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The Bay Area Real Estate Journal
The Art of Self-Reliance
By Sharon Simonson
The current state of the economy is having a major impact on retail. Will retail development change when it does come back, or will things just slow until the recession passes?
When it returns, development will have to adjust to a retail landscape in which there is little competition for sites among retailers. Instead of three retailers in every niche (e.g. Target, K-Mart and Wal-Mart), we will have two survivors and, in many cases, like Best Buy in home electronics, just one.
Today, land is anathema, but even when a normal market returns, we will likely have just a single major tenant for each needed category in a project. Those tenants are as tough and smart as developers and, in the absence of competition, will drive land prices through the floor. So developers with a fondness for survival will avoid buying or heavily optioning sites in this climate. Rather, they may do better by aligning themselves as a preferred developer with the remaining tenants. The problem is simple: While it is not a bad survival technique, working as a preferred developer is distinctly less profitable than a free agent and occasionally outright dangerous.
But, on a more positive note, if California continues even with a fair percentage of its historic growth retail will grow in its traditional pattern, a new 100,000 foot center for every 20,000 to 25,000 new residents, a regional center for every 150,000 population increase, and so on.
Are you changing any of your property management techniques in light of the presumed pressure on operating margins?
No. We’ve always tried to grow the income on which we can absolutely rely—management fees from properties we own ourselves—ahead of expenses. We’re a small firm, we’ve never had a lay-off, and I’ve always answered my own phone and opened my own mail.
Are you seeing a flood of properties come to market for sale?
Yes, but it’s a flood of poor quality assets. All we’re seeing in the market today is second- and third-tier properties mispriced by 150 to 300 basis points.
Do you think smart buyers will in fact find opportunities in the next 18 months to two years, as some investors anticipate?
Almost overnight, the smart investor has decided that the deals, at least big ones, have arrived. Before now, many were holding back.
The banks are starting to unload their REO portfolios, and the smart investors think they will be dumping these assets at incredible prices. The risk in retail will be the dearth of tenants. Even at 30 cents on $1, a center will still be a loser in three years if it remains half empty.
Because banks are initially interested in moving big numbers—large portfolios of 15 to 50 properties at a time—the opportunities aren’t there yet for the smaller investor, and any individual owner who can is waiting. That can’t last. Life trumps business and sooner or later death, divorce, disaster and dissolution force untimely sales.
Assuming you expect to buy in the next several years, what will you consider as you pick and choose the right investment? Will you consider expanding outside Northern California?
Our approach won’t change in the future. We like centers that produce at least a fair return in their existing condition, centers where we think we can do something to increase value; say, an older center that we can rebuild a few years out when the key leases expire.
And we’ve been working closely with a few great tenants—Ross, Safeway and Wal-Mart—for many years both formally and informally (they tell us where they would like to go, and we help get it done). Hopefully, we’ll continue to do more of that.
Every development deal we’ve ever done has been within the rough triangle formed by Santa Rosa, Sacramento and Santa Cruz. Unless a deal’s certainty of profitability was outweighed only by its simplicity, I doubt we’d ever stray outside our backyard.
Here, we don’t waste time on poor locations or projects with impossible obstacles (save perhaps Palo Alto). We can check with three friends within an hour as to whether a proposal makes sense. We can’t readily do that in Denver or Seattle—and I’ve always suspected the local guys in Denver and Seattle are at least as smart as we are.
What elements will have to be in place before lenders will fund new development or acquisitions? How long before you believe those baseline conditions will be in place?
As long as you don’t really need the money, some lenders are funding deals today. The few banks still in the market are funding refinances, expansions and acquisitions of existing projects rather than new development, because the guys who really don’t need the money aren’t even dreaming about new developments.
For the near term, real estate will be all about buying below replacement cost.
But when will the money return in armored cars? When the lenders decide (rightly or wrongly) the last drop of risk of loss has been bled out of the system. When will that be? I’m guessing a couple years.
Final Offer: John McNellis
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