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‘B’ MALLS ON INVESTORS’ A-LIST

BY JOEL GROOVER

Investors habitually assign grades — A, B, C and even D — to real estate.

Lately, though, those investors have been looking at the ‘B’ mall sector in a wholly different light.

“A few years ago you had just a handful of players pursuing ‘B’ malls,” said Steven Plenge, an executive vice president at Santa Barbara, Calif.­based Somera Capital Management. “Today you have a great many with that sort of asset strategy.”

For the past several years, retailers have been on their own version of flight to quality. The trend involves shutting stores in lower-quality malls to focus on stores in the best-performing ones. This retail migration, along with REIT consolidation, has generated considerable activity around the country’s nearly 600 top-tier centers, notes Paul Morgan, an analyst at Arlington, Va.­based Friedman, Billings, Ramsey & Co. “Now the public companies own 80 percent of the ‘A’ malls,” he said. “Of the ones still in private hands, it could take a long time before some of these families decide to sell.”

Though the pool of available top malls is drying up, ‘B’ assets remain plentiful. This diverse category includes regional centers in secondary or tertiary locations, as well as strong though not dominant properties in major markets.

Looking out for No. 2
Private firms and public REITs alike are vying for the best of the B’s. They are also buying up lagging ‘B’ properties and re-tenanting them or transforming them into hybrids by adding exterior entrances, big-box tenants and lifestyle components.

Lower prices, good locations and cheap, readily available debt fuel the trend, says Arthur M. Milston, a managing director at New York City-based Granite Partners, which is marketing six B’s in the Southeast for Colonial Properties Trust, a diversified REIT based in Birmingham, Ala.

Often, smaller markets are unable to support upscale lifestyle centers, says Milston, but redevelopment strategies that open up dated B’s can transform them into community focal points and eliminate vacancy-prone in-line spaces. That is exactly what has been happening in such mature markets as Southern California. “We’re more or less done with the B’s and C’s in California,” said Gwen MacKenzie, CLS, a senior vice president at Irvine, Calif.­based Sperry Van Ness. “I can’t think of one that’s not under redevelopment. Properties that years ago may have been neglected now have a ton of people chasing them.”

The Mall of Victor Valley is a good example of just such a center’s finally getting its due. Originally developed in 1986 by Cleveland-based Forest City Enterprises, the mall sits 97 miles northeast of Los Angeles, in Victorville, Calif., where suburbanites fleeing big-city gridlock and smog will swell the population of 78,000 by 27 percent over the next decade, experts say.

Somera and San Francisco­based Rockwood Capital bought the 507,000-square-foot center for $70 million in March 2003. “It offered a limited shopping experience, but at the perfect location,” Somera’s Plenge said. The new owners were busy wooing upscale tenants and weighing redevelopment plans in July when The Macerich Co. swooped in and bought the mall for $104 million. “Its year-to-date sales are up over 17 percent,” said Edward C. Coppola Jr., a Macerich executive vice president. “We felt the mall was on the verge of going to another level.”

Macerich employs what Coppola calls a “rifle rather than shotgun” approach to acquiring mid-tier malls. The goal is to find well-located properties that can be remade into more-productive assets by leveraging Macerich’s heavy market presence. Last year, for example, Macerich spent $10 million on an interior renovation of the 1970s-era Vintage Faire Mall, Modesto, Calif. The upgrade helped boost sales per square foot from $250 to $450. Coppola now considers Vintage Faire an A-quality mall.

Grade anxiety
The category does have its detractors. This year’s Emerging Trends in Real Estate, an annual forecast by PricewaterhouseCoopers and the Urban Land Institute, urges investors to steer clear of B’s. Their declining cap rates make them “too pricey,” the report cautions. Indeed, just as they have in the top-tier sector, cap rates for ‘B’ malls have dropped over the past couple of years. About two years ago, Plenge says, an ‘A’ center was bearing roughly 8 percent, while a ‘B’ could run somewhere in the high 9 percent or 10 percent range. Today the classes have seesawed, with the B’s going for 7.5 percent to 8.5 percent and the A’s ranging at about 5 percent to mid-6 percent, he says.

Meanwhile, the spread between A’s and B’s is closing. The result is what Plenge calls “definition creep” — some A-class REITs are now “reaching down into malls they wouldn’t have chased two years ago.”

Emerging Trends also predicts that retailer consolidation over the next five years will force some tenants to abandon B’s for fortress malls. “Fashion malls and lifestyle centers steal shoppers from the high end, and discounters rob sales from the bottom,” writes Jonathan D. Miller, the report’s author and editor.

Friedman, Billings’ Morgan says such concerns are legitimate, particularly for the weakest strata of B’s, but he cautions that blanket assertions about this highly differentiated class can miss the mark. John L. Bucksbaum, SCSM, the CEO of General Growth Properties, agrees. “There are important distinctions,” Bucksbaum, said. “A dominant mall in a smaller marketplace doing $350 per square foot can be every bit as good as one that does $500 someplace else.”

General Growth and Chattanooga, Tenn.­based CBL & Associates Properties favor strong or dominant malls in fast-growing middle markets. Less vulnerable than their counterparts in sleepier locales, such properties now spark fierce bidding and sport high price tags. William C. Hartwell Jr., senior adviser at Cornelius, N.C.­based Sperry Van Ness/McMahon & Associates, notes that General Growth paid $160.5 million last March for the 1.1 million-square-foot Four Seasons Mall, Greensboro, N.C. That three-level center boasts sales per square foot of approximately $345. “Four Seasons is the No. 2 mall in the market, but that is not slighting it by any means,” Bucksbaum said. “It was highly sought-after.”

Indeed, the frenzied pace of middle-market acquisitions shows no sign of slowing down. “We’ve bought 14 malls in the past 18 months,” said CBL President Stephen D. Lebovitz. “It has been the most active period for us in terms of acquisitions in our history.” CBL, which went public in 1993 and now owns interests in, or manages, 167 properties, including 67 malls in 27 states, is known for its exclusive focus on mid-tier properties with strong growth potential. By most accounts, the strategy works. According to Louis W. Taylor, an analyst at Deutsche Bank Securities, CBL’s funds from operations figure has grown 12.1 percent since 1993 — the second-highest among mall REITs.

Lebovitz says the industry’s preoccupation with A’s has worked in CBL’s favor. “Clearly, a lot of institutional people have never understood middle-market malls,” he said. “As long as they remain a well-kept secret, that’s fine with us. We’ve been able to make a ton of money from them.”