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THIRD-PARTY FALLOUT

Mall management firms face a shrinking universe

BY DEBRA HAZEL

Jones Lang LaSalle’s trophy management property: Union Station, Washington, D.C.

It may be one of the most unexpected outgrowths of the REIT revolution. Faced with ownership consolidation, a declining product base and the growing power of the industry’s three major players, small third-party mall management firms are struggling to compete for what appears to be a diminishing amount of business.

According to ICSC research, REITs now own and manage 46 percent of the 1,200 enclosed regional malls in the United States. The “Big Three” managers — General Growth Management (a subsidiary of General Growth Properties), Jones Lang LaSalle and Urban Retail Properties — operate about 110, or nearly 10 percent. That leaves small management firms struggling to find new clients and coping with less lucrative contract terms in order to survive.

“There’s a finite number of opportunities for third-party management,” said Gerry Curciarello, managing partner and CFO of L&H Real Estate Group, a small, Chicago-based third-party manager. “I just don’t think there are that many out there.”

Today L&H manages 3.3 million square feet of retail space for other owners, versus 4.5 million square feet six years ago. (Over that period, however, L&H has acquired several projects, adding to its overall management portfolio.) The company performs leasing duties for only four additional projects and design and construction services for yet another.

This shift reverses decades of industry history. Until the mid-1990s, regional malls were largely owned by financial institutions, such as pension funds and insurance companies, which then hired professional management firms to operate, market and lease them. Managers earned monthly or quarterly fees and often received a percentage of their project’s income. In 1984 General Growth even sold most of its malls to Equitable Real Estate while continuing to manage them on a third-party basis. Five years later General Growth acquired The Center Cos., Minneapolis, which operated more than 30 regional malls, to become one of the dominant managers in the business.

But by the early to mid-1990s, a credit crunch had forced some institutional owners and lenders to the sidelines, causing many privately held developers to form REITs in order to access capital. To fulfill Wall Street’s growth objectives, the public companies began buying malls with a vengeance — Simon Property Group now owns some 240 centers; General Growth owns about 120. The sellers often were the very institutions that had hired the third-party managers, and this reduced opportunity even further, particularly in class ‘A’ centers, because the new owners were managing them themselves.

Compounding the problem is the decline in the number of regional malls from about 2,000 at one time to about 1,200 today, as older, smaller centers are closed or converted to open-air projects.

“There has been a perpetual sell-off by institutions, so what you have seen since 1997 is a rapidly diminishing market,” said John M. Millar, SCSM, a former chief of third-party management at General Growth and Jones Lang LaSalle, and now executive vice president and principal at Divaris Real Estate, Virginia Beach, Va. The four malls in the company’s management portfolio were recently sold after Divaris oversaw their redevelopment. “The REITs have taken all the good stuff, and what’s left now is the distressed properties,” he said.

One of the ways the Big Three have become so dominant is through consolidation. The Yarmouth Group was acquired by Equitable Real Estate, Compass Retail (an Equitable spin-off) by LaSalle Partners, and then LaSalle by Jones Lang Wootton to form Jones Lang LaSalle. Urban Retail Properties became a pure management company after a partnership of Simon, The Rouse Co. and Westfield America acquired its parent, Rodamco North America, and Rodamco’s mall assets. After the January 2001 REIT Modernization Act, General Growth reorganized its third-party management division into a taxable subsidiary.

And all three have continued to grow. At press time General Growth’s third-party portfolio included 37 centers across the United States, totaling 40 million square feet. Management, development and leasing fees totaled $78 million annually, according to Cleveland-based investment bank McDonald Investments, approaching 6 percent of the firm’s $1.4 billion in annual revenue. The company added 12 malls to its portfolio last year, including The Dallas Galleria, a rare available trophy center. Last year it even looked like General Growth would acquire Jones Lang LaSalle.

Urban Retail manages 45 retail properties, totaling more than 40 million square feet. Revenues have grown 67 percent since October 2002, including 27 new contracts.

And Jones Lang LaSalle manages 35 regional shopping centers and transportation terminals across 21 U.S. states, the District of Columbia and Puerto Rico, for a total of about 25 million square feet.

Ross Glickman

All three firms say they plan to grow further, which would diminish the pool of available malls for smaller firms even more.

“We’ve knocked down the opportunities in our sweet spot for acquisitions [new contracts], and that’s between 250 and 300 shopping centers,” including centers already managed by Jones Lang LaSalle’s competition, says Gregory Maloney, SCSM, president and CEO of Jones Lang LaSalle Retail, Atlanta.

Continuing ownership consolidation can only remove more projects from the available list. As of June, General Growth had acquired four centers this year that it previously managed for someone else, reports Tim Haislet, SCSM, senior vice president of third-party management for the company.

As a result, managers cite the need to adapt to new ownership, corporate structures and deals as key to growth. They acknowledge spending more time rainmaking. General Growth now has two people dedicated to finding new business, and other management company CEOs find their time even more pressed as they take on additional new-business searches. Executives at Bayer Properties, a Birmingham, Ala.-based development and management firm, spend about 20 percent of their time searching for new business.

“The key is reputation,” said Curtis Furgason, Bayer’s senior vice president of property management. “If you do a quality job, business will come your way.”

New business is coming from new owners. Whereas such large institutions as Cigna, Equitable Real Estate, Lend Lease Real Estate and Prudential Real Estate once dominated ownership, the current low interest rate levels have resulted in the comeback of the entrepreneur. One such owner, Atlanta-based Gregory Greenfield & Associates, is a key Jones Lang LaSalle client. (Its president, Greg Greenfield, was a colleague of Maloney’s at Compass Retail.)

“There are a lot of opportunistic, smaller investors taking ‘B’ or ‘B-plus’ centers,” General Growth’s Haislet said. “But because they don’t have management expertise, they come to us.”

Investment banks, including The Blackstone Group, JP Morgan Investment Management, UBS Warburg and Wells Fargo Bank, also use third-party managers, as do real estate companies specializing in other facets of the industry but looking to diversify, such as Equity Office Properties and Brookfield Properties. Municipalities, too, are becoming players, through public-private partnerships.

“The field has widened,” said Ross Glickman, CEO of Urban Retail. But that doesn’t mean third-party managers are in the clear. To keep business, managers are offering additional services, including accounting and other financial assistance. Bayer provides construction management services as well. Perhaps most useful, but somewhat galling to the managers, is acquisition preparation. Many owners are simply looking for the manager to turn a property around so that it can be sold, requiring a heavy use of manager resources, only to possibly lose a contract after the sale.

“It’s not cost-effective — it’s so frustrating,” said Cindy L. Ciura, SCMD, vice president and director of marketing at Schostak Bros., Southfield, Mich., which has a third-party component in addition to its own development-management portfolio.

Urban Retail has even begun expanding its own client base to include catering and planning special events, such as theatrical productions for the General Services Administration, the agency that oversees equipment procurement and facilities for the federal government and disposes of excess government real estate. The GSA has just renewed a seven-year contract with the company.

Contracts, too, have changed, varying widely based on the condition of the property and on the services to be rendered. For large distressed properties, those most often outsourced now, many managers insist on a guaranteed flat fee, usually about $20,000 to $30,000 per month, while working on leasing, which has its own separate, per-deal commission. Owners of projects needing significant redevelopment will be charged a flat fee during the planning stage and then between 3 percent and 5 percent of the hard costs (materials and labor) during redevelopment. Managers will also receive a percentage of the sales increases as projects improve.

On the other hand, the owners of successful centers find themselves in the enviable position of fielding multiple bids, which can go as low as 2 percent of gross revenues.

“There’s a lot of cutthroat bargaining,” Millar said.

Contracts are shorter too, down from between two and three years to just one (though any can be terminated with 30 days’ notice).

Still, management firms insist that opportunities remain — including, strangely, from the REITs. Bayer manages centers for Inland Real Estate Trust in markets where the REIT has yet to establish a corporate presence. And REITs also sell centers, General Growth’s Haislet notes. “The major REITs won’t own every asset type, and there are also a large number of properties that don’t fit their mold,” he said.

As a result, the roughly 55-45 division between private and public mall ownership has tended to stay fairly steady, though the public companies hold a much larger proportion of the ‘A’ projects.

“Real estate tends to be a favored investment, and it’s cyclical,” said Stephen L. Huber, SCSM, executive managing director at real estate services company Insignia/ESG, Cleveland. “We’re in a retail cycle.”

And that leaves some third-party managers optimistic. Schostak plans to increase its management portfolio to about half its business, Ciura says. and smaller regional companies like Bayer will continue to emphasize intimate local knowledge as a management advantage, according to Furgason.

Yet the Big Three are likely to continue to draw the most contracts. The larger companies have a natural advantage in spreading costs over a greater number of projects and leveraging leasing opportunities, notes Rich Moore, senior vice president and analyst at McDonald Investments. “Retail real estate is not a commodity product,” Moore said. “The management team makes a huge difference. If I’m a private owner of one or two malls, it’s a no-brainer to go to someone like [General Growth].”

General Growth is starting to look at managing other formats, including neighborhood, community and lifestyle centers, as Urban Retail has already done. And Jones Lang LaSalle’s Maloney says he believes that his company’s portfolio will eventually total 100 centers, given the firm’s goal of signing one new client each month.

“We will get there,” said Maloney, “though it will be a stretch.”

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