Ed Vinson certainly doesn't need any more frequent flyer miles. The Mills Corp. executive vice president got more than he could use during construction of the company's glitzy new Madrid Xanadu in Spain, sometimes crossing the Atlantic a couple of times a month to meet with the firm's partner and check on the mall's progress. The upgrades to first class will come in handy, too, as Vinson helps Mills move ahead with projects in Italy and maybe elsewhere.
Mills is in the first wave of a trend that's likely to reshape U.S. mall REITs in the next few years: the globalization of retail real estate development. With North America “malled” to near capacity and sky-high prices on existing properties, American owners are looking overseas for new opportunities and partnering with local companies to smooth the way. Of particular interest are under-retailed countries such as Spain and Italy, although Asia and Mexico are getting attention too.
At the same time, foreign capital continues to flow into the U.S. market, and offshore players continue to buy up North American centers.
New York research firm Real Capital Analytics says foreign investment in U.S. retail real estate reached $3 billion in 2003, up from $247.8 million just two years earlier. Continued rapid growth is expected.
The trend is still in its infancy. It's so new that some companies don't want to talk about their overseas intentions. Others, like the newly created Westfield Group make clear their desires. In April, Westfield combined its American, U.K. and Australian/New Zealand operations into one Australian-based company to reflect “the increasing globalization of real estate,” says Frank Lowy, president of the company, which holds $34 billion in property assets. “Increasingly, these opportunities require substantial financial capacity and a balance sheet larger than any one of the existing Westfield entities,” he says.
A recent Bear, Stearns panel of REIT CEOs predicted that in five years every major U.S. mall REIT will be operating internationally.
Globalization is not just for industry giants either. “What are you going to do here, in the U.S.?” asks Vincent Polimeni, CEO of the New York-based Polimeni Organization. “Everyplace worth developing has been done.” Polimeni is partnering with Chicago's Heitman Real Estate Investment Management to build a $160 million portfolio of hypermarket-anchored retail centers in Poland, where it already has 10 centers. Heitman is 50 percent owned by Old Mutual, a U.K.-based financial services firm.
“Europe is the next frontier for retail real estate,” says Polimeni.
One big impetus for crossing the Atlantic is cap rates, which range from 5.5 percent to more than 10 percent in emerging markets such as Estonia, compared with the U.S., were trophy malls are going for as low as 6 percent. The first American REITs to make business commitments are Virginia-based Mills Corp. and Simon Property Group of Indianapolis. Late last year, Simon announced a partnership with an Italian retailer that will extend its reach into that nation. Another U.S. mall REIT, Chelsea Property Group of New Jersey, is developing properties in Asia and Mexico.
In part, U.S. developers are simply following their retail partners around the globe. Big-box giants such as Wal-Mart and Costco are exporting their fierce style of competition to Europe and Asia, where they are meeting equally fierce competition from European hypermarket operators such as Tesco. And European retailers like Zara and H&M are continuing to pour into the U.S. locations. Trendy Spanish womenswear chain Mango, which has 704 stores in 72 countries including outposts in Venezuela, Turkey and Taiwan, is pondering its strategy for an upcoming American launch.
Even as the American firms eye other lands, foreign pension funds — drawn by stability and the dollar's weakness — are pumping more capital into U.S. retail properties. “We've seen a marked increase in interest from overseas investors, all of whom have money allocated for the U.S.,” says Howard M. Sipzner, executive vice president and chief financial officer of Equity One Inc. of Miami, which owns 189 community and neighborhood shopping centers throughout the South. Sipzner just returned from a European tour where he talked with 20 potential investors.
“This is one of the most exciting times in my business that I've seen, and if you'd asked me 18 months ago I would have called it one of the worst,” says David Gester, a vice president in Baltimore-based RTKL Associates, one of the leading designers of retail projects worldwide. “There's been a big bounce in entrepreneurial thinking and requests for proposals, and they've been unprecedented in their diversity. I think we're finally seeing developers coming to grips with the next thing in retail, post-mall.”
“Money is pouring into the industry,” says Dale Anne Reiss, global director of real estate, hospitality and construction for Ernst & Young. “What were seeing is twofold: U.S. firms going to Europe and Asia, and European investors coming to the U.S.,” she says. “Everybody is looking for an edge, a niche where they can exploit their skills and gain a few basis points.”
Mills Goes the Extra Miles
Mills leads the pack with its Madrid Xanadu project. Opened last year, it includes 1.4 million square feet of retail space with 20 anchors, 220 specialty retailers, 30 restaurants and a year-round indoor snow-sports facility. (Xanadu won Retail Traffic's SADI award for design excellence. See section starting on page 129). It is 98 percent occupied “and doing very, very well,” says Vinson, Mills' managing director of international development. “Many if not all of the retailers have reported numbers that are well above their plan.”
Moving into foreign markets requires patience and a knowledge of the local business conditions and laws. That's where a strong local partner is required. In Mills' case, that was Parcelatoria de Conzalo Chacon SA, a Spanish real estate developer that owns the land. “It would be presumptuous and somewhat foolhardy for a company like ours to anticipate taking our show on the road, so to speak, without paying very particular attention to how business is conducted,” says Vinson.
Encouraged by its success at Xanadu, Mills now is focusing on other opportunities, especially in Italy. In Rome, it is bidding for the rights to develop the Mercati Generali, an open-air produce center on 20 acres, less than a kilometer from the Coliseum. Vinson says Mills also is pursuing two projects in Milan.
Italy is considered ripe for development. Construction of centers there has long been held back by the difficult regulations, resulting in per capita retail space of just 1.2 square feet — or 5 percent of the 21 square feet here in the U.S. Now, however, U.S. and other developers are willing to tackle the possible roadblocks because they see open land and economic potential ahead.
Christopher Wicker, president of Retail Consulting Group of Paris, told attendees at ICSC's European Conference that shopping center investment in Italy between 1999 and 2003 totaled $2.8 billion, third in Europe behind Spain's $4.98 billion and France's $3.3 billion.
Simon's joint venture with Italian firm Rinascente Group will give it a larger presence in the Italian market. The REIT says it was drawn by Rinascente's savvy. The retailer's portfolio of 38 centers with six more under development is controlled by Eurofind, whose majority owners are the Agnelli Group of Fiat fame and Auchan, a large French retailer with properties in 12 countries, including two of the largest centers in Italy.
Rinascente runs La Rinascente and Upim department stores, as well as the Auchan chain of hypermarkets and the Sma, Cityper and Punto Sma supermarkets. It also operates two do-it-yourself chains. Clearly, the retailer knows the local turf intimately — which is likely to serve Simon well as it navigates new markets.
Under the terms of the deal, Rinascente contributed its centers, valued at about $1 billion, to a joint venture called Gallerie Commerciali Italia, in which Simon bought a 49 percent stake for about $500 million. The venture will develop some $250 million worth of new properties this year and may add as much as 4 million square feet within five years.
Simon already has interests in Europe. It holds a $70 million stake in a joint venture controlling five malls in Poland and three in France, but the Rinascente deal provides more extensive benefits.
“What we've found in France and Poland is that buying into a development pipeline can create a substantial amount of equity value,” says Steve Sterrett, Simon's chief financial officer. “But it's hard to walk into Europe and buy a portfolio. This was a significant portfolio and a development pipeline.”
U.S./U.K. joint venture Heitman, which owns 23 properties, has been developing properties in Central Europe since the mid-1990s. Its venture with Polimeni, in which Heitman owns 60 percent of the equity, will develop the centers on behalf of Heitman's Central Europe Property Partners II investment fund. It “reflects our confidence in the Central European property markets and our desire to increase our investment in retail properties in the region,” says Christopher Merrill, managing director of Heitman's International Private Equity Group.
Polimeni, which has 10 hypermarket-anchored centers in Poland, has been developing properties there for six years, specializing in small cities that are under-retailed. “Once Poland joins the European Union, Polimeni says, there will be even more opportunities. As it is, the spread of retail investment “is making it much more ‘one world,’ especially in Europe” — a fact U.S. REITs can no longer ignore, he says. “They're seeing the same opportunities I saw — only slower.”
Asia, too, is drawing U.S. attention. Chelsea Property Group, a developer of outlet centers, entered the Japanese market in 1999 in partnership with Mitsubishi Estate Co. and Nissho Iwai Corp. and is now Japan's biggest outlet owner with four centers and a fifth planned. Chelsea also is looking to Mexico for opportunities, developing Mexico City's first upscale outlet center in a venture with Sordo Madaleno y Asociados.
General Growth Properties, the No. 2 mall owner in the U.S., has no major offshore projects yet, but acknowledges that it will eventually expand beyond American shores. “Ultimately, it is reasonable to expect to see us do something,” says John Bucksbaum, CEO. “This is generally a mature industry in the U.S., and depending on what country and what continent, there certainly are opportunities in developing countries that could be appealing.”
The interest in other lands “is a natural extension of what I would refer to as the globalization of retail, with more retailers crossing borders — both foreign retailers entering the U.S. and U.S. retailers going abroad,” says Bucksbaum.
But he is also aware of the risks. “Whenever you decide to do this type of development or management or ownership abroad, it is more difficult,” says Bucksbaum. You need to do it in conjunction with a very strong partner. There is currency risk and political risk inherent in various parts of the world.”
No Easy Transition
RTKL's Gester, who has lived in Rome, Amsterdam, Beijing and London and has worked on projects in nearly a dozen nations, agrees that cracking overseas markets can be difficult. Now living in Los Angeles, Gester says it's hard to judge the needs of local shoppers and the demands of local bureaucrats.
TrizecHahn failed to do that, Gester says. It “dipped its toe in the European waters and got a couple of successes under its belt, and was going to show Europe how it was done.” Trizec's projects included the Westend and Polus centers in Budapest, the Czech Republic, and the Polus City Centre in Bratislava, the Slovak Republic. All were sold when the company ran into financial trouble three years ago.
The lesson: This is not about short-term benefits — development timelines are longer and payouts can be slower. “It's not unusual to see projects on the board for 10 or 12 years before they finally become a real proposition,” he says.
In some countries, landlord-tenant laws and zoning regulations don't exist, and title insurance isn't used. Pitfalls are everywhere, and bribery is not unheard of, says Richard Muhlebach, senior managing director with Kennedy Wilson Inc., a Beverly Hills-based international real estate services firm.
All of which underscores the need for a reliable partner to handle the politics, regulations and peculiarities of the market. “You can't really go over to a country, plant your flag and try to colonize it,” says Muhlebach. “The processes are all different, so you really need to have somebody who understands the real estate industry. It's not easy.”
Without help “you run a huge risk,” agrees Frank Badillo, senior economist and manager of global research for Retail Forward, a consulting firm based in Columbus, Ohio. Badillo says Tesco Plc, Britain's largest retailer, offers a lesson in how to do it right.
Tesco is investing more than $3 billion in an effort to establish itself in South Korea, Taiwan, Thailand and Malaysia through a joint venture with Samsung. Late last year it announced a move into what may be its toughest market yet — Japan — through the $229 million acquisition of Japanese retailer C Two-Network. “In each of those cases they partnered with a local company and have done pretty well at learning how to adapt to the local culture,” Badillo says.
Still, the trends are toward U.S.-style transparency and the creation of a Global REIT industry. A “steady march of securitization and transparency in real estate ownership” is veering the planet, notes a recent report by Ernst & Young. It found U.S.-style REIT laws to be increasingly common, noting that France, South Korea, Japan, Singapore and Taiwan have all adopted such laws in the past three years and that the European Union and the U.K. are considering them.
“Not only is this legislation spurring expansion of commercial real estate markets in these countries, it's also promoting more offshore investment by U.S. REITs,” the report states. Global tax treaties that grant favorable treatment to investors regardless of their nationality may also spur investment, it reveals.
Another boon: The relative bargains in Asia that were created by problem loans secured by real estate. As European banks work out their bad debt, Ernst & Young says, more properties are becoming available in Japan, China, Taiwan and Thailand. (See story on page 96.)
“The movement of capital around the global real estate market is like the tides; it ebbs and flows,” states the report. “Right now, the tide is high.”
And it flows both ways. As American interest grows overseas, so does the demand for American properties, particularly from European and Australian investors.
How much interest is there in U.S. property? Considerable, says Equity One's Sipzner, who just talked with investors in four European countries. “It's something we will do periodically as part of our overall investor relations,” he notes. “We're still a new story, so we found a lot of value in just heightening awareness of that story. We found the knowledge of U.S. real estate among European equity investors was very high.”
Foreign investment isn't entirely new. Australians are carving out a sizable piece of the U.S. market. (See story, page 94.) The strong underlying performance of local centers in terms of leasing and sales growth makes them attractive to overseas investors, too, he says. “The strong markets are getting even stronger and therefore are offering more value.”
German, English and Dutch pension funds have long been active in U.S. real estate, and they remain so. But they, and their American counterparts, are increasingly attracted to developing markets.
The multinational nature of retail real estate development is well illustrated by Wola Park, a 960,000-square-foot enclosed center that opened in Poland in 2002. “Wola Park was built in Warsaw for a consortium of English, Spanish and Italian investors, with a French contractor and an American design firm,” notes Paul Makowicki, a principal in the Seattle-based firm of Callison Architecture, which did the design work.
Poland and other Eastern European countries emerged as favorite sites for development in the early 1990s, after the fall of communism infused them with free-market thinking. Leading the way were supermarket-anchored centers, followed a few years later by hypermarkets. Some 120 new retailers are expected to enter Poland alone by the end of next year, according to Ernst & Young.
Throughout Europe, says RTKL's Gester, “the REITs are coming in and putting their development teams on the ground.” Geographically, he says, “the overall balance is interesting. People are looking beyond their regions to smooth out longer-term cycles.”
Yet along with that interest in overseas business, Makowicki also detects some caution. American REITs overall, he says, “are tentative about investing large sums of money in development internationally, particularly if you look at the Asian markets, with China being the economic engine, and varying places in South America and eastern Europe.”
Europeans, on the other hand, “are a little more adventurous,” he says. “So you see a lot more European investors in Eastern Europe, and a lot more upping their interest in China. I wouldn't say they have dived into the pool, but they are certainly actively looking.”
Both Makowicki and Gester stress that it is crucial for any non-local developer to fully understand the cultures of any areas in which they are considering projects. “You have to have a sense of that particular market so that it can resonate with the user,” says Makowicki.
At Wola Park, for instance, “the key was trying to create an interior environment that spoke to the history of the site and the history of Warsaw. Whether it was the floor patterns or the light fixtures, we had to build a story that the natives of Warsaw could relate to.”
Many matters must be considered before committing to an overseas expansion. “For any U.S.-based company, one of the issues is how welcome they're going to be in some of these places,” says Badillo. Indonesia and Malaysia, for instance, may be difficult places for U.S. business because of their predominantly Muslim cultures. “In an age when terrorism is a real and growing threat, doing business abroad has some greater risks,” Badillo says.
Not the least of the possible risks is that of sharp currency fluctuations “that could wipe out the value you have in a property,” he says.
Underlying all of this global movement is the growing appetite for consumer goods around the world. Hot retail concepts are spreading fast these days, whatever their country of origin. Even as American big-box stores open around the planet, European retailers such as Zara and H&M have capitalized on Americans' for the different and trendy.
So, will travelers of the future find the same retailers wherever they go, from Buffalo to Beijing? Probably not; it's still a big world with plenty of differences in culture and taste. Limited Brands., for example, failed in its attempt to bring Bath & Body Works to the U.K.
But there's no mistaking the signs of change. Says Kennedy Wilson's Muhlebach: “This is the beginning of the globalization of shopping centers.”
HOW NOT TO BE AN UGLY AMERICAN
Don't take a North American mindset and transplant it.
At a time when U.S. relations with many foreign countries are strained, it's important not to act like an imperialist American, wanting to force the U.S. version of retail on the natives.
“The biggest issue American developers have is migrating their mindsets — what's appropriate in tenanting, servicing, rental structures,” says Paul Makowicki, a principal in the Seattle-based firm of Callison Architecture. “A lot of issues need to be resolved. You can't take a North American mindset and transplant it.”
The regional differences can be huge. David Gester, a vice president with Baltimore-based architect, RTKL Associates, notes, for instance, that department store anchors “are few and far between in almost every market except the U.K.” Stores are smaller, he says, though there are far more of them.
In Asia, vertical retailing is more popular than anywhere else in the world. In Australia, rooftop parking is widely used. In Spain, parking is often underground. And in most places, public transit is considered an integral part of a successful project.
Makowicki notes that in Asia, servicing models are different as well. Shopping center deliveries usually are made with smaller trucks and deliveries are more frequent, making the loading docks that are ubiquitous in the United States far less common. “You don't have all the back service corridors,” he says.
They've come from Down Under to conquer the world.
Australians have been particularly active players in the United States. Westfield America Trust, now part of the new Westfield Group, bought its first property here in 1977 and now owns 66 malls in 14 states. Recently, though, there's been a spate of new interest as three Australian/U.S. REITs began raising money to acquire power and community centers here.
In one of them, CBL & Associates, a Chattanooga, Tenn.-based REIT, struck a deal in which it contributed a 90 percent interest in 51 of its community and power centers to a new Australian REIT that CBL formed with Galileo America Shopping Trust, a unit of Galileo America REIT. CBL got more than $500 million in the deal, as well as management and leasing fees for the properties. It also retained a 10 percent interest.
That deal and others were powered by Australia's “astute business culture,” says John N. Foy, CBL's chief financial officer. Australian employers must by law withhold 10 percent from workers' paychecks, which can then be invested in stocks or trusts that provide for retirement.
“The Australian pension funds as a result are some of the largest in the world,” Foy says, and they're attracted to the returns and safety presented by U.S. retail real estate. “A tremendous amount of capital is coming in because of the stability and growth that real estate can afford them.”
HOW DO YOU SAY BABY BOOMER IN CHINESE?
The Chinese retail market is growing 7 percent annually.
Of all the developing markets, China represents the greatest potential for retail growth. Just as in the United States, Asia's baby boomers are coming into their own, and they are spending money as never before. China's retail market is expanding 7 percent a year, according to McKinsey & Co., which predicted that the nation's retail sales could grow to $713 billion by 2010 from $405 billion in 2001.
Foreign companies are vying for a share of this potentially vast market. Hypermarkets, led by France's Carrefour and England's Tesco, are spreading throughout the region and proving popular with consumers, who find the combination of low food prices and plentiful merchandise irresistible.
“European hypermarkets are being incredibly aggressive in mainland China,” says David Gester, a vice president at Baltimore-based architectural firm RTKL Associates. “They learned a lesson in Eastern Europe, where people had been shopping every day until the hypermarkets came along.” The next phase of the invasion is likely to be the opening of European do-it-yourself stores, he says, followed by hypermarket-anchored malls.
American big-box stores have entered the fray, too. Wal-Mart came to China in 1996 and now has 34 stores there. Its 2002 purchase of a 38 percent stake in Seiyu Ltd‥ gave it a presence in Japan. All told, the retail giant directly operates 1,357 stores in nine countries, and those stores contributed nearly $50 billion in sales last year. Costco has 113 foreign locations, including five in Korea and four in Japan. The company plans eventually to have as many as 70 stores in Japan.