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STRONGER TENANTS FUEL POWER CENTER SURGE

BY NANCY COHEN

Power centers work best for us, says Linens ’n Things.

The power center, the engine of shopping center development through the 1990s, stalled when retail contraction flooded it with excess space. Properties closed; lenders and investors shied away. But the pundits who proclaimed that the format’s ride was over spoke too soon.

Over the past three years, the number of power centers has increased 39 percent, for a record total of 1,100 in operation in 2003, according to the National Research Bureau. And developers say the sector is healthier than ever. The bankruptcy and consolidation that winnowed the ranks of category killers, discount department stores and wholesale clubs left behind a roster of strong, expansion-minded power center tenants.

“We’ve waded through the Ameses, the Caldors, the Service Merchandises,” said David Henry, vice chairman of Kimco Realty, New Hyde Park, N.Y., the largest open-air center developer. “The weaker players have shaken out, the space is coming back on line, and the gorillas — Burlington Coat Factory, Kohl’s — are expanding aggressively.” Driven by leasing activity, he says, Kimco is developing an additional 2.9 million square feet of power center space, which will add about 11 percent to its power center portfolio.

ICSC defines a power center as a 250,000-to-600,000-square-foot property dominated by three or more generally freestanding, large anchors, such as discount department stores, off-price stores, warehouse clubs and category killers. As with lifestyle centers, however, developers sometimes create their own definitions, making the sector difficult to track.

But one sign of the power center’s soundness, its developers say, is that its big-box tenants continue to win market share from the retailers that anchor malls and community centers.

See chart, Powerful Tenants (PDF, 260K).

“Wal-Mart, Target and Kohl’s control the lion’s share [of general merchandise sales], which makes centers with them more desirable than the mall,” said Scott Wolstein, chairman and CEO of Developers Diversified Realty, the Cleveland-based REIT that is among the largest players in the category. “Wal-Mart alone is eight times the size of the entire department store industry — and there’s the transfer of grocery sales to discounters too.”

Of course, no retail venue is immune to the effects of a weak economy. Though most leading power center tenants have steadily expanded since 2000, their same-store sales growth has, with a few exceptions, declined since the first quarter of 2002 (see chart). And power centers may actually be more vulnerable than malls in a soft market, warns Michael Baker, ICSC’s director of research. Although power centers offer attractively priced merchandise, he says, they house a greater proportion of the hard goods — pricey consumer electronics and furnishings — whose purchases may be postponed.

“Consumers have pretty much pulled the plug on discretionary spending,” Baker said. “These retailers have suffered over the past year. The discounters and clubs appear to be doing fine, but really it’s only been food, consumables and gasoline that held up sales.”

Such concerns notwithstanding, power centers have become entrenched in the retail landscape and, apparently, redeemed themselves in investors’ eyes.

“A signal of their viability is [that] you can sell them for extremely low cap rates,” said Matthew Ostrower, a REIT analyst at Morgan Stanley. “They used to be 100 to 200 basis points higher than conventional shopping centers. That gap no longer exists, and there’s robust demand.”

One reason is the paucity of alternative investments, which makes well-tenanted power centers increasingly attractive. “It’s difficult to find a strong, secure yield,” Wolstein said. “Power centers populated by long-term credit tenants provide security.”

Consequently, a vigorous market for building and selling power centers has emerged, developers say. “We keep some under our control, those with exceptional locations and tenant makeup, but now cap rates are so good, it’s difficult to decide to hold them,” said Thomas L. Williams, president of North American Properties, a privately held development firm in Cincinnati. The company is developing 1 million square feet of power center space this year.

Similarly, Duke Realty, an Indianapolis-based REIT, builds to sell about 350,000 square feet of power center space each year. This summer Duke is opening — and shopping around — Stony Creek Marketplace, a 195,000-square-foot power center on a 60-acre site in Noblesville, Ind. Tenants include Barnes & Noble, Linens ’n Things and T.J. Maxx. A 225,000-square-foot Meijer hypermarket on a 22-acre parcel Duke sold to the retailer will provide another draw.

In the Chicago area, too, an appetite for new building has returned after a pause to digest vacancies, says David Bossy, a principal of Mid-America Real Estate Corp., a real estate services firm in Oakbrook Terrace, Ill. “In metropolitan Chicago 2001 and 2002 saw 22 million square feet of big-box space absorbed,” he said. “In 2003 we’re seeing 5.5 million square feet of big-box absorption and 5.9 million of new construction. After a hiatus retailers are becoming active again, relocating stores and filling in markets.”

Retailers will drive considerable construction elsewhere as well, predicts Wolstein. “Wal-Mart, Target and Kohl’s in one year will build 600 new stores, so there’s the potential for 600 new shopping centers as long as that trend continues — and, for the foreseeable future, it will.”

Even factoring in such aggressive expansion plans, supply has by no means outstripped demand, Wolstein asserts. “If there were an oversupply of retail, sales per square foot would decline, but the converse is true.” He also points to occupancy rates as a barometer of the format’s health. “We own 86 million square feet, and we’re at 96 percent occupancy,” he said. And Developers Diversified is building an additional 3 million square feet a year, he says.

Nevertheless, the renewed development and the repositioning of other properties into power centers are reviving concerns about overbuilding. “There’s a significant amount of space still being built in the middle of a cyclical downturn, and we’d argue that most of the new supply is in power centers and strip centers,” said Morgan Stanley’s Ostrower. “That should be of concern to investors.”

Developers counter that their refusal to build on spec acts as a safeguard. “We lease, then build — not like in the past, where people built, then leased,” said Norman Peters, senior vice president of Cafaro Co., the Youngstown, Ohio, development firm.

Others say dwindling opportunity will ultimately slow development. “The major markets are pretty well saturated,” said Herb Weitzman, chairman and CEO of the Weitzman Group, a Dallas brokerage firm, and Cencor Realty, which manages and develops community and power centers. “Since 1990 there’s been 20 million square feet of power center built in Dallas alone. That’s a lot of new space on top of the malls already here.”

Nevertheless, Weitzman’s company has 11 shopping centers coming out of the ground or under construction in Texas this year. “There’s always a pocket, just not as many as there used to be,” he said.

When the generous supply of space and the U.S. recession are taken together, lease rates, at least at the most desirable properties, have held up surprisingly well, landlords report. “Power centers are a very healthy segment,” said Kimco’s Henry.

Rents have steadily improved since the power center’s debut, notes Wolstein. “Over the last 15 years, the rent per square foot’s increased, from $3 to $4 to $10 to $12. Lease rates have held up well because they’re derivative of sales: As long as they can pay more rent, you can get them to.”

Along with their rents, power centers themselves have grown over time to accommodate larger and more numerous stores. “The format is continuing to evolve into the super power center,” said Bossy of Mid-America. “We’re doing a 600,000-square-foot center in Mundelein, Ill., with a Home Depot, a SuperTarget [and] a T.J. Maxx, and they’re all on steroids.” Many big boxes have expanded in size by at least 75 percent to 140,000 square feet, he says; discounters that have added food and drug departments have swelled by as much as 150 percent to 200,000 square feet.

Flexing those pumped-up muscles, some retailers now insist upon owning their property rather than leasing it.

“Ten years ago developers would prefer ground leases or build-to-suit rentals, but over the last three to five years that’s changed,” said Larry Myrvold, senior vice president of Duke Realty’s retail group. “The Kohl’s, Targets, Wal-Marts and Home Depots of the world are preferring to purchase the real estate. We’ve become more flexible in understanding what drives the opportunity — and it’s not creating a rental stream of every available square foot.”

Still, Myrvold draws a distinction between a power center developer selling land to a retailer that can catalyze a project, and a mall developer subsidizing a department store. “I might have to sell the ground at a slight profit or break even to develop the rest of the site, but we don’t give it away,” he said.

Other distinctions between the property types are blurring, however. Mall retailers are experimenting with nonmall locations (SCT, July 2003), big-box stores are trying mall sites, and power centers — which once typically sat across the street from regional malls — are being incorporated into larger developments. One example of this retail convergence is Developers Diversified’s Riverdale Village, Coon Rapids, Minn., an 840,000-square-foot property containing both a power center and a lifestyle center.

“Retailers are less orthodox about the format than the total sales and synergies at each location,” said Wolstein, the project’s developer. “They used to be snobby about co-tenancies, and that’s no longer the case.”

Indeed, some retailers hardly distinguish their locations by type anymore. “It’s not a question of the kind of development, but where it is,” said Greg Darus, vice president of real estate at OfficeMax, Shaker Heights, Ohio, which operates more than 970 office supply superstores. “A power center is like any other piece of real estate — its location defines how well we do.”

Yet the power center remains the preferred site for many big-box retailers, even as they explore new options. Of the 50 stores Linens ’n Things is opening this year, a record six or seven will be in mall locations, but most of the rest will be in power centers, says Shirley Culman, vice president of store planning and construction for the 400-unit chain, based in Clifton, N.J.

“We’re looking at alternative sites because so many alternatives are now available, and the mall folks are making it [financially] palatable,” she said. “But power centers are our strength. We can be with all those national co-tenants — a book guy, an office guy, a pet guy — and do great business across from the mall. That’s our mainstay.”

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