Hundreds of aging shopping centers across the United States — some with vacancy rates topping 50% — are becoming attractive investment targets for joint-venture partnerships in search of double-digit returns. In many cases, retail owners are teaming up with well-capitalized investors to reposition shopping centers. Leasing specialists, meanwhile, are tapping each other's expertise to bolster the tenant lineup at under-performing malls.

Intense competition from open-air lifestyle centers and a spate of big-box store closures have heightened the vacancy problem at antiquated malls, such as the Flemington Mall in New Jersey. Metro Commercial Real Estate Inc. and the Plapinger Group overhauled and converted the mall into a power center after its main anchor shut its doors. Repositioning specialists say combining the talents of two companies in a joint venture can be an effective way to save these aging shopping centers.

“Joint ventures can be a plus for REITs [real estate investment trusts] because they reduce the cost of investing in large assets and can help them enter new markets,” says John Kriz, managing director of real estate finance for Moody's Investors Service, a New York-based credit ratings company. In joint ventures between investors and developers, the investor typically provides the bulk of the capital, sometimes more than $250 million, to purchase a portfolio of properties, while the developer contributes its retail expertise to the partnership. In essence, the developer is able to add properties to its portfolio that it otherwise couldn't afford to purchase on its own.

Still, it all boils down to execution. Although joint ventures can provide companies access to capital and help them increase the size of their managed portfolios, Moody's warns that there are drawbacks to the partnerships. Kriz says the management of joint ventures can be complex and time consuming. The two sides also need to develop a clear exit strategy for the partnership.

There are certain red flags that raise concern and could even cause Moody's to lower the credit ratings of the companies involved in a joint venture. In particular, the credit rating agency frowns upon the idea of a joint venture taking on too much secured debt.

“The hassle factor of running joint ventures is grossly under-appreciated by both sides,” Kriz adds. “It's a bit like being married. You can have disagreements with your spouse, and resolving them can be difficult.”

He says common problems include determining how much each side will contribute to the equity of a project and deciding when to sell an asset.

So, choosing the right partner is paramount to success. Craig Estrem, COO of Madison Marquette, which specializes in repositioning shopping centers into open-air lifestyle centers, says the company is careful to form joint ventures with partners that share the same long-term goals, which include holding onto the property for about three to seven years and generating returns of at least 9%.

Estrem is convinced that the benefits of gaining access to capital far outweigh the drawbacks of the partnerships. “Everybody would prefer to make their own decisions and investments,” Estrem says, “but that's not the way this business works because it's so capital intensive.”

Consequently, Madison Marquette formed a joint venture in 1998 with CB Richard Ellis Investors, the investment arm of Los Angeles-based CB Richard Ellis. The partners have purchased four properties for $175 million, and in early August the two companies were close to reaching an agreement to sell the first property in the joint venture.

Madison Marquette expects its joint venture with CB Richard Ellis to yield an unleveraged internal rate of return of 11%, Estrem says, which includes rental revenues from the shopping center as well as proceeds from the sale of the property three to seven years after the initial purchase. Investors, he says, look for unleveraged returns of between 9% and 13%.

Estrem is quick to add, “Three-and-a-half years ago, when the stock market was going so well, nobody wanted a 10% return on their money.”

A Growing Problem and Opportunity

“Each year, there are more and more malls that are in trouble,” says Daniel Hughes, president of Mount Laurel, N.J.-based Metro Commercial Real Estate Inc. In fact, New York-based PricewaterhouseCoopers estimates that 200 to 250 enclosed malls are in need of significant improvements just to stay in business. Several high-profile retailers have shuttered stores in recent years, including Kmart and Macy's. In early August, the May Co. announced plans to close 32 of its Lord & Taylor stores, most of which are located in enclosed malls.

The heightened appetite institutional investors are showing for real estate assets is fueling joint ventures between investment managers and retail developers. By teaming with companies that manage the huge commingled funds of institutional investors such as pension funds, developers gain access to the capital needed to acquire real estate properties. In these joint ventures, developers typically contribute between 10% to 20% of the equity and the investment managers provide the rest. “There's a lot of money out there to go into all types of real estate,” says Estrem of Madison Marquette.

In another major joint venture, Developers Diversified Realty Corp. (DDR), a Cleveland-based REIT, has teamed up with New York-based Coventry Real Estate Advisors, which plans to raise $250 million from institutional investors to redevelop enclosed malls.

De-malling America

An aggressive redevelopment plan is sometimes the best strategy for an aging mall. In July, Developers Diversified and Coventry made their first acquisition as part of the joint venture's Coventry Real Estate Fund II, the $48.5 million purchase of Ward Parkway Shopping Center in suburban Kansas City, Mo. The repositioning project calls for converting the entire 800,000 sq. ft. enclosed mall, which originally opened in 1959, into an open-air community center.

“The interest from the leasing community has been extremely strong, which is why we're excited about the opportunity to acquire the property,” says Dan Hurwitz, a director and executive vice president at Developers Diversified. The Coventry II fund, which is the pooled capital of several institutional investors, is an example of investors' increased appetite for real estate assets, says Hurwitz.

A large portion of the shopping center, about 600,000 sq. ft., was converted into an open-air center in 2002. Popular retailers that typically favor power centers over malls were added to the tenant roster to attract customers, including Target, Pier One Imports, SteinMart, T.J. Maxx and Dick's Sporting Goods. Developers Diversified is now working to fill up the remaining 150,000 sq. ft. of the property, which also will be overhauled.

Developers Diversified is a 20% co-investor in Ward Parkway Shopping Center and will receive fees for property management, leasing and construction management. The terms of the contract also stipulate that DDR will receive a “promoted interest,” defined as bonus revenue distributed after the property hits a predetermined income goal.

Strong institutional interest in real estate also is the reason behind the joint venture between Madison Marquette and CB Richard Ellis Investors. The partnership has purchased the Old Hyde Park Village in Tampa, Broadway Market in Seattle, 300 Grant Avenue in San Francisco and the Marketplace at Birdcage in Sacramento, Calif.

The company purchased the Marketplace at Birdcage for $30.5 million in February 2000. After adding a 45,000 sq. ft. Michaels and a 35,000 sq. ft. Linens ‘N’ Things to an anchor lineup that included powerhouses such as Barnes & Noble and Best Buy, the center reached full occupancy. Now that the joint venture has succeeded at boosting occupancy and revenues, the partnership plans to sell the shopping center, says Estrem. In early August, the partners had reached a tentative agreement with a purchaser, which they declined to name.

Thinking Outside the Box

Leasing specialists also are joining forces. In June, Metro Commercial and Baltimore-based The Daniel Group decided the different strengths of the two leasing companies was an ideal combination to reposition malls. Metro, which has exclusive relationships with major big-box retailers, will line up tenants such as Target, while the Daniel Group will capitalize on its relationships with specialty retailers to lease up the smaller spaces.

By combining their strengths, the two companies believe they offer a compelling package to owners seeking to fill vacant space at their malls — Metro Commercial will find the anchor tenants while the Daniel Group lines up the smaller specialty tenants.

“The solution to improving the performance of malls is a very creative plan, and it involves not operating within the old norms,” says Hughes of Metro Commercial. In some cases, a repositioning effort may only require a retooling of the tenant lineup, while malls deemed completely outdated might be overhauled and converted into community centers.

Metro Commercial and The Daniel Group both have extensive experience repositioning malls on their own. By 2004, the team hopes to be working together on four projects.

Since Metro is the leasing representative for several major discount and “category killer” stores and The Daniel Group has relationships with virtually every specialty retailer in the U.S., the partnership expects to have little trouble finding mall owners to hire them for repositioning projects.

“There are a lot of aging malls with empty anchor stores, and those are the kinds of projects we can work on very easily,” says Rene Daniel, president of The Daniel Group.

Hughes says one way to boost the performance of malls is to attract stores such as Target, Best Buy and Barnes & Noble that are typically anchors at power centers. The goal of the joint venture is to improve the bottom line for mall owners by strengthening the tenant lineup and attracting more customers to the centers. “The good news is that most of these enclosed malls are in spectacular locations,” says Hughes.

Like Developers Diversified, Metro Commercial has found that a complete overhaul is the only solution for some enclosed malls. When the company was hired by the Plapinger Group two years ago to revive the Flemington Mall in New Jersey, the 120,000 sq. ft. enclosed center had lost its main anchor — Burlington Coat Factory — and several of the specialty stores were under-performing.

In a $10 million renovation project, the enclosed portion of the mall was torn down and converted into a power center with a 90,000 sq. ft. Kohls and 25,000 sq. ft. Michaels. “The center's full and it's vibrant once again,” says Hughes.

Daniel emphasizes that improving the mix of tenants is the key to re-energizing many older malls. “I just think all the gloom and doom about malls is overstated,” says Daniel. “Too many people think you need to spend $8 million on renovations to a mall in order to make it successful. What you've got to spend money on is the tenants that make up the mall.”

Steve Webb is a Jacksonville, Fla.-based writer.

Local Powerhouse Resuscitates Plaza for Out-of-State Owner

When the out-of-state owner of Mervyn's Plaza in Chandler, Ariz., was struggling to find tenants for his half-empty strip center late last year, he knew he would need help. To fill the space, Los Angeles-based real estate owner Howard Stone teamed up Michael A. Pollack Real Estate Investments, the dominant owner of retail properties in metropolitan Phoenix. Six months later, the 180,000 sq. ft. plaza was 100% occupied.

By forming the joint venture, Howard Stone acquired local real estate expertise while Mesa, Ariz.-based Michael A. Pollack was able to further grow its huge real estate portfolio in Arizona, which now totals more than 3 million sq. ft. By becoming 50-50 owners in the property, the partners also were able to split the risks and rewards of repositioning the property. Each side paid half of the $250,000 cost of renovating the plaza and the partners are sharing the income at the center, which has risen by more than 50% now that the property is fully occupied.

As the rising tide of retail bankruptcies leaves behind an increasing number of vacant storefronts, joint ventures between out-of-state owners and local real estate experts are becoming more common, says Michael Pollack, president of the company that bears his name.

“We're seeing this more and more. There are a lot of large boxes available in our marketplace,” says Pollack. “For someone like us, who pretty much dominates the market with over 60 shopping centers in Arizona, it's a lot easier for us to fill the space. We had confidence in our ability to turn it around because our market share is so strong, we knew we would be able to fill it.”

Michael A. Pollack launched an aggressive marketing campaign aimed at attracting local and regional tenants to fill the vacant space at Mervyn's Plaza. To entice tenants, the company also offered rental discounts of up to 25% below market rate in the first year of the lease.

Pollack subdivided the 25,000 sq. ft. of space left vacant by the closing of a store by apparel retailer Marshalls and leased 15,000 sq. ft. to Coomers Craft Mall and 10,000 sq. ft. to a local discount clothing store. The company also signed up Schroeder's Music and a local floor-covering store to fill some of the other empty space.

“We just looked for the right tenant mix and found it,” says Pollack. “Some people might say it was a bit of a gamble, yet on the other hand, we have such a market share on that street — we already own seven other centers on it — that it made sense to go forward with the project.”
— Steve Webb