Where's retail development headed these days? RED Development is drawing a pretty good roadmap.

There's Cornerstone of Leawood, a lifestyle center on 34 acres in Leawood, Kan., population 27,000. Seventy-five miles to the north is the soon-to-open Shoppes at North Village in St. Joseph, Mo., a city of 73,000. And 100 miles northwest of that is Papillion Promenade, an 800,000-square-foot town center in Papillion, Neb., home to just 16,000.

All three are in the lengthening shadows of major metro areas — the first two Kansas City, the third Omaha — and all have attractive demographics. (Median household income in Leawood: $102,496.) But their biggest common feature is the fact that they are substantial developments in small markets — places that would have been unlikely to attract such investment just a few years ago.

“A lot of people have finally discovered that there's a significant amount of business to be done in middle markets around the country,” says John Bemis, senior vice president of the shopping center group at Aronov Realty Management in Montgomery, Ala.

“Some people show a little trepidation about middle markets because they haven't operated there before,” Bemis says. “Many times retailers think that middle markets are somehow different from major markets in their wants and needs. But with improved communications, the middle markets aren't what they were 20 years ago. The trend cycle has been reduced significantly, so what's hot in New York this spring is hot in the middle markets this summer.”

Driving the movement is the need for new and more cost-effective markets. With development in primary markets reaching the saturation level, the focus of ground-up development has shifted to secondary markets, particularly those that are underserved by existing retail and whose economies are stable or expanding.

There isn't much low-hanging fruit left in the primary markets in the form of good locations with upside retailing potential. In fact, none of the five regional and super-regional malls due to open through 2006 are in any of the nation's 20 largest cities. Add infill, repositionings of existing centers and the growth of mixed-use projects and you have even more competitive pressure.

The middle markets have stepped into the void. The best of them provide developers with fresh areas in which to construct greenfield projects or buy existing centers that need redevelopment. “There are fewer major malls coming to market, and buyers are looking for secondary-market properties in areas that have been stabilized,” says Charlie Singletary, a partner in the Austin, Texas equity firm Torreon Capital.

“One of the things that's happening is that there is such an excess of demand over supply that people are buying whatever they can get their hands on,” says Marcus & Millichap's Bernard Haddigan, director of the brokerage's national retail group. “More locals and regionals are going into smaller markets.”

Although there are no statistics on the total number of projects under way in middle markets, a quick look at centers being built around the country provides a glimpse of the trend.

In addition to its other centers, RED Development is building in Little Rock, Ark. (The Promenade at Chantal), Omaha, Neb. (Village Pointe), Westminster, Colo. (The Shops at Walnut Creek), Woodbury, Minn. (Woodbury Lakes), and Chandler, Ariz. (Fulton Ranch Towne Center and The Promenade at Fulton Ranch). CBL & Associates, another active player in middle markets, is developing Burlington Marketplace in Burlington, N.C., and the Imperial Valley Mall in El Centro, Calif., and it just opened the Wilkes-Barre Township Marketplace in northeastern Pennsylvania.

A secondary or middle market city is usually one with a population of less than 250,000, though some define it as anything smaller than the top 20 U.S. metro areas.

However the middle is defined, it's clear that developers and retailers are looking for places where the appetite for retail hasn't yet been satisfied, and they usually are outside the cities. According to Census Bureau data, 92 percent of the population growth in the 53 U.S. metropolitan areas with populations of 1 million or more has occurred in the suburbs and beyond — places like Leawood and St. Joseph.

“The majority of the country's population lives outside the metro areas of a million or more people,” says Aronov's Bemis, whose firm is the largest privately owned real estate management company in the Southeast, with 100 properties. “And retailers have come to find in the last 10 years that they can be profitable in these midsize markets and even in many of the smaller markets, as long as the center is merchandized properly and is of the proper size.”

Case in point: Aronov just opened Dogwood Promenade, a power center in East Jackson, Miss., across the way from its Dogwood Festival Market, a 445,000-square-foot lifestyle center that has averaged more than $100 million in annual sales since it opened in 2001.

Doing business in smaller markets requires some adjustments. “You have to be smart in these markets. You have to be cost conscious,” says Jeff Gray, director of real estate for Hibbett Sporting Goods of Birmingham, Ala., a rapidly expanding chain of 450 small stores in non-primary markets in the South and Midwest. (See sidebar on page 38.) “You're not going to do the business that you're going to do in Houston, let's say.”

Rex Paine, a partner in Torreon Capital, notes that smaller markets “need to have a wider draw” to compensate for their lower population density. That means strong anchors and a good retail mix as well as a relatively low level of competition.

Given those conditions, “if the economy stays decent, secondary markets will be the ones that developers go into, even if they are smaller than you would expect,” Paine says. Adds Torreon partner Singletary, “In all the states that are growing in population, there are growing secondary markets.”

Bemis offers Montgomery, Ala., as an example. With a population of just over 200,000, it's not a major metropolitan area. But Montgomery has experienced strong job growth in the past few years because of an influx of manufacturing enterprises, capped by its selection as the site of a new $1 billion Hyundai plant — the fourth giant auto plant to be built in Alabama in recent years.

Aronov is expanding its 800,000-square-foot Eastdale Mall on the city's upscale east side by adding a 95,000-square-foot JC Penney and other retailers. Nearby is another hot draw, the new Shoppes at EastChase, owned by Jim Wilson & Associates. Both represent a geographic shift away from the city's longstanding regional shopping center, Glimcher Realty Trust's Montgomery Mall, which in the past year has seen a series of store defections to the east side.

Middle market growth isn't confined to the Sun Belt. Matthew Fitzgerald, a retail broker with Marcus & Millichap's Madison, Wis., office, notes that middle markets within three hours of Chicago have seen strong growth due to the intensity of competition in the primary markets.

“Competition for deals in the Chicago metro area is pushing caps so low to get deals, and those missing out on deals are willing to move to strong secondary markets like Greenbay and Madison,” Fitzgerald says. “There's a tremendous amount of capital in the market.”

As the trend has developed, though, the cap rate spread has narrowed. “Cap rates are coming down because our buyer pool has expanded,” Fitzgerald says.

“All boats rise with the tide,” adds Haddigan. In many middle markets, he notes, properties that had cap rates of 11 percent a few years ago now are in the low 9 percent to high 8 percent range. He noted, for instance, that the spread between Chicago and Springfield, Ill., has narrowed to between 75 and 125 basis points from its previous level of 175 to 250.

Who is buying in the middle markets? “REITs are extremely active right now, but private capital represents more than 50 percent of the market in the under $15 million range,” Haddigan says. Those private buyers are mostly wealthy individuals. Haddigan says he sees little activity on the part of insurance companies and pension funds.

Will the strength continue? Haddigan sees no reason to expect it won't. “I think this market will stay strong through 2006,” he says.

In many ways, Kansas City-based RED Development is the poster child for middle market development. In the nine years since it was established, RED has built lifestyle centers in growing but under-retailed markets in the Midwest and Southwest.

Dan Lowe, the RED partner in charge of project coordination, entitlements and financing, says the company concentrates on markets where growth prospects are bright and costs are lower — places such as Lincoln, Neb., and Fort Wayne, Ind.

“Lincoln is the state capitol and a large university town. Fort Wayne has several universities,” Lowe says. “The middle markets we have focused on are experiencing residential growth, and that's due to the fact that there are large employers in those markets.”

That's true of St. Joseph, which Lowe says has several big companies that generate jobs. Yet the town, 50 miles due north of Kansas City, hasn't been heavily developed. “What's true of all our markets is that they are on a square-foot-per-capita basis underbuilt from a retail perspective,” Lowe says. In fact, most have about half the national average of 40 square feet to 45 square feet per capita.

North Village is the first major development in St. Joseph in several years, and it's the first lifestyle center in the region. While its size — 730,000 square feet — makes it a big undertaking for a small area, the fact that the center will serve a larger trade area adds considerable value, according to Lowe.

“Secondary markets are proving to be quite strong,” says Lowe, “and it's more affordable to develop in those markets as well. We can pass along overhead costs that are 25 percent less to our retailers.”

Will RED someday embrace bigness? Maybe, but for now the developer seems happy to work those areas it knows best. Says Lowe: “We have considered larger markets, but for now our focus will continue to be on the middle markets. It's where we believe the opportunities are.”

Small Town Success Story

Hibbett Sporting Goods doesn't think bigger is better.

Some retailers just feel more comfortable in the middle. That's true for Hibbett Sporting Goods, a name you won't find at any tony Manhattan locations.

Over 20 years, the Birmingham, Ala., retailer has parlayed a few stores into a fast-growing chain of 450. It's done so by seeking only small markets with populations between 30,000 and 100,000.

The company's approach has been to open “small-box” concept stores in 21 states throughout the South and Midwest, eschewing big cities for places like Greencastle, Ind., Winnsboro, La. and Americus, Ga. The stores usually are no bigger than 5,000 square feet and are in strip centers and enclosed malls, often anchored by a Wal-Mart.

“Our big thing is that we wanted to go into markets where there was the least amount of competition possible and where there was a need for our concept,” says Jeff Gray, director of real estate for the chain. “We want to be important to that market.”

Hibbett has been attacking such markets with gusto since 1996, when the company went public, and is now growing the chain at a rate of about 15 percent a year — a net gain of about 60 stores this year, Gray says. Wall Street has applauded that growth: since its IPO, Hibbett stock has risen from about $6 a share to a high earlier this year of nearly $28, though it has since fallen to the low $20s.

“There's a lot of growth just in our existing states,” says Gray, though he acknowledges that a push toward the west is likely. “We feel like we have 3,000 to 4,000 potential markets in western states right now.”
Curt Hazlett