Class-C Malls Enjoying a Wave of Popularity
The sales market for lower-end malls picked up dramatically last year and is running under a full head of steam.
After lackluster sales in 2001, about three dozen Class-C malls valued at $30 million or less traded last year. And so far this year, five more properties have been sold and three more are under contract. Another 15 or so are on the market.
The increased demand for lower-end malls - usually defined as those whose nonanchor space generates less than $275 in annual sales per square foot - stems from a confluence of factors. Among them: a rebound by retailers, the availability of cheap mortgage financing and the prime locations of some properties - which make them attractive candidates for redevelopment even if they are currently distressed.
After being battered by a wave of bankruptcies, the retail sector has performed relatively well over the past year or so, despite the weak economy. "Where office values are based more on supply and demand in the marketplace, retail property values are based on the sales potential of tenants - you can't lose sight of that," said Philip Montgomery, chief executive of Dallas-based P.O'B. Montgomery, a regional redeveloper of retail real estate.
Sinking sales volumes can often trigger "kick-out" clauses in retail leases, allowing mall tenants to leave without hefty penalties. That, in turn, can hurt the revenues of neighboring tenants, who may also leave, setting off a "domino effect" that can wipe out whole sections of a mall, Montgomery said.
Such problems in many secondary and tertiary markets had caused the lower-end mall market to dwindle for several years leading up to 2002. Many of the department stores that traditionally anchored such properties - including Sears, JC Penney and Montgomery Ward - were on a downturn, pummeled by the rise of fashion discounters like Ross and TJ Maxx. The decline of some traditional outparcel players, like Toys R Us, also hurt.
But as the retail sector has rebounded from its lows, malls have come to look more attractive to some investors than office and apartment buildings, whose rents are softening.
Another driving force in the growing demand is the innate value of the land under many older urban malls, which are often located in desirable areas with little space available for development. That makes such properties attractive candidates for redevelopment.
"There is a big opportunity now to acquire and redevelop these assets, especially the older ones, because they're located in urban, in-fill locations," said Peter Henkel, managing partner of Coventry Partners, an opportunity fund operator. "Many of these were built in the 1960s or 1970s, and are in locations that you can't reproduce." Henkel said such deals, rare in 2001, are frequent now.
But redevelopment can be tricky, as Montgomery points out. "When we redevelop these malls, we look first to see if the anchors are still working - that's the core," Montgomery said. "Malls are difficult to tear down and complicated to undo. So we're seeing some people decide to hang onto these things, believing that they can be revived." Class-C malls are generally trading at prices that produce initial annual yields of more than 11%. That compares to 7-9% for Class-A malls and 9-11% for Class-B properties.
One of the lower-end properties that traded last year was Antioch Center in Kansas City. Mo. Eastbourne Investments of Williamsville, N.Y., bought the 686,000-square-foot property from Curry Real Estate of Kansas City for $12 million, in a deal brokered by Kessinger/Hunter. The Sears-anchored mall generates about $211/sf in sales and sits at a prime location. Eastbourne may redevelop the property to bring in discounter retailers. In another such deal, Sooner Investment of Oklahoma City last year bought the 760,000-sf Richardson Square Mall in Richardson, Texas, from Simon Property of Indianapolis for $30 million, via Cushman & Wakefield. Sooner plans to partially tear down the existing structure and replace it with a Lowe's home store.