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TIAA reaffirms commitment to retail despite MoA offer

By Debra Hazel

Although TIAA said in late June that it would sell its 55% stake in the Mall of America, the pension fund says it remains committed to shopping centers.On June 20, New York-based Teachers Insurance and Annuity Association-College Retirement Fund (TIAA-CREF), the largest pension fund in the world and a shopping center investor since 1948, announced that it would consider selling its best-known retail real estate asset, its 55% share of Mall of America in Bloomington, Minn. Two days later, Joseph M. Luik, senior managing director and Kathleen M. Nelson, TIAA managing director, spoke with SCT Editor Debra Hazel about the potential sale, TIAA's criteria for retail real estate investments, and its ongoing commitment to the shopping center industry.

SCT: I guess we should start with Teachers' interest in selling its share in Mall of America.

Mr. Luik: I'm not sure we have fully analyzed the possibilities of how we could sell. We're waiting literally for the market to tell us what it's worth. I think it's fair to say that today a lot of assets are worth a lot more than the normal appraisal techniques have valued things in the past. So we'll wait and see.

Is that the reason why now is the time to sell, because so many projects are getting very good prices?

Mr. Luik: Absolutely. It's all market-driven. We're under no pressure whatsoever to sell the Mall of America or any other asset. Every sale that we make, whether it's retail, office or any sector, is driven primarily by the market's perception of value and what we believe the value is, and the future upside.

Can you give us an idea of what you're hoping to get for the Mall of America?

Mr. Luik: I have no idea.

Published reports say that you are speaking with Simon DeBartolo Group and Triple Five Corp., who are the co-owners of the center, about increasing their stakes. Are those reports accurate?

Mr. Luik: It's a possibility.

Have you been approached by other companies?

Mr. Luik: We've just begun the process.

Do you have any idea of the time frame?

Mr. Luik: It's a short time frame, probably 30 to 45 days.

Ms. Nelson: Just one other point: while we're known as the pre-eminent lender of regional shopping centers, we also proactively manage our portfolio, and are constantly going through our portfolio looking for dispositions.

Asset Allocations

So selling a center is really nothing new. This just happens to be one of your better known properties, probably your best-known property.

Ms. Nelson: I think it's safe to say it's probably our best-known regional shopping center investment, or our best-known real estate investment. But we have sold other properties, other mortgages. In the past couple of years we have sold two distinct portfolios of mortgages, which included about $600 million of mortgages on regional shopping centers.

Mr. Luik: We've done, in the recent years, an analysis of shifting trends in the retail sector, prompting us to develop a precise analytical framework to assess the long-term aspects of mall-secured portfolio loans. This process examines demand, performance, sales productivity, regional properties, competitive strengths and weaknesses. That sometimes indicates a strategic sale. Over the last two years, we've applied this not only to wholly owned properties but to the mortgages [and] the assets underlying [them], and sold two large portfolios in 1997 and 1996.

Have you been investing the proceeds in other retail properties? Essentially, how are you changing your allocations, retail vs. office vs. other?

Ms. Nelson: The properties that we sold were performing, fine centers. However, in reviewing that portfolio and using that analytic framework, we determined there were malls that met our core investment criteria and those, perhaps, that had reached their full potential for us. So we took a look at some of the centers, packaged that and sold the portfolio. We did extremely well in that sale.

In terms of reinvestment, last year TIAA-CREF invested close to $5.5 billion dollars, over $1 billion of that was in regional malls. So in selling these $600 million in mall notes, we didn't necessarily earmark that $600 million into retail, but it did come back.

So this shouldn't be interpreted as a greater or lesser investment in retail than you've done in the past?

Mr. Luik: Let's talk about conventional mortgages first. As a lender, we've got about 30% of our total portfolio invested in retail. That's a number that we're very comfortable with, and I suspect we will maintain that 30% level for the foreseeable future. We're not driven by percentage allocations that are geared solely to asset classes. We're looking for solid core investments that an institutional lender would like to have in his portfolio.

Over the last two to three years, we've essentially looked at assets that didn't meet that criteria, sold them and added new assets that did meet that criteria. About one-third of those, as it turned out, also were in retail. I would say over last two to three years, we've done over half of the new centers that have opened in the country, for example, Wolfchase Galleria, South Park, The Mall of Georgia, and Park Meadows.

Through CMBS [commercial mortgage backed securities] securitization, we did the Scottsdale Mall expansion, which essentially made it a new mall, and The Westchester. I think you can see that we're not out of the business. What we're doing is financing extremely strong dominant regional malls.

Ms. Nelson: One of the important things to know is that we're not just another large pension fund looking for our piece of the pie in financing retail. TIAA was the first major lender to finance the shopping mall business. We provided a start, and we provided financing for the pioneers, for Al Taubman, for Ernie Hahn, Dick Jacobs, Ed DeBartolo, Herb and Mel Simon, Leonard Farber, Jim Rouse. We've done, I would say, a majority of the Rouse centers, a majority of the Hahn centers.

Have you been investing in the shopping center REITs, as well?

Mr. Luik: Yes. But let me back up and discuss the [corporate] philosophy, and it's a credit to John Summers [former TIAA TITLE TK]. When we reorganized our division about four-and-a-half, five years ago, we decided to keep the CMBS, unsecured REIT debt [and] purchase of REIT stock, in the Mortgage and Real Estate department. I think we're the only institution that has those securitized and public instruments purchased by real estate.

We've been able to utilize our relationships with these people and our knowledge of these companies to make not only what we think are extremely secure, well-priced purchases for Teachers but also to provide for our customer, the borrower, unique financings that give them the flexibility that's necessary to do their business. We've been buyers of unsecured debt of REIT stock of preferred stock of the Simon company. We've bought from any of the major shopping center REITs that have now gone public; we own various segments of their capital structure. In addition, we continued to be their conventional lender when it was necessary.

I think by having real estate people analyze real estate companies, you get a better, more flexible product to the borrower, and a better price for secure instruments for the lender.

Do you intend to increase your investment in that sector as opposed to the owning of physical land itself?

Mr. Luik: We're not the owners of real estate, though we are probably the largest lenders to the shopping center industry. We're mortgage holders, we own unsecured debt, we own preferred stock. Do we anticipate increasing? That will be driven by the market. If the market last year wanted more unsecured ... more CMBS from the companies. Today, it's probably turning a little bit. You're seeing borrowers wanting more secured debt, i.e. mortgages, so we're doing that. We're focused on the customer.

We're a lender, and we expect to have well-underwritten, well-priced loans. Our money isn't any greener than the other institutions. What we're trying to do though, is give the borrower flexibility.

And with the way the retail business is going these days, you're not just a lender on real estate, you're a lender to a business. The retail/shopping center industry has become a business much like the hotel industry.

More importantly, the borrower knows that Teachers is going to be in that business 10 years from now. So when the world changes -- and it will, when real estate changes -- and it will, it will be able to come back and make the changes that are necessary to the capital structure.

Industry Trends

As we're speaking in late June, we're seeing the stock market blipping a bit. You have crises going on in various parts of the world in terms of Japanese economy, etc. Where do you see this going in terms of the US. economy, and how does it affect your investments?

Ms. Nelson: I might touch on how the world affects the future of regional retail. We think there are certain markets where retail is overbuilt. But we do think there are some markets, some exceptions. We are looking at what we call the population and employment growth markets.

We mentioned the Mall of Georgia earlier. We are committed to provide both the construction financing and the permanent financing for the Mall of Georgia. There are people who feel that the greater Atlanta market is over-retailed. We think that area, what some of us refer to as the third ring area, is kind of the future for retail. It's not just the population growth corridor, it's the employment growth corridor. That's what is so exceptional about our staff here. We have experienced real estate people looking at the market every day, and we were able to analyze the Mall of Georgia in that kind of setting.

It's more than just a set of numbers. You have people who can see the nuances and potential a bit more.

Mr. Luik: It's a combination of statistics, demographics, job creation, all of those factors that should be utilized in the analysis of a retail investment. It's the same the shopping center developers and retailers themselves. Like anything else, you can draw any conclusion you want from a set of statistics and numbers.

There is also an additional sense about retail. Mall of America is a case in point. A lot of statistics reported the Twin Cities were overretailed or adequately retailed back in the early to mid-1980s. We looked at the numbers and analyzed them from a different point of view. The sales have proven that that market could sustain another regional mall.

To go back to the global question, one issue we always face is not just the shopping center developers and what are the markets where the developers are willing to build, it's a question of retail. The shopping center developers are providers of retail space. It comes down to what retailers are doing. What are the retailers doing with respect to changing demographics? How are they looking at their products and what they are going to provide to the population? There are radical changes occurring in the demographics of this country, and how are the retailers adapting to those changes?

That plain blue sweater [being sold] in the Northeast isn't necessarily the same product you'll want to sell in the border towns in Texas. You have to start looking at that. We look at that, and just because it's a regional mall with good demographics doesn't mean it's going to work. The question is, Will you get the retailers into that mall that will have the sales necessary to sustain it over the long term?

Tenants

Are you continuing to reassess your investment criteria in light of changing demographics?

Mr. Luik: No question. This is a continuing process. When we look at an existing regional mall within our portfolio, we're not just looking at occupancy. We don't look at a mall that's 93% or 95% leased and say it's successful. We take a look at the historical trend of sales and try to project with the developer where they're going. That's the real indicator of the future success of the mall: the sales that are being generated.

Ms. Nelson: The credit of the department stores and the in-line mall stores is something we look at very carefully. It's not just the credit, but the market share.

Mr. Luik: Though it sounds like we're talking on both sides of the issue, [besides] the creditworthiness of tenants and the cash flow from the shopping center, one concern we have when you're talking about the nuances of the regional mall is the inability to attract local tenants, the inability to adapt to the local environment.

We've all talked about how you could throw someone into a center in Albuquerque, or Cincinnati or Gainesville, Fla., and they'll find a lot of the same tenants. You won't know where you are.

Mr. Luik: They all look the same. When we analyze a center, we look at that. We take a look at the number of local tenants, and we don't always consider that to be a negative because they're not as creditworthy as some of the nationals. As a matter of fact, it could be a very strong positive, and if you look at the sales of that local credit tenant, a noncredit tenant but its sales are strong, that's good.

When you get into the retailing/entertainment business, you see even more of that because you start looking at restaurants, you start looking at any of the food providers. Most of the local guys don't have very strong credit but they can be the most successful retailers in the center.

Ms. Nelson: Our retail portfolio overall has been one of the strongest segments of our real estate portfolio. I would add, though, that we have had a handful of problems. [With] the size of our investments, you'll just have to have a few problems.

We have found that actually one of the main reasons for a failed mall is the lack of attention to the demographics by the owner of a center. In situations where they have not paid attention to the change in demographics ... they just were looking at the center and not at the marketplace and completely lost the market. If that particular owner or center does address what's going on in the marketplace, the change in demographics, it will succeed.

The other main reason for a failed center is the loss of an anchor. That is why we look at the department stores in the shopping center, their commitment to the shopping center through their operating covenant and the capital they put into their stores. We watch that very carefully.

How do you deal with an environment in which there is continued consolidation?

Ms. Nelson: We watch that very carefully. We have a separate research group that monitors the marketplace daily. We are concerned about consolidation in the retail industry. There are certain plusses, certainly financial strengths that it adds to companies -- when Federated took over Broadway, it certainly bailed Broadway out of bankruptcy. But Federated was just a few years out of bankruptcy itself. It did provide the financial support to the Broadway chain, but it also knocked out a major competitor in the west. It literally left Northern California without a major department store -- Nordstrom is more of a specialty store. And it resulted in store closings.

Mr. Luik: Realistically, we found that with a real good center with strong demographics, that's got the right tenancy and a strong ownership, we've never seen a real long-term problem when they've lost a department store. The developer has always been able to go in and do something with that space. I would say most of the time, in our portfolio, they've done something that is more positive with the center.

Ms. Nelson: We have a good example with Vallco [Fashion Mall] in Cupertino, Calif. We have had the mortgage on it since Sheldon Gordon developed it in the mid-1970s, then bridged across the road and built a second phase. The department store anchors were Sears, Roebuck and Co., The Broadway and JC Penney. All of the department stores' operating covenants had expired -- it was over 20 years old.

When Federated bought Broadway, it closed the store at the expiration of the operating covenant. Because of that, the center occupancy went downhill, and we found ourselves in a default situation on the mortgage, and eventually foreclosed on the center. Now, we hope to close the sale of the center to Jacobs this summer. Jacobs is managing the center, and they have brought their retailing history, expertise, and relationships to the center, and have negotiated a deal with Federated to reopen as a full-line Macy's, and a Dillard's is joining the center as a fourth department store. There is a possibility of a fifth specialty department store. It's a real success story.

Mr. Luik: That proves the point. If you have a good market with a good center, good location, it will work because the retailers want to be there.

Of course the other side of the coin is the consolidation. Competition is good in any segment of the economy. You always worry as you start to lose the competition, when you get down to just four or five retailers: Will they start to take their eye off the ball, and do they start to not pay as much attention to the sales or the things they need to stay on the cutting edge of retail?

Retail changes every year. You've got to be on the cutting edge or you can go backwards exponentially. We can take a look at the department stores back in the 1980s -- besides the financial conditions caused by Wall Street and, quite frankly, poor balance sheet financings -- a lot of them took their eye off the ball and they're not around any more.

The Federated stores actually were operating pretty well. They just couldn't pay that huge mortgage that [Robert] Campeau took on them.

Mr. Luik: I agree. But notice what all the department store chains did when they went into bankruptcy: The first thing they do, and the bankruptcy judge lets them do this, is close some stores. They take a look at the underperforming stores and close them. It's amazing the number of stores that were closed. These stores were underperforming.

Put aside the financial problems generated by the junk bond financings. Those are nonperforming stores. Why wasn't the retail industry looking at those stores and doing something to increase sales? It's a cutting edge business, and you've got to be there. I think the Dillards, the May Cos., the Federateds today are doing it. There's no question about it: They're stronger than they've ever been.

And on the development end, they're bringing in different types of anchors. You didn't used to see a Target in a regional mall. Now it happens. Wal-Mart is anchoring a mall in the Midwest.

Mr. Luik: You don't just look at the analysis of the existing asset, you've got to look outside the walls at what's happening in the primary trade area, the secondary trade area. What's your competition? Competition, now, is not another regional mall. Your competition is other retail venues, and if they're good and they're strong, a good is getting them to the mall before they go across the street or two to three miles away. That's a key to the long-term success of these assets. That's what we're looking at.

Ms. Nelson: Mall of America did that.

Mr. Luik: Mall of America was really a trendsetter, and I give Simon all the credit in the world. They really were the first ones to bring in the off-price guys, the category killers, and brought them into the mall. There was a lot of concern by the retailers that it wasn't going to work and it's proven to be a booming success. The best news is everyone's starting to imitate it. The retailers are happy, the developers have figured out a way to make it work.

What does a developer with a plot of land have to do to satisfy your criteria and get you interested in investing in a project?

Mr. Luik: A retail development is probably the most complex development to do in terms of financing because there are so many different aspects to it. This is what generated discipline in the industry at its inception. You had to have a plot of land; you had to have a developer with the financial strength to do it; you had to have department stores that agreed with the demographics and the market; then you had to have the department stores somewhat agree with each other with respect to their operating covenants. Then you had to lease it to the retailers. It's a complex structure that has to be put together with an awful lot of parties. Then you've got the lender, and the lender has to look at all of the various components and see if it fits his or her criteria. So there's no easy answer to that question.

The first thing you've got to do is start with a good piece of land with extremely strong demographics, demographics that not only are strong today but will continue to be strong and will continue to get stronger. Then you need the retailers. When you have all those pieces of the puzzle, then you get the long-term lenders involved.

Foreign Aid

There are few real development opportunities left for regional malls, at least not compared with 10 or 15 years ago. Are you looking abroad now for international retail opportunities?

Mr. Luik: We've done two retail deals in the United Kingdom. We're looking at two retail deals on the Continent today. We have found that the retailing market in Europe is probably where the U.S. market was in the late 1960s. There is an immense amount of opportunity there, and we think the ability of some of the local developers and local merchants to be involved in U.S. quality retail is phenomenal. We've made investments over the last two to three years and expect to make more in the future.

Ms. Nelson: We've [Invested???????] in the AIG fund that is in retail in France.

So it's not necessarily through mortgages, it's through funds.

Mr. Luik: Actually, most of what we've done has been through the equity route because in Europe, we don't have a strong or as readily accepted long-term lending yet. So most of what we've done over there has been through equity investments in joint ventures with local developers or institutions, or some fund investing. We're looking at a deal now in Europe, a 50/50 joint venture with a local developer, for a $160 million shopping center.

Ms. Nelson: The key is the local partner. That's very important.

Mr. Luik: He knows the market, he knows the retailers.

You're not looking to bring XYZ developer over from the States.

Ms. Nelson: There are some major hurdles to overcome for an institution like us to get involved in a big way in investing internationally.

Mr. Luik: I think the U.S. investors who run overseas because they see an opportunity that is caused by some cyclical development in local economies are not the lenders who are going to be there a couple fo years from now. They look at it as a quick buck.

We looked at the U.K. for over three years before we made our first investment. We've also been analyzing the Continent for three years, till we get to make that first investment, and we're right on the edge of doing it. It's a complicated business, no matter what you invest in over there in the real estate arena, whether office, retail or anything else.

One of the key issues you have to deal with, which most of the other insitutions that go over there forget about, is currency. That can make you a lot of money or lose you a lot of money very quickly, and it's taken us a long while, with U.S. liabilities, and no foreign denominated liabilities, we've got to get everything back into a hedged U.S. dollar position.

Other Formats

Closer to home, are you planning to invest in other formats besides regional malls?

Ms. Nelson: Other than superregional malls, we have financed our fair share of grocery-anchored centers. We have not financed the big box centers. We stayed on the sidelines when they were the retail investment of choice and I think it was the right place to be. Most experts say the real overdevelopment, the real oversaturation was in the big boxes.

And you will continue to invest in the grocery-anchored business, as well?

Mr. Luik: Absolutely. We've not done investing in very focused entertainment/retail projects, the ones that are 50% to 60% entertainment, and the rest retail. We're still analyzing that sector of the retail industry.

Ms. Nelson: I think the way we've provided the financing of entertainment has been when entertainment has been integrated successfully into a regional mall format, like Mall of America, most spectacularly, and like Mall of Georgia's concept of kind of integrating entertainment with the standard retail. Probably that is the way we would continue our standard of investing.

What kind of dollar figures do you anticipate you'll do in retail investment in 1998?

Ms. Nelson: We're expecting to commit to over $1.5 billion.

Mr. Luik: Also remember that's a combination of conventional mortgages, some investing in retail REITs, and we've also been able to adapt to the unsecuritization of the market.CHECK THIS

We've been able to do with Scottsdale, a single asset CMBS, where we arranged to be involved in the structure of it. We took not only the new piece of the investment grade, but also the no-investment grade component. Most importantly, we provided the borrowers with the flexibility of knowing whom to go to when they have the necessity for change.

We're the ìdirecting certificate holderî so that if they want to add another department store and they need to increase the mortgage, the loan or make any changes to the underlying collateral, they come to Teachers; they don't go to a trustee who essentially is holding the cash and distributing it to the bonds. They're going back to the real estate pro who'll know how to deal with these changes and the underlying answer.

Two years ago, no one was talking about CMBS. Do you anticipate the creation of other vehicles for investing in real estate?

Mr. Luik: Certainly all the headlines are about the public companies that own real estate. So public companies naturally gravitate toward balance sheet financings that are not always secured by the underlying asset. I think it's here to stay, there's no question about that. Nuances or changes will occur, of course, but I couldn't begin to anticipate what they'll be.

The Future

We're in a cycle where you're getting maximum value for your investments. When do you think the next downturn will hit?

Mr. Luik: I will make a prediction: There will be a recession, and when the recession hits, there will be a downturn.

Ms. Nelson: But when it comes, it will be like the last one -- it won't happen at once. Last time around, it started in the Midwest, the Northeast, the South, the Southwest. It didn't hit California until the end, and that's why the West Coast was the last to come out of it.

Mr. Luik: But this recession will be sort of a cyclical type recession, you'll have the same set of problems you have in a normal cycle.

When you're talking about what happened in the 1980s/early 1990s, you had massive overbuilding, you had incredible oversupply of every type: retail, office, industrial, hotels. You don't have that this time. You'll have weaker malls that are going to feel the effects a lot more than the stronger malls. But that shakeout was really necessary for the retailing industry. A lot of shopping centers that were here in 1985 are no longer regional malls today.

Ms. Nelson: We're a lot more comfortable with the underpinnings of real estate this time around, and the underwriting criteria that's been stringent and they're sticking to it. So when the next recession comes, we think we're in much better shape and ready for it.

Mr. Luik: The key to the market today vs. a couple of years ago is its liquidity. Even if you have a recession, there is still going to be liquidity in the capital lines in real estate. The problem we had in 1992 was there was no liquidity. There was no capital available.

You had very good shopping centers that retailers wanted to expand in -- even though it was a tough time there was a department store wanting to go it -- and you had borrowers who were unable to get the capital necessary to do the improvements that were necessary.

We had retailers that were owned by other companies that were involved in other businesses that were sucking out the cash flow from the good retailers and using it to pay other bills.

How have you prepared for the inevitable recession, whether it's 18 months from now or five years from now?

Mr. Luik: Let me give you a generic answer for all of real estate classes, not just for shopping centers, because I think it is important to look at it that way. Our underwriting is as strong as it has ever been. There is a lot of equity in properties that is ahead of our loan. We're absolutely concerned about cash flows, of the validity of those cash flows.

If there is any major risk that we perceive to be an equity risk, we either insist upon the developer setting up escrows to cover those types of risks, for example major lease rollovers where capital will be necessary. We're a lender, we get paid a lender's return. We're not going to take equity risk unless we're paid for it. Our underwriting is based upon a lender's return on the lender's risk. The cash flow is strong; you have escrows and contingencies set up to cover any equity risks.

Ms. Nelson: With respect to retail, we look at retail as not just another piece of real estate, but an ongoing business, so we're analyzing an ongoing business. We analyze the developer's experience, the department stores' credit, the department stores' sales experience, the interaction between the department stores, the operating covenants.

While the business people get the information from the developer world, we have our own research group that does the demographic studies for us, particularly on retail.

Mr. Luik: Teachers is a unique institution. Before we invest in anything, whether it's real estate, corporate lending, we develop expertise, we set up specialties. And retail is no different. In the retail real estate, it's no different, either. We make sure we have expertise in what we invest in. We understand the risks in what we're investing in. That's the real key if you want to be a long-term lender, and that's what we are.

Ms. Nelson: That's why we continued to invest in retail even when in the 1980s it was looked on as sort of a feckless real estate, because you had the department stores. You did not finance a regional mall unless all of the anchors were signed up and about 50% of the mall stores were credit tenants. That's different from, say, an office building or a hotel. It has served us well. It has been a very healthy part of our business.

One other point I think is important: We have some concerns about the consolidation of the developers, Rouse buying Hahn, etc. We have a national accounts group that handles our big national accounts which include most of the big names in retail like Rouse and Simon DeBartolo, etc. With the consolidation of the real estate developers, we start having exposure issues. When one of our big relationships merges with another of our big relationships, we're getting to a point where our exposure is such that we may have to maybe think about disposition.

Mr. Luik: We have to continually reassess our portfolio with our biggest borrowers. What this has enabled us, and forced us to do -- and always with the knowledge of the borrower -- is to rework the portfolio to accept payoffs on loans, to have co-lenders on loans to minimize our exposure somewhat.

But it also has given us the continual opportunity to bring in new borrowers. It's interesting that over the years there are a couple of major developers we haven't done much business with, and now over the past two or three years we've begun to cultivate those relationships. With our reputation and their skills, it's been a good relationship for both of us.

Teachers is a long-term investor. We hold these deals in our portfolio. We're not just a conduit, where we come in and sell it all off. We live with these deals: with our underwriting, we're looking at the long-term underwriting to make sure this will be successful over the next 10 years. This is in any area, any asset class. We're going to hold these. Even though we are going to actively manage our portfolio, we go into every deal assuming that we're going to be there. It doesn't always work out that way -- the world changes -- but we underwrite as a long-term lender and a long-term holder.