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ONE-STOP SHOPPING FOR SERVICES

LARGE LANDLORDS ARE LEVERAGING THEIR PORTFOLIOS TO CUT COSTS

By Steve McLinden

Landlords have borrowed something from the tenant playbook, it seems. If a large chain can use its economies of scale to squeeze a lower price from vendors, surely a mall owner can too — and some have in fact begun doing so. As the industry consolidates, ever-larger shopping center owners can translate their bulk into operating efficiencies they can use to great advantage.

One of the largest open-air shopping center REITs in the U.S. is now at work “bundling” its building-maintenance responsibilities through a single third-party provider, in what could be the largest outsourcing pact of its kind in the retail sector. Last month Developers Diversified Realty Corp. began the massive task of committing responsibility for facilities services at its 740 centers across 45 states and Puerto Rico to a third-party firm called FacilitySource. For DDR this means that its regional property managers and other staff will no longer have to process about 250,000 vendor payments and countless related phone calls and reams of paper yearly. Instead, the company will entrust most of these duties to a specialist that will negotiate better prices on supplies, services and equipment. The move will also reduce the number of outsource companies DDR relies on and allow the flow of work to be monitored centrally.

“This is quite a cultural shift for us,” said David Favorite, DDR's vice president of property management for community centers. “But we wanted to take advantage of the size of our company and let our property managers spend more time at the centers with tenants.”

Favorite and John Kokinchak, DDR's senior vice president of property management, spearheaded the effort, which DDR launched about a year ago and now says it hopes to expand to all regions by late this spring or early summer. “It is a huge undertaking that in the end will bring to bear the purchasing power we have in the property management world,” Kokinchak said. “Those economies will help us to remain competitive in the industry and, in some instances, will actually give us the edge in competition.”

DDR says it is too soon to project the fiscal impact. But Mark Gibson, an expert on such practices at Ernst & Young Real Estate Advisory Services, says retail REITs can save from 75 cents to $1.50 per square foot through these provider arrangements.

Thus far, retail REITs have been slower to embrace the trend than office and industrial owners, Gibson says, in part because the savings would not go directly to the bottom line, as happens with typical triple-net operators. “Ultimately, what I think will happen with developers and owner-operator retail REITs is that they will share those savings with their tenants, because it really will make them more competitive,” he said.

The cost savings from these arrangements come from quantity-discount pricing, economies of scope and scale, and efficient use of staff, among other areas. “During this recession, [operators] will need to squeeze out every extra dollar,” Gibson said.

For much of this decade, retail REITs have been aggregating more and more of their purchasing power to benefit tenants, particularly after post–Sept. 11 insurance premiums rose, increasing fixed expenses for centers and tenants alike.

Simon Business Network, a division of Simon Property Group, has been offering product and service discounts to its retailers through about 100 preferred vendors since 2000. Simon's retailers enjoy economies-of-scale reductions on facilities services, utilities, security, construction and renovation, and more.

For the past seven years, Forest City Enterprises has been operating a partial bundling — or “modified gross lease” — program, through which it pools many of the expenses it can control, including insurance and common-area maintenance expenses, and then shops around for volume deals. “Ultimately, our goal is to be as fair as possible with tenants,” said Alan Schmiedicker, Forest City's senior vice president of property management.

Several national retailers are using third-party bundlers. JCPenney hired Milwaukee-based Johnson Controls in 2001 to handle facilities maintenance at its department stores. Johnson Controls says it receives some 2,000 work orders from the roughly 1,000 Penney stores in any given week.

“Johnson Controls has become Penney's one-stop shop,” said David Lewis, regional property manager of Wichita, Kan.–based Wygand Omega Management, which manages 12 shopping centers throughout Kansas, plus the mixed-use J.J. Brandeis & Sons department store building in Omaha, Neb. “Penney's wanted to focus on selling their goods and services and not to focus on such things as HVA systems and filter changes. They realized that they didn't want their people sitting in their offices making all those phone calls.”

Lewis, a member of the shopping center advisory board of the Institute of Real Estate Management, says a representative of Johnson Controls meets with Wygand Omega about maintenance and building services issues at Penney stores, instead of Penney's own building engineers. Such agreements typically allow large building owners to reduce on-site maintenance staff and reallocate resources, he says.

The largest providers of aggregation services to commercial real estate companies are CB Richard Ellis, Cushman & Wakefield and Jones Lang LaSalle. The Staubach Co. and Grubb & Ellis are expanding their programs, and some of these firms derive over a quarter of their income from facilities-services bundling, Gibson says.

The same approach will work for international retail property owners as well, says Gibson. In Europe, however, office and industrial property owners have adopted the practice, but retail owners have not. “Retail everywhere is crying out for this [cost-saving] solution, especially malls and big-box stores. But, typically, the U.S. and U.K. must take the lead in these types of initiatives.”

In Europe there are few cross-border barriers, because large building-maintenance service providers are in most major markets, Gibson says. But service bundling may prove to be difficult in eastern Russia and southern Argentina, he says, because most large providers lack offices there.

Doug Harman, vice president of property services at Ivanhoe Cambridge, says service bundling is common within large retail properties in Europe but not across channels. Ivanhoe used it for tenant savings in the 800,000-square-foot Wola Park shopping center, in Warsaw, which it has since sold. Ivanhoe's business model in Canada is different. “We have central purchasing to tender the more expensive services on a regional basis,” Harman said. “This results in savings and is cost-effective.”

Cross-system bundling is best left to the third-party pros, Gibson cautions. “If you don't use a third party, the vendors will tear you apart,” he said. “You really have to have someone support you in underwriting the risk.”

Gibson says he has seen some service agreements on the office and industrial side fall apart because of poor execution. “This is a daunting challenge, especially to do it right, so it's crucial to have the right aggregator,” he said. “This isn't right for everyone. It's quite an art form.”