Tuesday, July 21, 2009

Why is retail so fickle?

Almost everyone here has seen the telltale strip mall that has seen better days. We usually surmise that one of two factors has impelled the tenants to flee a shopping center or other commercial district: either the demographics in the area have changed (usually becoming lower income), or a newer, shinier shopping center has opened up within close proximity. The photos below are scarcely groundbreaking, because what we have here is a strip mall that has clearly reached the end of its marketable life.
Here’s the most prosperous looking corner, but looks can be deceiving, because its vacancy rate is still 100 percent. And here is a crude panorama of the entire sprawling strip of stores, with its clear anchor on the far right:
Anyone with an eye for logos or big-box architecture can recognize the anchor building as a former WalMart; the company has a vibrant history of abandoning these buildings, only to move to a brand new, bigger structure less than a mile away.
To the far left of this panorama is a smaller strip, built perpendicularly to the aforementioned. It clearly isn’t faring any better.
And in between the older and the newer WalMart? Another struggling strip mall, where the anchor, Value City, still seems to be functioning well, but all the in-line tenants are struggling. Here’s the scene immediately to the west of the previous photos.
The Value City (which I unfortunately failed to photograph) is to the left of this second photo. And, if we venture further to the west, we get a booming new WalMart and generally prosperous retail leading to the old town center (which also could use some help).

Aside from the severity of the blight here, is there anything else that makes these shopping centers distinct? For one thing, it doesn’t take place in an inner-ring suburb; sadly, this is precisely what you might expect to see in parts of Indianapolis. But these pictures come from Plainfield, Indiana, one of Indianapolis’ surging suburbs and part of one of the fastest growing counties in the country. If you look at the distance of this picture, in between the old WalMart and a row of smaller, in-line stores to its left, you can see what most likely drove all the retail out:
Yes, a JC Penney, part of the Metropolis, a new open-air lifestyle center that has become the principal shopping hub for the city’s western suburbs. (The edge of the vacant WalMart is barely visible in the far left of the above photo.) Metropolis is still growing—not just finding more tenants but purchasing adjacent parcels for the intention of expanding its gross leasable area. No doubt most of the tenants formerly housed in this completely vacant strip mall all moved to this new location, or to other, newer, more desirable strip malls in the area.

So, nothing profound here. But this is a particular black eye to a boom-burb like Plainfield, whose civic leaders would no doubt love to see this blight removed from the principal east-west artery in the city, which also happens to be US Highway 40, the historic National Road. Plainfield shows no evidence of being a suburb in decline; in fact, if anything, it has ascended to become one of the most prominent suburbs in recent years, competing with the more established northern suburbs at luring new arrivals to the Indianapolis area. Yet the city still struggles with this broad swath of depressed, vacant real estate. What does this say about retail in general, and what can be done in scenarios like this, which are taking place all over the country? Here are my thoughts on why retail tenants in particular have to make the shift so often:

1) Location. By most regards, this is so obvious that it doesn’t merit consideration. We’ve all heard the maxim. But delving into the ramifications of retailers’ decisions to locate can reveal much more about loyalty to a specific shopping center or the lack thereof. The demographics in Plainfield favor this area; nearly every other shopping center along the Main Street here is thriving or at least has an occupancy rate of 75% or more. I could speculate the lifecycle of this strip mall has transpired as follows: a) WalMart leadership recognized that the trade area for their store at the original blue-and-gray structure is growing rapidly since Plainfield matured from a humble little satellite of Indianapolis to a prominent suburb of over 25,000 people; b) the regional leadership at WalMart hurriedly bought a spot along the principal artery 1,000 feet away from the new store and built a supercenter nearly twice the size of the original; c) the other tenants at the old WalMart strip mall see customer traffic counts plummet with the departure of the anchor tenant; d) the burgeoning City of Plainfield entices a major new lifestyle mall development called Metropolis (creating a Planned Unit Development, or PUD, in their zoning ordinance facilitate it), just 1,000 feet in the opposite direction from the new WalMart; e) smaller in-line tenants depart the strip mall for newer, more attractive retail plazas in the city, including (but not limited to) the Metropolis lifestyle center when it opens in 2006. Doesn’t take a rocket scientist to figure this out, but the design of this shopping sarcophagus bears all the marks of long-faded glory: the vinyl awning crowning a fake stucco fa├žade was a popular motif from about 1990, and the complete absence of landscaping in the parking lot generates the uncomfortable heat island effect in the summer while rendering the overall design stale and uninviting. (Compare most new strip malls with elaborate landscaped islands, even when city ordinances don’t require them.) The decline of this strip mall happened so quickly the property managers probably had little time to react, which provides an excellent transition to the next point.

2) Leasing agreements. The managers of these shopping centers are often required to devote most of their energies to securing an anchor tenant: because these tenants absorb a preponderance of leasable space and generate both high sales volumes and customer traffic, owners and managers generally entice them with incredibly generous rents, sometimes offering a lease with no rent at all. Sometimes they even sell the property to the anchor tenant. Thus, the manager’s revenue depends on leases from the other in-line tenants, who may settle for a flat rent rate for a set number of years (typically less than five) but more often then not will negotiate a rent based on existing market conditions, where it will “step up” over time or correlated to the consumer price index. In-line tenants may often pay the preponderance of common area maintenance. These onuses suffered by the smaller retailers (and the dependence owners have on them for the revenue) means these agreements can be highly competitive. And since owner typically focus on finding stable anchors, the small in-line tenants enjoy freedom to shop for the best deal, which usually factors in rents, Common Area Maintenance (CAM) costs, and the desirability of an anchor tenant, among other things. Fidelity to a certain shopping center will scarcely last beyond the terms of a lease, and both anchors and in-line tenants are always seeking better deals.

3) Easy finance. So if the market is so competitive, why build so many new shopping centers in the first place? This is where my own knowledge gets foggy, and I can only hope to quote others more informed than I am. The sour economy has precipitated a steep rise in shopping center vacancies; as an article by Stacy Mitchell from the New Rules Project puts it, “the forces driving retail expansion have become untethered from actual consumer demand.” But how are developers able to access financing so easily when the battered retail landscape sits in plain view to even the most untrained eyes? According to White and Gray (1996) in their book Shopping Centers and Other Retail Properties, the emergence of the Real Estate Investment Trust (REIT) in the early 1990s transformed the landscape of shopping centers that were often family-run and guarded their financial data carefully, to public ownership of real estate in which the data became widely available. The reliance of public markets as a source of capital also opened the floodgates to a variety of participants in shopping center finance, allowing developers to find the exact type of security that meets the their desired return on investment and risk tolerance at that point in a market cycle (pp. 77-78). The continued proliferation of powerful REITs has most likely influenced the development of new large-scale shopping malls—thus explaining why in the late 1990s and early 2000s new mega-malls were constructed concurrent with others malls dying just a few miles away. This phenomenon embodies that culture that allows the creation of Plainfield’s Metropolis Mall, but what about the smaller retail casualties featured in this picture?

4) Easy credit and standardization. Retail is an exhaustively bifurcated discipline; dare I anger the intelligentsia by calling it a “science” or “art form”? That said, in the United States, for the most part it is quite easy to build a shopping center; site clearance in many exurban or suburban areas such as Plainfield is relatively free of barriers. In places where permitting for retail is easy to obtain (which is most of the country), the costs stay low and the risk of delays pushing it outside a favorable market cycle are minimal. Thus, many amateur developers will cut their teeth with a simple strip mall at an intersection where a subdivision is going up in one of the other four corners. Strip malls are cheap if they lack any of the frou-frou, and often they don’t need frills to lure tenants if the demographics there favor growth. Thus, a site can attract tenants without a great promotional budget, and because they were cheap, even a mediocre occupancy rate should generate enough NOI to allow the developer/owner to amortize quickly. In fact, spending money for a shopping center with high design standards might seem unwise, because the aesthetic will seem dated within a few years, demoting it from prime retail status once the neighborhoods around it are fully built out with residential and the new exurban frontier is just a few miles further away. By this time, it doesn’t matter—it appears better to stick to a mass market design with the loans the developer received, reflecting undemanding consumer tastes in the same way that the abundance of available credit for consumers has diluted demand for quality or durability. After all, why be choosy with the products one buys, whether they’re refrigerators, clothes, or real estate, when there’s plenty more money available to upgrade or replace?

Thus, we get strip malls like this one in Plainfield. Clearly the owner is making no money on it now, but it may have been fully profitable and amortized during its 10 to 15 year lifespan. And today, a strip mall from (as my estimates put it) between 1985 and 1989 is a full 3 or 4 acres of abandoned property. It is obsolete, like many of the homes in Midwestern inner-cities. Straight-line depreciation rules typically place a non-residential building at 39 years, though this accounts for office space far more effectively than retail, which most documentation would suggest has a much shorter life. Recent bills have favored reducing retail straight-line depreciation to fifteen years. Conversely, some strip malls enjoy a second life through extensive renovations and upgrades, often adding features such as landscaped grid in the parking lots or wooden signage that endow them with upmarket features the Plainfield strip mall clearly avoided at its inception. As mentioned before, elaborate landscaping was a luxury until about a decade ago; now it has become standardized as a means of attracting customers. The Cincinnati developer Phillips Edison has integrated the purchase of underperforming shopping centers into its mission statement, and it usually works to instill new life through upgrades that make the shopping centers more fashionable and aesthetic. Thus, through the obsolescence of 15-year-old strip mall designs, a new caliber of standardization emerges, higher than the one from a decade prior but equally mass produced. No doubt in another decade or two, an additional design element will enter the strip mall design standard, making it increasingly easy to estimate the age of a retail center simply by its appearance.

Where does this leave the blighted strip malls of Plainfield? A firm like Phillips Edison would no doubt have a field day with them: the town itself is fiscally healthy and poised to grow further. However, the city is saturated with retail. Our current recession’s most enduring incarnation maybe the miles of vacant retail without a developer willing to shell out the money to refurbish it, proving that the consumerist infrastructure responded to a demand that was artificially inflated by our previously limitless access to credit. The consumer body is too big for its retail clothes, and, with far greater limitations to credit now in place, it may take time for us to grow back into all the empty storefronts built at a time when Americans had plugged themselves into a relentless buy-buy-buy ethos. In due time, this eyesore along Highway 40, Plainfield’s Main Street, will find a redeveloper, though its second life might not be strictly commercial.

Retail may be fickle, but it is only as fickle as the perpetually picky buyer. The lack of loyalty that a retailer has to a certain spot only reflect the customers’ own lack of loyalty to a particular shopping center, mall, or retail typology altogether. If the current recession really does impel the American populace toward a newfound parsimony and reluctance to buy everything in sight, perhaps the average shopping center’s depreciation time will slow. Otherwise, we are only witnessing a pause button on the perpetual flurry of consumers to buy the newest and shiniest (if not necessary the highest quality), and shopping centers will continue to find their butterfly nets are out of reach of the choicest retailers in only a dozen years or less.

These trends are obviously not new: they precipitated the decline of Main Street retail well over a generation ago. And shopping centers were rising and falling during the 1990s boom as well. I’ll conclude with the fitting opening of a favorite, obscure movie of mine, Michael Tolkin’s 1994 opus The New Age, which begins with Katherine Witmer, a successful Los Angeles graphic designer (played by Judy Davis) in an exasperated call with one of her clients:
Katherine: Barry, what are you saying? But Barry . . . Barry . . . you owe me thirty-eight thousand dollars! Barry, Barry . . . you promised me that money. Well, thank you Barry. Good-bye, Barry. (Very calmly and deliberately, Katherine starts to erase all the files on her computer.)
Sue: [her assistant] What did Barry say?
Katherine: Barry was fired.
Sue: Wow, too bad, I like[d] Barry.
(Katherine quietly drags her mouse and begins to erase all of her bank files.)
Sue: Katherine, what are you doing? . . . Katherine, you’re erasing all the files. Wait, we haven’t back up these files yet! Katherine, you’re destroying all your work.
Katherine: (while she’s erasing) The bank doesn’t need a hundred thousand brochures because the bank doesn’t exist anymore. The bank doesn’t exist anymore because too many of its big real estate loans went bad. Its great big real estate loans went bad because it made loans for shopping centers that can’t find enough tenants. The shopping centers can’t find enough tenants because there are too many shopping centers! There are too many shopping centers because a lot of greedy fucks got loans from corrupt banks.
Sue: What are you going to do?
Katherine: I’m going shopping.

[Minor elisions to the screenplay and italicizations for emphasis done by AmericanDirt.
For more info, see the following:
Brueggeman, William B. and Jeffery D. Fisher. Real Estate Finance and Investments. Boston: McGraw-Hill Irwin, 2008.
White, John Robert, and Kevin D. Gray, Eds. Shopping Centers and Other Retail Properties. New York: Wiley and Sons, 1996.]

3 comments:

Wendy said...

Funnily enough, I ended up here from looking for pics of old Washington Square. As soon as you mentioned Plainfield in an aside, I thought 'he's talking about that strip mall.' although it is occupied now (Burlington strikes again!) a lot of your points still hold true.

Sam said...

The strip mall with the Value City actually housed the first Wal-Mart we had in this town, then they built the blue structure around...1990 I think. Then in the mid 2000's, they bulldozed the trailer park just east of the first location and put up the current Wal-Mart. I too, am a little disgusted by the empty husks of buildings that Wally world seems to leave in it's wake...The blue strip mall now houses a Burlington(not a great sign, but better than nothing I suppose) and a barbecue joint where that Mexican restaurant was. The strip mall with the Value City also houses a location for an upcoming gym chain(Planet Fitness). I consider these places eyesores, but some occupancy is better than none...

(I love this blog by the way, your posts about the County Line Mall in Greenwood, Lafayette Square and Washington Square are total nostalgia trips for me.)

AmericanDirt said...

Thanks for your comments, Sam and Wendy. I agree, Sam, that sometimes the only way to rationalize the seemingly epidemic-level growth of vacant retail is to recognize that any occupied retail is an improvement over abandonment, no matter how low-rent that retail might be. (Besides, just the fact that I'm using the word "low-rent" is a bit of an elitist judgment call on my part.)

I appreciate the feedback and welcome more, as I continue to work to roll out a new American Dirt on my own domain. Stay tuned.