much of what the retailer is looking for and demanding in centers has affected whether the center is distressed or whether it is on the market. Co-tenancy has been a big discussion. For retailers, they have to produce sales and if they sign up for a well anchored, well leased center, that is why they are paying the rent they’ve agreed to. They have to have some guarantees along the way. I don’t think that is going to go away. Retailers have a great concern as to who the owners are, where they are spending their time and energy right now.

SREB: We heard a little of that at our Chicago Roundtable. Retailers want to know if the owner of the center is going to be around, and if they have money in the bank. Do you find that to be true in this part of the country as well?

Uttenhove: Definitely. Retailers have always wanted to invest their time and energy where they can get a return. That has increased, without question. If there is not a track record, or there is not capital available, the odds are the owner is not going to be able to deliver in this kind of market.

Read: Retailers are doing that with a different urgency. We had more retailers come into our booth this year in Las Vegas still looking at 2010 openings. We had something like 23 to 26 retailers who were looking for vacancies to fill this year. Typically, good anchor tenants fill their pipelines by May. There is a lot of concern about whether some developers can meet the construction schedules. I don’t think retailers are as worried about 2011, but I think they are wondering what product will be available in 2012 without new development. That has led to a nice change in the retail market because there are a number of anchor retailers who are changing their size to fit [vacancies]. A number of retailers have expressed a willingness to work within some of the confines, which creates more opportunities.

Marc Weinberg, Jackie Wammock, Julie Solomon, Christopher Decoufle and Michael McMillen discuss the commercial real estate industry at the Atlanta Retail Roundtable.

Weinberg: I have seen that with a few of more clients, where they have gone from a 60,000-square-foot requirement to fitting in 35,000 square feet. Other retailers are managing their sizes to fit the available spaces. Because they have shrunk their inventories, they don’t need as much space. That size difference is also creating a problem. If you look in the Atlanta market, the Alabama market and other markets from Virginia to Florida, we are seeing a disappearance of boxes. They’re gone. In the primary markets in Atlanta, those boxes are gone. The Circuit City boxes and Goody’s boxes are taken in top markets. What are retailers who want to enter the market going to do? They are going to downsize and manage the size of their stores to the market. I work for Save-A-Lot for the entire state of Georgia. We are seeing a diminishing opportunity whether it is in Fitzgerald [Georgia] or Atlanta. They have a huge growth plan. This shortage of boxes is going to make developers look at new opportunities. The challenge for the developer will be to figure out how to do this in a non-anchored format. You may not have a Target or a Kohl’s, but you could have a Ross and other tenants. I think we are going to feel this backlog more in the next few months.

Wammock: I would agree completely. Last year, we had four empty anchor boxes. As of right now, one lease is signed and we have two letters of intent. We only have one box left. There are people who are looking at these boxes.

SREB: Do you have to right size the boxes?

Wammock: The retailers, as Marc was saying, have been more flexible than in year’s past because there is not a lot of opportunity for them. The biggest challenge for development is how to make development deals that are sitting on the sidelines work. There is going to be a need, whether it’s 12 or 24 months out, for more space.

McMillen: I would echo that in the middle markets, except for the rent is still a big issue. Eighteen months ago, we had nine Walmarts that were paying us rent that were dark. Today, we have one. They’ve been replaced by Big Lots, Tractor Supply, Save-A-Lot, Dollar Tree and the like. The reason we are able to do those deals and get them done, is because you can usually get a fairly reasonable buyout. You usually have to put some money into these deals to subdvide the boxes.

Weinberg: We’re not talking about 2007 economics here. We are talking about 2002 or 2004 economics in terms of the rental scheme that these tenants will pay to be in there. It is another ball game. Your basis has got to be low or there has to be some exit strategy for the landlord.

Uttenhove: These are uncertain times for everyone, including the retailer. There is a conservative approach to forecasting sales. Marc, you are absolutely right, there is an assumption that we will be back. That may not be the case. Sales have been impacted; there is a lot of unpredictability about this market that is affecting how retailers are forecasting.

Decoufle: What kind of productivity do retailers have in Atlanta as compared to other markets?

Weinberg: It depends on the retailer. Atlanta has historically been one of the most competitive grocery markets in the country. The grocery stores do well here depending on where they are. None of them do great.

Puline: One of the trends we are seeing is retailers spending more of their own money on their buildouts. Years ago, they would expect a turnkey or lots of tenant improvement dollars. That is one thing that helps [landlords] while they are receiving lower rents.

Solomon: That depends on the retailer in that case as well. Some of them will do it to lower their rent.

SREB: Are you finding any easement on restrictive covenants?

Read: Those clauses have always been around. It is certainly been much easier to work with national anchor retailers on getting consents. We have some that just aren’t going to change, but we have gotten a number of consents for smaller retailers. What has happened in many cases is that the retailers have already talked. It has been a nice change. The complexity of the issue will arise when we get back into new development. The retailers will want to get back to the old days of being the only person in the center in that category.

McMillen: I hope that the tenants understand that we are looking at a lot of broken deals with co-tenancy clauses. We are having to walk away from great opportunities because we are pigeon-holed and there is no way to add value. The developers got into this mentality where they were going to sell the center anyway so they didn’t care about the exclusivity and co-tenancy clauses because they weren’t going to own the center in a year. There is no way out of it unless you can sit down with the tenants and work through it. Otherwise, you will have a vacant center on your hands for a long time.

Uttenhove: It still might be hard when you are trying to sell a fashion tenant on Tractor Supply.

McMillen: There is fashion in Tractor Supply! Actually, we do see retailers like Belk going into smaller towns in good locations. I’m referring here to where a pet store goes dark and the lease reads that you have to replace it with a pet store only.

Wammock: Three or 4 years ago, we weren’t worried so much with issues like co-tenancy. We felt we would manage the risks — what were the chances of three of the four anchors dying out? Guess what, it has happened. Going forward, if retailers do expect to get the co-tenancy and concessions that they used to get, we are going to have a problem owning property because it will be difficult to refinance these properties. The banks are scrutinizing co-tenancy and other issues.

SREB: Regarding co-tenancy, another issue is alternative retail uses like health clubs. While they may draw daily use to the center, they are a drain on parking for other tenants.

Solomon: A lot of my tenants exclude health clubs, or they want them a minimum of 250 feet away from their front door. They want to make sure the customers can shop at their stores.

Read: You have to have that discussion up front. To have these restrictions well thought out allows a developer to have a future merchandising plan. Some of these centers are so big that it could be a mile from the retailer to a health club box.

SREB: Are healthcare and medical uses commonly excluded as well?

Read: They are usually excluded in national retailer leases. These anchor tenant deals get done with 25 exclusions and that gets copied to the next anchor deal. The next thing you know, the same clause shows up in four anchors. I don’t have a problem going to the retailer justifying our reasons. You have to put an acid test to exceptions. You want to know why there is a value to the anchor and to the landlord. We’re not always going to agree, but you can have the discussion.

Sours: On the investment side, we represent a non-traded REIT that is sitting on over $1 billion that it is trying to deploy. They can’t find the product. They have historically been triple-net retail; they can’t find that and they are diversifying now into office an other products.

Ginley: They are looking at doing joint ventures with large REITs and expanding as opposed to buying 30 or 40 Walgreens at a time. They will pay cash and finance deals later at 50 percent loan-to-value in syndicated loans. They usually package five to seven centers. There just aren’t any easy deals out there. Everything takes a long time and it is tough.

McMillen: We have seen a lot of joint venture activity pick up in the last 6 months. Pension fund advisors, life companies and REITs are looking for value-added sponsors.

Decoufle: The world is awash with cash and everyone needs yield. You will see pension funds upping their real estate allocations.

Novak: If the carried interest legislation passes, you will have a fundamental change in the way deals get done. Your equity will now be placed in ordinary income rates instead of capital gains rates. Developers will have to structure deals differently, since returns on investment will be impacted.

Shuman: Some of our clients have a tremendous amount of cash and they are having difficulty in placing it. They are also looking at joint venture deals. The deals that they want to buy aren’t for sale. Guys who are sitting on $1 billion cash don’t want to buy broken assets; they will leave that to someone else.

Connolly: We are seeing deals that are being made more complex and taking longer than they should. You can have a simple outparcel transaction and you have to negotiate every little detail. Where it would normally take a month to get a contract, we are seeing it take 5 months.

Shuman: If everyone is saying the banks’ underwriting is much more detailed, why shouldn’t everybody being doing that? I’m glad people learned some lessons from the past few years. If everybody is being more careful, then it will slow things down.

Weinberg: Staffing also is slowing things down. There is less staff in a lot of people’s offices these days. I was in a major retailer’s regional office 2 days ago and they walked me through what was their development section. It was dark. Everyone has fewer people so it is difficult to get deals done.

Alan McKeon, Ted Benning and Mike Puline attend the Atlanta Retail Roundtable, which was hosted by Morris, Manning & Martin in Atlanta.

Benning: There has been a fundamental shift between a growth driven strategy by most of the retailers to an operational strategy. The operators have taken over again. They have imposed procedures and controls. So many of the people who we are working with don’t want to make a mistake. They want to check everything. If there is a big decision, they want to make sure someone else makes that decision. That operations/compliance mindset has been imposed on what has traditionally been an entrepreneurial business. The two worlds are really in conflict right now.

SREB: Steve [Gunning], you represent a lot of retailers. Where are they looking in the Atlanta market?

Gunning: They are still looking in the core markets: Perimeter, Alpharetta, Roswell and the like. They are staying away from the markets that are further out. Closer in, densely populated areas is what they want. Midtown and the West side are popular. The Peachtree/14th Corridor is also popular. They also look at redevelopment opportunities. I recently met with a developer who had a well located center, but he hadn’t put any money into it for years. He now has some significant vacancy. The developer told me what he was going to do and I realized that he was going to remerchandise and redevelop the center. I thought to myself, ‘this is what development is going to look like for the next few years in Atlanta.’ Developers will take an existing asset and redo it to make it work for retailers.

Wolfe: We have gone through the exercise of looking at everyone of our assets and made a determination of how much capital to put into each in order to entice retailers.

SREB: As an owner, do you look at redeveloping a property all at once, or tenant-by-tenant?

Wolfe: It depends on the asset. We have a spot in Mableton where we are looking at a freestanding building. We plan to add to it later. We have some intown centers where we are going to rework the entire properties.

Uttenhove: Without question, retailers are looking at the core intown markets. We are struggling from the retailer side and the owner side with mixed-use. There is a desire to be intown, but committed to convenient parking and other criteria. Some properties that have challenges are mixed-use.

SREB: There is a lot of vacancy in the mixed-use projects here.

Uttenhove: That also creates an opportunity from a local market. There is a lot of focus on the local retailers.

SREB: Has there been a change from the counties or cities where you are working? They gain a tremendous amount from the sales and property taxes.

Solomon: I would say it is harder. Retailers are having a hard time getting their permits for things like signage. You’d think a lot of these cities would roll out the red carpet for a new business and they are not.

Wammock: Do you think that is because we have several new municipalities in the area? [Editor’s note: Over the past several years, Sandy Springs, Johns Creek, Milton and Dunwoody have incorporated in the north Atlanta metro area.]

Left to right: Matt Sours, John Ginley, Bill Read and Alan McKeon.

Read: There are a few counties that are doing better. Douglas County has been helpful in getting new deals and have allowed for some increased signage. They made a big difference. If you look at some of the municipalities, we have to add to the construction periods for people to get permits. That is the last thing any merchant or landlord wants to do; they want to get open.

Solomon: Many have also cut staff and hours of operation.

Wolfe: In some cases, we are adding on at least 30 days for permits, maybe more in some cases. I’ve had a few deals lately where we have gone into a free rent penalty because we missed the mark due to the municipality slowing things down.

Weinberg: I have seen many smaller towns who will jump through hoops to get a great tenant. If you are asking about tax incentives to get new deals, there are a few of those but there are not a lot.

Solomon: The city of Rome just gave some tax incentives to the retailers in a new development there.

SREB: We have a number of cities and counties who ask us to help them promote their retail.

Weinberg: There are programs, but the traditional chamber of commerce methods of the counties are not working to promote the kind of development they want to bring to their areas. They are now going out and trying to figure other pathways to bring business to their markets. We have a program that started in Tennessee where we are soliciting business from the municipality to develop the marketing for them. They can then aid the developer by outlining the retail vision for the market. That is a different thing than trying to do tax incentives or other financial incentives.

Read: We are requiring on deals where we know there is the potential for this type of conflict that retailers hire an expediter. We want to take this out of the retailers’ hands and put it in the hands of a professional.

Wammock: We have spent some time during the lease negotiations, particularly with anchor tenants, where we knew the municipality was going to give them a hard time. It was an education process for the tenant.

Reece Stead, Jim Hamilton and Homer Lee Walker.

Stead: We are seeing a lot of the cities saying they are being more business friendly. We still haven’t seen a fundamental change in the governments.

Wammock: I had the economic development manager for one city running around with tenants. He has called me saying he was bringing a tenant to the market and wanted me to meet him to show a building. This city has a lot of shop vacancy and I though it was very proactive on his part.

Benning: On redevelopments, we are getting cross-code generational projects where a project was constructed under an old code and now we are under a new code. The developer or owner has put so much pressure on cost; they’ve hired a low price architect who is going to produce the minimum number of documents to get a permit. They go to get the permit and there has been no time budgeted to explain to the building official how this complies with code. We have to take a lot of time to explain how these drawings do comply. We spend more time on that than we ever have.

SREB: How are the regional malls in the area doing?

Uttenhove: The stand-out, well-anchored malls are doing well. The challenge is when you have a lot of small shop space. The specialty tenants have suffered some.

Gunning: I was with a client this week and we walked through two different malls. My perception was that there is more temporary tenants than I’ve seen in previous years. They are filling the space but probably at lower rents. It is a good incubator for new retailers.

Solomon: They have gotten creative. They have started to look at local tenants and concepts like Legoland — different tenants to bring in families and customers.

SREB: Alan [McKeon], what kind of research are

McKeon: We are seeing a barbell effect among today’s shopper. We are seeing a big difference between boomers post recession and millienials. It is impacting the malls in terms of who is going and why they are going today. Boomers have more of an emphasis on value. They are feeling price pressure. You see Nordstrom Rack and other value retailers expanding. Millenials are cued into social media. They are looking at coupons and mobile applications that offer value. They’ve grown up knowing only deals. Getting millenials to go back to purchasing at full price is going to be a real challenge. Social media is a good way for malls to pick up lost marketing budgets.

SREB: One sector that is interesting about this time is the department stores have changed their business model. They suffered greatly when times were good. Now, they are holding their own. Have they realized what their business model is?

McKeon: They have realized the opportunity to drive [consumer] deals. If you look at the volume of coupons, special offers and special sales that the department stores have, they are really responding to consumer demand. They know who the target is and they are giving you a reason to come back tomorrow. If you go back tomorrow, you’ll have another deal to come back in 3 days and another one after that. Another area that’s changed — someone touched on this before — was that retailers are more operationally focused. That is working for department stores. They are using consumer demographics to identify and target their customers more effectively in small groups.

SREB: Is there more of an opportunity for off-price shopping centers and outlets?

McKeon: Absolutely. Value centers have done very well. If you look where the growth is, it is power centers that have value oriented retailers and outlet centers. Outlet centers have done very well through the recession. We have trained the consumer and we are not going untrain them quickly to go back to paying maximum dollar. Whether you are Coach who has moved from a $400 price point to a $295 price point – that is a value to someone; or whether you are Nordstrom Rack taking the same product and having it manufactured at a specific price point so you feel like you are getting Nordstrom quality at a specific price point – both represent core opportunities for retailers.

Read: The outlet sector was one that was overbuilt. How many times 10 years ago did you see vacant outlets? They stopped being built. Slowly, consumers began to see the value of it to now, where they are well leased and doing well. Part of that is because they are not on every corner. The market is a great equalizer.

SREB: What about restaurants?

McKeon: The restaurants talk largely to consumer experience. The millenials, in particular, are looking for experiences. The independent restaurant chains are doing a lot of innovation. In the category overall, the traffic growth is in the value priced chains. This is something like the two-for-$20 promotion at Chili’s. That is what is driving the consumer today.

SREB: What are your thoughts on social media marketing, like Scoutmob or Groupon?

Weinberg: A lot of electronic marketing is going on. I had a client who asked me to look at one their restaurants. They told me it was doing very poorly. I went there one night and it was jammed. I sent him a text and asked what he was talking about. He called the restaurant and found out they had done a Groupon offer. Established independent groups, like Concentric and Here-To-Serve in Atlanta, they have their own version of marketing they are doing with their mailing lists. They may not be participating in Scoutmobs and the like, but they have their own discounts. It is the unique and new independents, like Flip and Yeah! Burger that are driving the market without discounts.

Tosh Wolfe, Scott Shuman and Whitney Knoll.

Wolfe: To Marc’s point, I eat out four to five times a week and my choice is often dictated by what Scoutmob coupon is on my phone.

Perlman: I was in a restaurant the other day and three people in front of me realized it was on Scoutmob. They passed the iPhone down the line.

Novak: A lot of the restaurants are figuring out on the fly what they want to do and they can get to you at 4 in the afternoon when you are figuring out where you are going to dinner.

Weinberg: You will begin to see some geography based technology. The malls are already using this, where you are walking through and as you walk past a certain store it pops up there’s a sale.

Wammock: Yes, big brother is watching you, but he’s also offering you a discount to go eat.

Stead: Consumers are becoming so engrained that they are only purchasing things they are getting for discounts. If you look at the housing market, the minute the government took away the home credit, sales fell. Consumers want to be incentivized.

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