While consumers search for retail bargains this holiday season, shopping center investors are encountering nothing but frothy prices. That's why Pennsylvania Real Estate Investment Trust (PREIT) decided this spring to redevelop three mature properties it recently added to its portfolio totaling 2.7 million sq. ft. in Hyattsville, Md., Voorhees, N.J., and Newport News, Va.

“We have the expertise to see double-digit returns on capital investment in these malls, which is hard to achieve by acquiring new properties where we would only get a 7% return,” explains Ronald Rubin, CEO of PREIT.

To Rubin's point, a survey of shopping center executives conducted by the International Council of Shopping Centers (ICSC) in November indicated that 53.4% of shopping center executives plan to increase capital spending in 2005, compared with only 41% last year.

It's little wonder that investors are willing to pour money into their properties. The sector remains quite healthy. The vacancy rate registered 10.1% in the third quarter, down from 10.5% at the end of 2003, reports Marcus & Millichap, an Encino, Calif.-based brokerage firm.

Pent-up investor demand, low interest rates and skittishness toward the stock market have all led to huge sums of capital flowing into high-quality retail real estate, says Bernard Haddigan, director of Marcus & Millichap's retail group.

On a deal volume basis, strip-center investment is up 70% this year, but the regional mall activity has peaked, says Robert White Jr., president of Real Capital Analytics. “It's the only retail property type where [investment] dollar value is likely to end the year below 2003,” he says.

Eight regional/super-regional centers totaling 8.8 million sq. ft. will be built over a three-year period ending in 2006. By comparison, 13 centers totaling 14.6 million sq. ft. were built between 2001 and 2003, according to ICSC. Simply stated, the total square feet of new mall construction during the next few years will drop by about 40%.

While traditional malls still have their place, it's far easier for developers to find 50 acres for a lifestyle center in maturing markets than it is to find 300 acres for a mall, Haddigan says.

Meanwhile, investments in grocery-anchored centers are getting riskier as other retailers cut into grocery sales, Haddigan says. Costco and other warehouse clubs continue to steal market share while new Walgreens and CVS stores hawk more refrigerated convenience items.

In mid-November, cap rates for multi-tenant, grocery-anchored centers were under 7% in most markets and under 6% in California, says Haddigan. Any increase in the 10-year Treasury yield late this year could impact cap rates, pushing them 75 to 125 basis points higher in the New Year.

October chain-store sales may be a harbinger of a robust holiday season and a strong 2005, experts say. Stores posted 4.1% year-over-year increases in October, marking the strongest monthly performance since May's 5.7% rise, reports ICSC.

Many retailers are poised for growth in 2005. “Our clients plan to add at least as many stores — if not more — in 2005 as they did in 2004,” says Mike McBride, executive vice president of Fort Worth-based Westwood Contractors, which designs stores for 25 national retailers. Although retailers cut back on growth and remodeling the past three years, “they're at a point where they have to invest.”

Executive Insights

Name: Mark Zalatoris

Title: Chief Operating Officer

Company: Inland Real Estate Corp.Headquarters: Oak Brook, Ill.

Biggest Surprise of 2004:

“Consumer spending held up very well, even during the slowdown.”

Prediction for 2005:

“The strengthening economy is poised to help our sector retain its high level of [investment] interest.”