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A MEMBER SHARES MEMORIES OF CENTRAL EUROPE

By Arlene Richman

The author in Krakow prior to the start of the ICSC Study Tour.

Want to check out what’s new in shopping center development? Take a trip to Warsaw, Budapest or Prague. You might be amazed to see what has occurred since the fall of communism a mere 11 years ago. Think of the evolution U.S. shopping centers have undergone from the original strip centers and enclosed malls of the 1950s, and compress that timeline by 40 years, and you might get a sense of the scope and sophistication of the shopping center development that has occurred in just the last six to seven years in these Central European cities.

A group of ICSC members, representing the gamut of professions involved in the shopping center business, participated in an ICSC Study Tour of Shopping Centers in Warsaw, Budapest and Prague in November 2000.

Group participants represented a Turkish REIT; a U.S. investment bank sponsoring a $100 million Central European investment fund; a Canadian shopping-center investment company co-sponsoring that fund; an Israeli shopping center developer that has just received necessary permits to proceed with the first regional mall-type center in central Prague; architects and designers from Britain and Germany; development companies from Switzerland and Austria; a German bank; an independent Canadian developer/lawyer; and the sole U.S.-based participant, the author, a shopping center attorney based in Chicago.

While most of us were interested in the business opportunities within the countries we were visiting, some were also there to glean new ideas from some of the newest retail development in Europe to take back home.

The lack of representation of U.S. enterprises in our group was surprising at first. But as the tour progressed it became clear that this mirrored the apparent absence to date of U.S. participation in the development of shopping centers and retailing in these cities. The absence of American retailers was striking. Except for the ubiquitous McDonald’s, Burger King and Dunkin Donuts franchises and Estée Lauder boutiques, it was obvious we weren’t in Kansas anymore.

And while the development of the shopping center industry in these cities has been internationally sponsored, it is not U.S., but rather Western European, Israeli and Canadian investment, and joint ventures that appear to be driving the growth.

Most of the malls we visited were owned, developed by or had significant investment by foreign entities. The first enclosed mall in the Czech Republic, Centrum Cerny Most on the outskirts of Prague, was built by Intershop Prague, a Netherlands developer, and recently sold to Rodamco Central Europe, a Dutch investment fund. Myslbek Shopping Gallery in the heart of Prague is controlled by French interests. The owner of Galleria Mokotów in Warsaw counts Citibank and Deutsche Bank as well as Dutch company Nobelgo among its shareholders, and Klif Shopping Center in Warsaw was developed, and is owned by, Norwegian interests. EuroCenter Obuda in Budapest was developed and financed by Austrian concerns.

A familiar name on this side of the Atlantic, TrizecHahn is part-owner and developer — together with TAP Investments Ltd., AIG Central Europe Fund and the European Bank for Reconstruction and Development — of West End City Center, which opened in Budapest in 1999 (SCT, April 2000). Not surprisingly, it most closely reflects the North American regional mall prototype. Located on the Pest side of the Danube River in the heart of the business center of Budapest and adjoining the city’s major railway station (Nyugati Railway Station designed by Gustav Eiffel of Eiffel Tower fame) as well as a Hilton Hotel and office building also built by the developer, it reflects and rivals the best of new mall development in the United States.

Reflecting this international influence, international brokers Jones Lang LaSalle, and Healey & Baker (a member of Cushman & Wakefield) have been engaged to lease several of the newest retail developments in these cities.

One of the stops on the ICSC Study Tour of Shopping Centers in Warsaw, Budapest and Prague was Centrum Cerny Most, the Czech Republic’s first enclosed center.

While Warsaw, Budapest and Prague is each unique and spectacular in its own right, the cities face different challenges to development. These include infrastructure problems resulting from the destruction of roads and bridges during World War II in Warsaw, traffic congestion and overbuilding without adequate planning of centers around Budapest, and Prague’s lack of central-city locations for new development. Prague’s problem is a result of strict building restrictions prohibiting the tearing down of existing buildings for new construction (Prague escaped the wartime destruction that befell Warsaw).

Common threads
From a retailing perspective, though, the cities share several common threads. After decades of unavailability of consumer goods and services and shortages of basics like food, there is an eager consumer market. But disposable income is limited. We heard that average monthly incomes in these cities range from $300 to $500. But we were also advised that many basics like rent are less costly than in the States, making that monthly wage less meager than it sounds. (Perhaps it’s not a basic to everyone, but our tickets for an exceptional performance of the government-sponsored, internationally recognized opera company in Budapest cost $12 each.)

Perhaps this explains why all the centers we visited were anchored by a hypermarket or supermarket rather than a department store. Another explanation is that traditional department stores are still evaluating the markets. For example, Marks & Spencer operates downsized 900- to 3,000-square-meter (9,630- to 32,100-square-foot) apparel stores in several malls; the Spanish apparel chain Mango is about to test a freestanding store in the heart of the New Town in Prague. Given the wage scale, it is typical for both spouses in a household to work and, consequently, mall traffic is slow during the day on weekdays.

The early centers were originally leased by local shop owners. As those centers proved themselves, second- and third-generation centers were built, and foreign retailers — often through franchising to nationals — have opened, with some of the most recent centers being occupied predominantly by national and international retailers. Cellular phone stores (it’s not uncommon for a mall to have three or four) are strong draws and are located strategically, like anchors, at ends of mall corridors.

The centers are billed as shopping and family-entertainment centers, and there is a clear focus on family entertainment and the leisure component. Multiplex stadium-seating theaters and/or bowling alleys and video game rooms were common to all of the malls visited in Poland and Hungary. In Poland, the South African theater operator Ster Century and game room Atomic predominate. Food courts, including a bar serving alcoholic beverages in its common area; tea rooms; coffeehouses (don’t think Starbucks) and other sit-down restaurants were abundant, reflecting owners’ recognition of customers’ predisposition to these types of socializing venues. Owners also recognize that their customers are predominantly under age 50 and concentrated among the younger age groups.

Rents are set in U.S. dollars, euros or deutsche marks, not the local currency, because of the experienced and potential fluctuation in the value of the local currencies. This has led to some problems for retailers as their goods and services are sold to customers in the local currency. As that currency is devalued relative to the currency to which its rent is pegged, the effective lease rent increases. In some instances, we were informed, rents have been reduced to address this disparity and the consequential hardship on the tenant. In at least one instance, rents were repegged to a less-strong currency.

Rents at West End City Center in Budapest had been set in U.S. dollars. But as a result of the devaluation of the Hungarian forint relative to the U.S. dollar over the last year, retailers were getting squeezed as they couldn’t increase their prices to cover their “effective” increase in rent expense. By renegotiating its project financing to pay its obligation in eurodollars rather than U.S. dollars, the owner was able to amend its leases to provide for payment in eurodollars, thereby reducing its tenants’ risk from currency fluctuations.

Whether or not they provide for percentage rent (referred to as turnover rent) in their leases, all owners acknowledged that they have no means of ensuring and enforcing honest reporting of gross sales. Perhaps that will change with the increase in leasing to international retailers that follow standardized accounting practices. But based on early experience, these owners appear to structure their rents essentially on a fixed-rent and share of landlord operating charges without reliance on, or expectation of collecting, any percentage rent factor.

While the Study Tour itinerary was limited to enclosed centers, it is obvious from discussions with shopping-center representatives and independent real estate brokers that hypermarkets and do-it-yourself stores such as IKEA and the European equivalents of Home Depot have found a welcome market in and around the outskirts of these cities. Across from Centrum Cerny Most on the outskirts of Prague, near which IKEA will soon open a second Prague location, the road resembles a typical service road off a highway lined with big-box users in many U.S. cities. You realize you’re not in a U.S. city, however, when it is explained that although many people have cars, they use the train to get to this outlying center because of the high cost of gasoline.

These cities used to be neighborhood communities in which people waited in line to get their share of the limited milk, bread and, if lucky, some meat. In less than 11 years they have become, some believe, oversupplied with well-stocked supermarkets and hypermarkets — many of which are open 24 hours a day — neighborhood malls, specialty fashion centers and regional malls.

Centers are anchored with hypermarkets, household electronics stores, sporting goods/sportswear stores, music, cell phone and apparel stores, offering a variety of consumer merchandise unheard of barely a decade ago. Given the level of the average wage, and that unemployment is 10% in the cities and higher in the countryside, there is concern that there may be more supply than demand, not dissimilar to periodic cries that the United States is “over-retailed.” The similarities in experience don’t appear to end there.

Condensed learning process
The early retail and shopping center development in and around these cities was not subject to much zoning or building review because there was no expertise to guide the municipalities. Government was eager for private enterprise to purchase and develop the real estate. Infrastructure, land use, environment and accessibility issues were not initially recognized or focused upon. As real estate values have risen with the involvement of more international players, and as individuals have become more sensitive to the changes occurring in their communities, more deliberation and accountability have been built into the review-and-approval process. What is so incredible is that this learning process has been condensed into such a short time frame.

Second- and third-generation centers are making the original centers look and feel old and obsolete. To compete they must, within just a few years of opening, add new bells and whistles to compete. In Warsaw, Promenada Shopping and Entertainment Center opened in November 1996 without competition. Its tenant mix was predominantly local. In 1999 Centrum Janki, a 70,000-square-meter enclosed center (including a food court and movieplex in an originally planned second phase that opened in August 2000) and Klif Shopping Center, a 19,000-square-meter enclosed center in a densely populated residential section of the city, both opened. In September 2000 Galleria Mokotów, a 50,000-square-meter center with 170 stores, entertainment venues and restaurants leased by Jones Lang LaSalle, also opened.

Visiting all four centers in one day, it was striking to see the increased sophistication in design, materials, tenant mix and marketing over this short period. While Promenada’s design was limited by the use of a pre-existing building as its core (thus resulting in a vertical mall with four levels), the later centers all were able to build a traditional race track design (although Klif’s design was also limited by site constraints). Promenada has responded by adding an entertainment phase consisting of a multiplex theater, bowling and video center and restaurant, and is scheduled to start construction on a third phase that will bring a supermarket, food court and anchors to the project in 2002. It would make an interesting case study to see how Promenada fares over time in the market. The strength or weakness of its location vis-à-vis its newer competition will probably be a critical factor.

Location, location, location is as apt a description of the three most important real estate criteria in Central Europe as it is in the United States. Mammut Shopping and Entertainment Center on the Buda side of the Danube, is in one of the wealthiest residential districts of Budapest. Built in 1998 and owned by Hungarian nationals, the 25,000-square-meter center is also a vertical mall with four levels. And while it had poor sight lines and was cramped, noisy, uninspired in design and probably broke at least a dozen cardinal rules of enclosed-mall design, in contrast to most centers we visited it was humming at mid-morning on a weekday.

Just to make sure its customers stay in the neighborhood, however, in June 2000 the center opened an eight-screen movie theater and has a service-and-entertainment phase scheduled to open in autumn of this year that will consist of a bowling alley, Internet cafe and fitness and dance center.

While the Study Tour did not unveil any significant presence of U.S. retailers or shopping-center developers in the Central European cities we visited, the American influence and experience abounded. The centers we visited represented a microcosm (good and bad, mistakes and successes) of the 40-year evolution of the industry in the United States. Could they also provide the next step in the evolution of our own industry as venues for American retailers? You bet.

Arlene Richman is an attorney with the firm Sidley & Austin in Chicago specializing in shopping center and retail real estate transactions.

 

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