In the mid-1980s, parachute pants and the Rubik's cube were a lot more popular than open-air centers. Just ask Mike Jaffe, who helped revive the dormant practice of building open-air centers with tenants more typical of a regional mall with the Arboretum in Austin, Texas.

The project, which debuted in the late 1980s, was groundbreaking in more than one way. Aside from losing the enclosed concourse, the project also sat in a secondary market and was primarily geared to affluent shoppers. Add it all up and Jaffe had faced a leasing process that was not exactly a cakewalk. “There was a great deal of healthy skepticism about whether open-air centers were going to be a winning concept,” says Jaffe, who is now president of the Jaffe Cos. “When you are in that kind of situation, it's accurate to say that demand isn't that great and rents definitely aren't.”

For decades the dominant model had been to construct enclosed malls where developers had complete control over temperature, lighting and everything else. The idea was to have a consistent shopping setting that looked the same day or night, rain or shine, all so retailers didn't see sales fluctuate based on the climate.

Things have certainly changed on that front. But not without owners and developers going through some growing pains. Retailers were far from sold on the idea to go back outdoors as the first wave of open-air centers and lifestyle centers were constructed. Jaffe and other open-air owners had to do a lot of coaxing and offer deeply discounted rents.

“The pioneers who leased space in open-air centers thought they were taking big risks, so the landlords had to do very sweet deals,” says Greg Maloney, president & CEO of Chicago-based Jones Lang LaSalle Retail. Low rents and minimal common area maintenance costs helped lure in tenants. Some owners went so far as to offer several months of free rent.

The idea that affluent customers would bypass malls to shop in lifestyle centers was extremely attractive, but really just a theory. “Retailers knew what to expect with the regional malls, but they have been wary of open-air centers until just recently,” says Joe Tagliola, president of retail for Aventura, Fla.-based Turnberry Associates.

“Lifestyle centers simply did not exist then and were not a format that retailers understood or trusted,” Jaffe says. “The Arboretum of Austin, though highly successful, was a rare bird in the industry — the mall was still king.”

Apparently, there's been a palace coup.

The Arboretum, and dozens of other projects just like it, have proven to be successes. They now have something they didn't before: a track record. So owners and developers are at last reaping the rewards and rents on open-air centers are starting to rise considerably.

The Jaffe Cos., for example, is developing a next generation project, the Arboretum of South Barrington, a 600,000-square-foot, open-air project located in suburban Chicago. Scheduled to open next summer, the project is 50 percent leased with rental rates in the mid-$20s.

Comparing the leasing processes for the South Barrington and Austin projects is like the difference in popularity between Lucky brand jeans and Jordache. “The biggest difference had to do with retailers' acceptance and grasp of the product type,” Jaffe says. Today, retailers no longer question the viability of the open-air concept, which has been validated by traditional mall retailers like JCPenney, Kirkland's and Victoria's Secret that have taken their concepts off-mall and other retailers like Coldwater Creek and CHICO's that rarely consider mall locales.

Sweet sales

“The repeated success of these projects in terms of sales and reaching the affluent shopper has been proven nationwide,” Jaffe says.

In 2006, sales at town center and lifestyle properties increased to $274.95 per square foot up from a median of $238.34 per square foot two years prior, according to ICSC data. To be sure, that still trails what regional malls rack up, an average $403 per square foot, but open-air center sales did grow at a little faster rate — 16 percent compared to 13.9 percent for malls.

“The owners who did their leasing 10 years ago — getting below market rents or power center rents — are enjoying some nifty bounces in rents today,” says Joel DeSpain, senior director of real estate of Phoenix-based Opus West, which is developing a large open-air project in Austin, Texas.

The most successful open-air projects generate sales on par with regional malls, according to Jim Gardner, senior vice president of Barclay Group, a Scottsdale, Ariz.-based developer that focuses on open-air centers. He points to his firm's 500,000-square-foot Tucson Spectrum in Arizona where retailers are posting sales per square foot numbers twice the national average. As a result, the company has been able to grow rents 15 percent to 20 percent on renewals. The project has been successful enough to spawn a $100-million, 500,000-square-foot expansion, which the firm broke ground on in March after getting 80 percent of the space pre-leased.

“Compared to the first phase, we're getting an 80 percent increase in rents,” Gardner says, adding that the second phase includes a Harkin's theater, JCPenney, the Sports Authority and Bed Bath & Beyond. “Now that tenants know what kind of sales they're going to achieve, they're willing to pay more,” he says.

The average rental rate for superregional and regional centers was $20.51 per square foot in 2006, with rates ranging from $8.38 per square foot to $45.22 per square foot, according to ICSC's Dollars and Cents of Shopping Centers 2006 report, which is compiled every other year.

Unfortunately, the report lumps lifestyle center and town centers with power centers and community centers, so the data isn't perfect. But according to the report, open-air property rents averaged $11.79 per square foot and ranged from $3.57 per square foot to $17.58 per square foot. (Unfortunately, ICSC's 2004 research isn't suitable for comparison, given deviations in the way the centers are categorized.)

For example, Simon Property Group's open-air division, which consists of 79 properties, recorded 3.6 percent rental rate growth from December 2005 to December 2006, a full percent higher than the growth rate for its regional malls. Similarly, Inland Commercial Property Management Inc., which manages all properties for the Inland REITs, is signing leases that are 18 percent to 20 percent above last year, says Scott Carr, president of Inland Commercial Property Management Inc.

Retailers open up profits

For tenants, open-air centers are attractive for a number of reasons. While the sales-per-square-foot numbers are lower than regional malls, so are the rents. More importantly, occupancy costs in open-air centers are lower than regional malls. CAM costs at regional malls range from $1 per square foot to $11.22 per square foot, according to ICSC data.

All that adds up to higher profits, Jaffe says. “Retailers care about one thing and that is profitability of a particular store and the volume of sales they can do given the occupancy costs,” he explains. “The overall nut has to be something that makes sense because when you're working on such a slim margin every bit matters.”

Even with the rental increases, occupancy costs in open-air centers have only reached about 10 percent of overall revenues, according to Jeff Zeigler, senior vice president of Columbus, Ohio-based Continental Retail Development. He estimates that open-air center CAM charges are about 30 percent to 50 percent less expensive than mall CAM charges, which are growing annually because of increased heating and cooling costs.

Because of these reasons, retailers are pushing developers to build more open-air properties, says Steve Warsaw, president of leasing for Chicago-based Urban Retail Properties. “Although there are still many retailers comfortable in enclosed malls, there is a higher percentage of retailers that are looking for space in open-air centers,” he says.

Urban Retail, which does third-party leasing and management for a number of regional malls and open-air centers, is itself dipping its toe into open-air center development. Currently, the company is working on Orchard Park Town Center in Walker, Mich., a suburb of Grand Rapids. The project, which will include 600,000 square feet of retail space, along with office, hotel and residential space, is the first open-air venue near Grand Rapids, according to Warsaw.

Getting bigger

The success open-air properties have enjoyed has led developers to undertake bigger and bolder projects. The first lifestyle properties were typically 600,000 square feet or less, many without department stores. Some today rival regional malls in size. In fact, some mall owners point out that these mega centers are really just enclosed malls without roofs.

For example, Turnberry is developing the 1.6-million-square-foot, superregional Town Square Las Vegas lifestyle center. Located on 117 acres south of Mandalay Bay on Las Vegas Boulevard, Turnberry has commitments from RAVE Motion Pictures, Robb & Stuckey, Borders and others. Scheduled to open in November 2007, the center is 85 percent leased at rates that are equal to the prevailing $30-per-square-foot rates for regional malls in Las Vegas Valley, Tagliola says.

The same holds true for the Related Cos.' CityNorth project in Phoenix. Billed as a superregional lifestyle center, the 5.5-million-square-foot project is leasing at regional mall rates. “People told us we were crazy to expect those rates, but open-air centers have generated such impressive sales numbers, it's possible for them to demand higher rents,” says Executive Vice President Webber Hudson. “Retailers haven't balked at our rates because they expect to do huge numbers here.” The project is more than 70 percent leased with 16 months before it opens.

Similarly, King of Prussia, Pa.-based O'Neill Properties Group is commanding $15 per square foot more than nearby regional malls and open-air centers for its 1.6-million-square-foot Worthington project in Malvern, Pa. “We are the most expensive project in the market, but we expect retailers to do twice their volume here,” says founder and chairman Brian O'Neill.

The center, which is currently under construction, is about 55 percent leased and will offer a Muvico theater, a 140,000-square-foot Wegman's Food Market, Borders Books & Music and Target. O'Neill expects the project to be completely full when it opens in 2009.

The end of the boom?

The run of success (and rash of building) raises the uncomfortable question of whether the industry will overbuild these types of properties and therefore see an end to the sales and rental increases that have come to mark the past few years.

Related Cos.' Hudson, for one, thinks open-air rental rates will not continue to post such strong growth in the future. “As owners harvest the value of the concept's viability, the growth will level off to a rate commensurate with regional mall rent growth,” he says.

Maloney predicts the rental rate growth for open-air centers will be affected by the growing inventory of space, and he is particularly interested in seeing how new open-air centers in secondary markets are received.

“We have about 160 open-air centers today and we're looking at a 50 percent increase or more in the next 30 months,” he notes. “If we double the business in three years, will we be able to maintain the same rents and occupancy?”