A $1.7 billion hostile-takeover fracas kept the REIT world buzzing for months. Discounters made still more gains, even as some big-name retailers sank into bankruptcy. And through it all, retail real estate was among the hottest investments on the planet.

What a year it was — one punctuated by drama, ambition, triumph, failure and the expenditure of boatloads of money. While much the same could be said of just about any recent year, 2003 was different.

“The influx of capital into the retail real estate market was like nothing we've ever seen before,” says Mark Toro, a partner in Cincinnati-based developer North American Properties. “The emergence of retail as an attractive investment vehicle for pension funds, REITs and high-net-worth individuals and syndicators is extraordinary in our experience.”

The performance of retail REITs illustrates the point. Through September, according to the National Association of Real Estate Investment Trusts, retail REITs posted composite returns of more than 32 percent, compared to just over 21 percent for industrial and residential properties. Unlike those sectors, retail wasn't saddled with an oversupply of properties from the past few years, and the relatively small scale of new development during the year — only two regional malls opened in 2003 — helped keep the market firm. Retail clearly was the place to be.

It was a year marked by shifts. Long-besieged traditional department stores, for instance, increasingly moved toward the model made popular by Kohl's and other successful discounters. “The most remarkable thing I saw this year was that the recognition has come to department stores at last that they must change and adapt themselves to the realities of a completely new marketplace,” says Kurt Barnard of Barnard's Retail Consulting Group.

For JCPenney and Sears, that meant off-mall excursions that could accelerate the growth of smaller centers. In October Penney opened its first stand-alone store in Cedar Hill, Texas, and Sears debuted its new off-mall format called Sears Grand in West Jordan, Utah.

But some see such moves as imitative and unwieldy, like a sumo wrestler taking tap-dancing lessons. “Sears continues to try to figure things out, but they still can't,” says one developer. “The industry perceives Great Indoors (Sears' shrinking chain of home centers) to be a failure. Now the first Grand unit has opened, but the industry perceives that they are unlikely to deploy that with any speed or reliability.”

Ringside Seats

Perhaps the year's biggest drama of the year was the failed attempt by Simon Property Group and Westfield America Trust to acquire Taubman Centers and its 31 properties for $20 a share, or nearly $2 billion. After months of legal wrangling, the acquisition was finally thwarted by passage of an anti-takeover law in Taubman's home state of Michigan. “Everybody in the industry was talking about it,” says Gregory T. Karlen, president of real estate services firm Madison Marquette. “It was quite a thing to behold.” (For Taubman's take on the whole affair, see page 16).

“The REITs aren't buying properties anymore, they're just buying each other,” notes Scott Lunine, national director of retail for the Sperry Van Ness brokerage. Adds Madison Marquette's Karlen, “The appetites were so huge. There's so much money to spend that they didn't want to waste their resources buying one-offs.”

That's borne out by the sheer size of the deals done this year, among them Kimco Realty's acquisition of Mid-Atlantic Realty Trust's 41 East Coast centers for $444 million and Pennsylvania Real Estate Investment Trust's purchase of Crown American Realty Trust's 27 regional malls for $1.3 billion.

From an investment viewpoint, 2003 was “a lot of things happening at once, almost like ‘The Perfect Storm,’” Lunine says. First-time investors were joined by investors transitioning from multifamily and industrial properties, he says, and “all of a sudden the market turned itself around.”

Also of note was the fact that all classes of retail sold well, says Mark Gibson, executive managing director of Holliday Fenoglio Fowler, one of the nation's largest retail financing firms. “That's a major change from a year ago, or two or three years ago,” Gibson says.

The demand has led to a shift in pricing, say some, with cap rates shrinking. In the case of some big-box properties, caps fell 200 basis points in a year. “Who would have thought that power centers would be priced at cap rates typically associated with grocery-anchored neighborhood centers?” asks Toro rhetorically.

Buyers of glitzy retail malls, too, saw cap rates decline — to less than 7 percent in some cases. But, still, developers and analysts think most properties were worth it for the long term (See Trophy malls story on page 56.)

All these factors taken together will spell some good bonuses for those who made the deals. “Last year and this year have been very good from a brokerage point of view. A lot of people made a lot of money,” says Bernard J. Haddigan, director of Marcus & Millichap's national retail group.

But none of it would have been possible if consumers hadn't been willing to spend their money in the first place. Retailers shrugged off a bad holiday season last year and war shivers, and by summer were seeing the beginnings of a decent rebound in consumer spending that appeared to continue through the year.

In the retail ranks, the usual suspects emerged again as the big winners. Wal-Mart opened some 200 new stores — including five-dozen Supercenters, the format traditional groceries love to hate. Costco, the nation's largest wholesale club, continued to muscle forward, its 400 stores selling everything from five-pound packs of American cheese to Gateway computers. Kohl's added new lines and kept redefining what it means to be a department store.

Then there was Target, which cemented its position as discounter to the affluent. It concentrated its media on upscale buys like the Fine Living cable channel, opened two-story downtown stores and went into lifestyle centers and enclosed malls alike. (In California, Irvine Corp. announced that its Irvine Spectrum Center will be co-anchored by Nordstrom and Target, a pairing that a few years ago would have been considered an unnatural act.)

Toro, noting that his two teenage daughters “shop at Target with a vengeance” but dismiss the idea of buying fashions at Wal-Mart, says he was impressed with its marketing strategy and site selections — enough to declare that Target “is to a great extent the future of American retailing.”

Gone, But Not Forgotten

No discussion of 2003 would be complete without a moment of silence for those retailers that made the ultimate sacrifice. Kmart chopped 600 stores and 67,000 employees before emerging from bankruptcy in May. Whether it will stay out of bankruptcy is a hot topic in the industry. “I don't think they're going to make it,” says one broker. “Strong holiday sales could make the difference,” says another.

Other big names suffered too. Famed catalog retailer Spiegel went into Chapter 11 and shut 60 of its Eddie Bauer stores. Best Buy pulled the plug on 90 Sam Goody music outlets. FAO Inc. filed for protection too, closing 70 FAO Schwarz, Right Start and Zany Brainy stores.

Less high-profile was the demise of the 77-store Drug Emporium, whose parent, Snyders Drug Stores, filed for Chapter 11 in September — just two years after buying the smaller chain. “That was a really big boo-boo,” says one broker. “To go from acquisition to liquidation that quickly, I've never seen such a thing. I don't know if they really had a plan. Maybe they should've saved some time and done it all in the same week.”

No year would be complete without a massive accounting scandal. This year's came from Dutch giant Royal Ahold, the world's third-largest retailer and owner of U.S. grocery chains Giant Food of Landover, Md., Giant Food Stores of Carlisle, Pa., and Stop & Shop of Quincy, Mass.

After a nine-month internal probe, Ahold said overstated earnings at its U.S. Foodservice unit, which sells food to institutions, would result in a restated loss of $5 billion for 2002 and cause a “significant impact” on 2003 results. Some wonder what the bloodbath might do to Ahold's 1,600 supermarkets, especially given the hypercompetitive nature of the grocery business — a condition that only grew worse this year with the expansions of Wal-Mart and the warehouse clubs.

Marcus & Millichap's Haddigan estimates that the nation's grocery chains lost 5 percent of their market share in the past decade and predicts “more consternation” for them ahead. Lunine of Sperry Van Ness agrees, noting that groceries are squeezed by price cutters and specialty grocers alike. “I have a feeling they're not going to be around in their current condition in five years or so,” he says.

Minority Report

Something else happened in the grocery sector that some developers and brokers see as a sign of even bigger changes to come. Reflecting the shifting demographics of the country, ethnic supermarkets opened as never before. “They're going to have a huge impact in some areas,” says Karlen of Madison Marquette. “Their parking lots are full.”

One example: The eight Gigante supermarkets in California operated by Grupo Gigante, Mexico's third-largest supermarket chain. The markets, half of them new this year, are full-size stores emphasizing the produce, meats and prepared foods popular with Mexicans and other Hispanics. They draw not just Mexican-Americans, but shoppers of all stripes looking for a new experience.

“It's a new trend for our area,” says Daniel J. Hughes, president of Metro Commercial Real Estate, a Mount Laurel, N.J.-based brokerage. Hughes has signed full-sized supermarkets featuring Asian, Hispanic and Indian food. “They went into areas where there was a core ethnic population, but the stores aren't catering just to those populations,” he says.

The country's growing diversity has other impacts, too. Urban in-fill locations continued to gain favor among developers who'd pushed the suburban envelope to its limits, and retail came to places long ignored. The year's best example may be North American's Camp Creek MarketPlace, a million-square-feet lifestyle center that opened in July in a predominantly African-American community just west of Atlanta's Hartsfield Airport. Long shunned because of doubts about its buying power, the area had no retail within 15 miles, says North American's Toro.

The doubts are gone now. The center — anchored by Target, Marshall's, Lowe's and Linens N Things — is reporting exceptionally strong sales. Indeed, for the week of Aug. 4, Marshall's sales were the fifth highest in the chain.

Given all that happened in 2003 and all the money that was spent, it's clear who the big winners were, says Toro: “Anybody who owned a shopping center.” For those who didn't, the situation was a bit more complex.

“I would describe 2003 as opportunities missed and opportunities found,” says Lunine of Sperry Van Ness. For a while, “You could buy anything and get upside appreciation. Nowadays you have to be smarter, from a retail perspective and an investor perspective. That's the key — growing smart and investing smart.”

Good advice for 2004.

The Big Got Bigger

Wal-Mart opened about 200 new stores in 2003, including five-dozen supercenters, much to the chagrin of traditional grocers. The Bentonville, Ark.-based behemoth's new neighborhood market concept also made further inroads against established supermarket chains. Last month, the retailer even announced plans to get in on the burgeoning online music downloading industry with its own Internet music service to be launched in 2004.

In The Zone

Mall owners are envious of Mills Corp.'s recently forged relationship with PBSKids, which is partnering with the developer to open PBS Kids Backyard play areas at its malls. The first PBS Kids Backyard — a 3,000-square-foot learn-and-play destination — opened last month at St. Louis Mills.

what was HOT

The Year That Was

Whether they made us cheer or cringe, Retail Traffic remembers the past year's moments of fame and infamy.

Eating Out

Forget the food court. Sit-down restaurants became must-haves at major retail centers. Eateries such as Cheesecake Factory (which generated sales of $1,000 per square foot), Champ's, P.F. Chang's and Maggiano's proved to be bigger traffic draws than most department stores. On Friday nights, most malls saw more people in line to eat at The Cheesecake Factory than had visited Saks Fifth Avenue or Dillard's all day.

Big Box, Big City

Big boxes made further inroads into dense urban markets, rethinking their sprawling suburban prototypes to make every square foot count. Home Depot led the charge by opening a two-level, 80,000-square-foot Lincoln Square store in Chicago in April. Then, the home improvement chain announced plans to open two more multi-level stores in Manhattan's Flatiron and Midtown districts.

Roaring REITs

General Growth Properties was the shining star among public retail REITs, most of which turned in stellar performances. GGP's third-quarter earnings per share increased 22.5 percent, beating estimates. With $1.7 billion in acquisitions, strong internal growth (same-store NOI increased 6 percent plus for three consecutive quarters) and low financing costs, the winds are at the Chicago-based company's back moving into 2004.

Spare No Expense

The economy may have tanked, but retailers were still stocking high-priced items to lure in the very rich. From Victoria's Secret's million-dollar bra to $1,500 Burberry snowboards to Neiman-Marcus' $10,000 mermaid suit, big-ticket items were all the rage.

Common Ground

The May sale of City of Industry, Calif.'s Puente Hills Mall — in which 31 individuals, mostly 1031 exchangers, put up an average of $1.5 million each to acquire the $148 million mall as part of a tenancy-in-common deal — proved that small investors could combine their equity, qualify for a large commercial-backed securities loan, and purchase an institutional-quality property.

Down with the Mall

Demalling proved a successful turnaround strategy for underperforming properties. At Winter Park, Fla.'s Winter Park Village, architecture firm Dorksy Hodgson + Partners, gave the dying mall a major facelift by tearing down most of its 350,000-square-foot retail space and rebuilding its structure in several phases. Now the mixed-use complex, including apartments, restaurants, a movie theater and office space, is unlike any other in the city.

Dying Downtowns

The era of the downtown department store died with a faint wheeze as May Co. announced plans to shutter its 125,000-square-foot Lord & Taylor on Smithfield Street in Pittsburgh. Local brokers anticipate Pittsburgh's other downtown retail anchor, Federated's Lazarus-Macy's, will take advantage of its option to shut down next year if sales are “insufficient to reasonably operate.” In October, Federated also announced plans to close its 100-year-old Lazarus-Macy's flagship in downtown Columbus, Ohio.

Old Boys' Club

It's not always easy being a woman in retail. The National Organization for Women branded Wal-Mart a “merchant of shame” for alleged discrimination against females. In May, former Miss America Carolyn Sapp led an anti-Wal-Mart demonstration at a Las Vegas store to encourage women to join a class-action suit against the discounter. And in Murfreesboro, Tenn., six female associates claim a male Target exec got off scott free after allegedly groping them and making lewd comments. And yet, the women were forced to watch a sexual harassment video.

You're So Vain

Babes-and-beefcake signs and catalogs made Abercrombie & Fitch the mall's sexiest retailer, but the chain took its aspirational image too far. While other teen-focused chains slashed prices to keep up with the slowing economy, Abercrombie insisted its customers were willing to pay higher prices for the Abercrombie lifestyle. A string of sliding comp sales proved they weren't. The retailer even attracted a lawsuit from one Asian-American job applicant who claimed she was denied employment because her physical appearance didn't mesh with the corn-fed All-American Abercrombie image.

Call It Chica's

Despite its masculine moniker, Chico's FAS couldn't seem to make a go of it in the menswear business. The chain aborted plans for a rollout of Pazo — a testosterone take on its popular Chico's casual apparel formula — and opted instead to spend $85.6 million of its expansion dowry on the decidedly-more-feminine clothing chain White House/Black Market.

Acts Of God

How can retail sales rebound if the fates won't cooperate? First, an unexpected winter storm blanketed the East Coast during the important President's Day weekend, causing retailers to lose at least $422 million in sales. Then, the great blackout struck in August, zapping another $30 million in sales. And finally, a breakout of wildfires in Southern California destroyed properties and sent consumer spending spiraling.

Marrying Well

Marriages of convenience abounded, with PREIT more than doubling its holdings in May after adding the dowry of Crown American Realty Trust to its portfolio. JDN Realty Corp. wed Developers Diversified, and Mid-Atlantic Realty Trust became Kimco's blushing bride. But owners weren't the only ones feeling amorous. CB Richard Ellis married into the East Coast market with its Insignia/ESG acquisition.

Comeback Kid

Taubman Centers beat the odds, defeating a hostile takeover attempt by rivals Simon Property Group and Westfield America that most pundits thought was a done deal. The REIT owes some big favors to its friends in the Michigan legislature for passing a law that made the takeover impossible.

Keeping it Private

Private REITs were popular in real estate. Inland Retail Real Estate Trust led the foray into retail by acquiring more than 15.5 million square feet of community and power centers worth $2 billion.

Making Cents

One of retail's few growth niches, dollar stores, flourished. Comp sales soared as chains such as Dollar Tree, Family Dollar, Dollar General and 99 Cents Only gained upscale customers. And with 16,400 stores run by the top 10 firms, analysts say the U.S. has room for about 15,000 more.

European Vacations

European properties and investments became more appealing to U.S. developers. Mills Corp. opened Mills Xanadu in Spain and put two additional European projects in the pipeline. In November, Simon Property Group announced a joint venture with Rinascente Group to develop and own malls in Italy. Not to be outdone, General Growth Properties is also investigating international investments.

Sky-High Pricing

Buyers got no discount on major malls this year, with Simon paying $333 million for Palo Alto, Calif.'s Stanford Shopping Center; Mills paying $442 million for Torrance, Calif.'s Del Amo Fashion Center and $265.5 million for Milpitas, Calif.'s Great Mall of the Great Bay Area; and Macerich paying $158 million for Phoenix's Biltmore Fashion Park.

My Enemy, My Friend

A fickle economic environment caused many developers to spread their risks by partnering up with competitors. Forest City enlisted Westfield America to help shoulder the development responsibilities for the $380 million, 1.5 million-square-foot San Francisco Center project. Simon Property Group and upscale outlet maven Chelsea Property Group opened the $80 million Chelsea Premium Outlets in downtown Las Vegas. National and local players also teamed up to share development responsibilities, for example Burroughs & Chapin and CBL & Associates' teamwork on Myrtle Beach, S.C.'s Coastal Grand mall.

Talking Dirty

London-based French Connection Ltd.'s FCUK slogan struck a sour chord when it launched a clothing line and perfume aimed at schoolchildren. Federated Department Stores bowed to pressure from parent groups and yanked the merchandise. Other chains including Marshall Field's, Hecht's and Filene's still carry the line.

Call Security!

Kevin Shelton and Christian Hyman proved to be mall security guards' two worst nightmares. Shelton, the self-proclaimed “Money Man” of Florida, shot $2 bills into a crowd gathered at Sembler Co.'s Bay Walk in St. Petersburg. The resulting melee caused 12 injuries and brought a mountain of bad publicity. In Washington, D.C., the Office of Homeland Security arrested Hyman, who billed himself as a security expert. Hyman allegedly attempted to extort $120,000 from major mall owners in exchange for keeping mum about security violations he claimed he had found at their shopping centers. A subsequent search of Hyman's apartment uncovered explosives.

Widening the Aisles

In November, the Golden State gave department store chain Mervyn's a pass on ADA compliance after the Target Corp. division argued it would have to spend $30 million per year and close many of its 126 California stores if it was forced to widen its aisles to at least 32 inches to accommodate disabled shoppers. Disability advocates had filed a lawsuit against Mervyn's in May 2002.

Persona Non Grata

Retail higher-ups weren't immune from persecution. Red Lobster president Edna Morris's disastrous all-you-can-eat crab promotion landed her a pink slip. And CEO Christina Johnson parted ways with Saks Fifth Avenue after a string of alleged bad merchandising decisions put the luxe emporium in second place to rival Neiman-Marcus. And in June, former Rite Aid CEO Martin Grass pled guilty to conspiracy and accounting cover-ups and admitted he and several other company honchos attempted to hide losses from shareholders in the late 1990s.

Sinking Ships

Troubled retailers continued to lose steam, led by Kmart, which emerged from bankruptcy protection in May with a second-quarter $483 million net loss. A failed Eckerd remerchandising couldn't keep parent J. C. Penney Inc. from putting 2,710 stores on the block after 11 months of declining sales. And Winn-Dixie Stores Inc., which saw first-quarter comps fall 6.6 percent, couldn't stem massive market share losses to competitors Wal-Mart, Kroger and Publix in the Southeast.

Downloaded

Internet music piracy cost record stores millions in sales and even drove Wherehouse Music into bankruptcy. Rampant downloading also prompted Best Buy to sell its Musicland division, which saw sales decline 8.7 percent in 2003, to private investment firm Sun Capital Partners. The recording industry responded by lowering CD prices and filing lawsuits against habitual downloaders, including a 12-year-old girl who lives in New York Public Housing.

Party Pooper

Retailers blamed architect Daniel Libeskind for ruining one of the most profitable shopping destinations in the United States. Westfield America pulled out of its 99-year lease at the World Trade Center site after deeming Libeskind's redevelopment plan for the former Westfield Shoppingtown World Trade Center unworkable for retail purposes.