In an industry that has been flooded with an avalanche of bad news in the past 12 months, including sales declines, store closings and stalled or scrapped projects, the outlet center sector has proven to be one of the few bright spots.

For most of the U.S. retail universe, the Black Friday weekend of 2008 turned out to be a disappointment. During the three days starting Nov. 28, foot traffic at all U.S. retail establishments fell 19.3 percent compared to the same period in 2007, according to ShopperTrak, a Chicago-based provider of shopper traffic counting information. During that same weekend, however, traffic at the 21 outlet centers owned by Baltimore-based Prime Retail was up 8.3 percent, according to president Robert A. Brvenik. That story was repeated throughout the outlet center industry, which saw an influx of new shoppers in November and December, according to Lisa Quier Wagner, president of Quier Target Marketing, Inc., a Washington, D.C.-based consulting firm that specializes in outlet center marketing, and partner in EWB Development LLC, a Vermont-based developer of outlet centers.

“We are a truly counter-cyclical industry and I think it’s been borne out more than ever,” during this holiday season, Quier Wagner says. “We are hearing there are many people coming into outlet centers and saying this is the first time they’ve outlet-shopped. Traffic has been very strong every day since Black Friday.”

The trend of outlet centers outperforming regional malls and lifestyle properties began in the first half of 2008, when a barrage of negative news on the U.S. economy coincided with a precipitous decline in the value of the dollar. U.S. consumers, hit with a triple whammy of rising layoffs, drops in home values and vanishing retirement accounts, cut back on discretionary spending and altered where they spent those dollars. Discount stores and outlet centers gained a boost as a result. At the same time, foreign tourists, many of them Europeans, booked quick trips to buy discounted designer items in the U.S., to take full advantage of the favorable currency exchange rates. The Euro to dollar exchange rate, for example, reached $1.59 in July 2008 (althought it has since retreated to below $1.30).

As a result, outlet center operators have been posting same-store net operating income (NOI) increases while regional mall operators’ have seen declining NOI. For the third quarter of 2008, Tanger Factory Outlet Centers, a Greensboro, N.C.-based outlet center REIT, registered a 4.7 percent in NOI compared to the same period in 2007. Chelsea Property Group, the outlet center division of Indianapolis-based Simon Property Group, reported an NOI increase of 7.7 percent for its centers, while the NOI for Simon’s regional mall portfolio grew only 1.9 percent.

On Oct. 23, 2008, the Standard & Poor’s rating agency upgraded the corporate credit rating for Tanger to a BBB from a BBB-, marking its first upgrade that year for the credit rating of any retail REIT. Part of the reason for the change was Tanger’s conservative balance sheet—at the end of September, the company had a debt to total market capitalization ratio of only 31.2 percent and it had managed to secure a $235 million three-year loan facility which effectively extended all of its debt maturities to 2011.

But the fact that Tanger, which owns 9.1 million square feet of space, concentrates on outlet centers also played a role. “We expect Tanger’s operating performance to remain relatively stable, as the company benefits from offering a value-oriented product to consumers and a relatively low-cost venue for retailers,” wrote Standard & Poor’s analyst Linda I. Phelps in her Oct. 23 note. (Tanger officials did not return calls seeking comment.) The company’s sales rose 0.3 percent in the third quarter (the most recent period for when figures are available), to $341 per square foot, and even as retailer after retailer has announced store closings, Tanger’s occupancy level rose 50 basis points from the second to the third quarters of last year, to 96.7 percent. Meanwhile, Chelsea’s sales rose 4.2 percent year-over-year during the third quarter to $520 per square foot. And although occupancy at Chelsea centers fell 80 basis points, its properties remain almost completely full with a 98.8 percent occupancy rate.

“We always say outlets are good in good times, but great in bad times,” says Quier Wagner. “A lot of people are trading down from the high-level department stores or specialty stores because they still want that brand, but they want to achieve better value. And of course we are working for it—every developer that understands the value of marketing is out there aggressively advertising. This is the time for us to remind people we are out there.”

As a result of the steady consumer traffic over the holiday season, the real estate industry has begun to view outlet properties as the silver lining of the massive cloud hanging over the sector. But how long will this outlook last? Going forward, outlet centers won’t be immune from what could be the worst recession since World War II, says Jeff Green, president of Jeff Green Partners, a Mill Valley, Calif.-based consulting firm. There might be a slight decrease in occupancy levels across the sector, as well as flat growth on rental rates. Brvenik, for example, expects that for the fourth quarter of 2008, same-store sales for outlet properties will be flat compared with last year’s, due to heavy discounting by many retailers. That may be worse than the sector is used to, but it would still be better than the retail universe as a whole where same-store sales dropped overall during the holiday shopping season.

There is a reason why outlet center owners should be wary, despite the solid performance of the sector so far. Retailers tend to close outlet stores last, so a wave of closings at outlet centers may still come. Furthermore, outlet center developers have not pulled back on new projects as quickly as developers of other types of retail properties, which could lead to some issues if occupancy levels do begin to drop dramatically.

However, many outlet center owners say that there remains room for growth even in the face of the recession. One reason is that unlike regional malls, outlet centers have not yet become ubiquitous, according to Quier Wagner. For example, a handful of states, including Arkansas, Nebraska and Wyoming, don’t have any outlet centers at all, she noted.

Prime Retail plans to break ground on two outlet centers this year, in Grand Prairie, Texas and Livermore Valley, Calif. “We look at this as a period similar to the early 1990s,” Brvenik says. “It was a difficult time for retailers also, but it was one of the greatest growth periods for outlet properties.”

Value proposition
Among the primary reasons outlet centers have been able to maintain occupancy levels at a time when the retail sector has been overrun with bankruptcies, store closings and liquidations, is the unique rent structure employed at outlets. In enclosed malls, tenants have to pay steep common area maintenance (CAM) charges, in addition to helping pay for store build-outs. Since outlet centers tend to be open-air and employ minimalist designs, buildout and CAM expenses are lower, says Brett Robinson, vice president of development with Continental Retail Development, a Columbus, Ohio-based developer.

In addition, the base rental rates for outlet centers tend to be 20 percent to 50 percent lower than those at regional malls in the same trade area, depending on the age of the property and proximity to a major metropolitan center, notes Green. As a result, outlet center stores often become the most profitable locations for retailers, so even if Gap or Ann Taylor are closing stores, those companies would look at outlet centers last, not first, Green says.

Also, developers of outlet centers tend to have less trouble securing tenants for new projects than those of regional malls or lifestyle centers. Prime Retail, for example, has already signed leases for 50 percent of its 485,000-square-foot development in Grand Prairie, Texas. This during a time when many developers of other retail formats have been forced to postpone or scrap some projects altogether because of inadequate leasing levels. During the boom years, lenders were willing to grant loans on properties built entirely on speculative demand, says David L. Wing, vice president and general manager with Graycor Construction Co., Inc., a Homewood, Ill.-based construction firm. Now, concerned about a severe contraction in the retail sector, they require pre-leasing levels no lower than 50 percent before even considering a request for financing.

Prime Retail (a subsidiary of New York-based Lightstone Group) is still in the process of securing financing for Prime Outlets Grand Prairie, but it has already found an equity partner for the project. The company plans to break ground for the center this summer.

Still, outlet center owners have had some troubles. During the second quarter of last year, sporting goods retailer Camp Coleman, apparel seller Geoffrey Beene and sportswear store Big Dog notified Tanger they were exiting their leases early. With a total of 32 stores, those tenants accounted for 92,000 square feet of Tanger’s 9.1-million-square-foot portfolio.

Moreover, the credit crisis and recession are global phenomenons. As a result, the flow of foreign tourists coming to the U.S. has waned. During October 2008, the most recent month for which data is available, the Office of Travel and Tourism Industries reported the number of U.S. tourists from abroad totalled 4.0 million visitors, down 2.4 percent from the 4.1 million visitors during October 2007. With foreign visitors likely to stay home and domestic consumers focused on necessities, the amount spent at outlet centers has dropped and is expected to continue to decline in the coming months, says Green.

Meanwhile, as U.S. consumers cut back on discretionary purchases, including furniture, entertainment and apparel, outlet centers are vulnerable due to a heavy reliance on specialty retailers, Green notes. In December, apparel chains registered a same-store sales decline of 10.7 percent, according to ICSC. Same-store sales at luxury stores, another outlet center staple, plummeted 17.4 percent. Overall, U.S. chain stores, including drug stores, declined 1.7 percent.

As a result, not all proposed projects might be able to go through. Earlier this month, for example, Prime Retail made the decision to pull out of the Villages of Urbana, an outlet center/office development in Urbana, Md. which would feature up to 600,000 square feet of retail space. The company’s executives felt the project would not meet its minimum development yield level of 10 percent. “We just didn’t feel it was the right environment to go forward with that project,” Brvenic says. (Prime’s former development partner, Gaithersburg, Md.-based Urbana Corporate Center, still plans to eventually build the center. )

Meanwhile, last fall, Tanger pulled the plug on developments planned for Port St. Lucie, Fla. and Phoenix because it hadn’t pre-leased 50 percent of the space at the respective centers, said Tanger president and COO Steven Tanger, during the company’s third quarter earnings conference call. Tanger did, however, recently sign purchase options for sites in Mebane, S.C. and Irving, Texas.

Cautious, but optimistic
Developers of outlet centers have had to amend standard operating procedures as a reflection of the challenging economic environment. Chelsea Property Group, for example, has worked with its tenants on “market specific” initiatives to drive more shoppers to its stores, notes Michele Rothstein, senior vice president of marketing with the firm. “One thing we learned from post 9-11 is to keep marketing and keep a presence with the consumer and tourism community even when there may be declines in traffic, which is a distinct possibility,” Rothstein wrote in an email. “We need to continue to keep our message strong for the future when demand for shopping and travel increases.”

Despite the challenges of the market, Chelsea is pressing on with development. It plans to open the 400,000-square-foot Cincinnati Premium Outlets in Monroe, Ohio this summer. Also in the pipeline are centers in Merrimack, N.H. and Phoenix.

And there are companies that traditionally worked in other formats that are now testing outlet center waters. Continental Retail Development has announced plans to build its first outlet property, the 450,000-square-foot Designer Outlets of MidAmerica in Council Bluffs, Iowa, which it expects to open in the summer of 2010. The center will likely draw shoppers from a 100-mile radius. Continental, according to Robinson, has received favorable feedback from potential tenants.

“More and more retailers will find their outlet division to be their most profitable division,” says Robinson. “I really think outlet centers will begin to play a more prominent role, sometimes serving as people’s first choice in where to shop.” Continental Retail Development is also working on another outlet center, Designer Outlets of Tucson, which is scheduled to come on-line in 2011.

In addition, Atlanta-based diversified REIT, Cousins Properties Inc., a builder of open-air lifestyle centers and power centers, in November announced a joint venture partnership with Chicago-based Horizon Group Properties Inc. to develop the Outlet Shoppes at Oklahoma City, a 341,400-square-foot outlet center. It is slated to break ground this winter, contingent on updated expansion plans of its prospective tenants.