At 750,000 sq. ft. and 130 stores, the Prime Outlets San Marcos is a far cry from the factory outlet centers that hawked irregular goods from remote roadsides two decades ago. Just a 30-minute drive from both San Antonio and Austin, what has been Prime Retail Inc.'s largest shopping destination is also a prime example of an industry trend to develop large centers near urban areas.
That trend continues this month as Baltimore, Md.-based Prime Retail unveils the first of two expansion phases for Prime Outlets. When the second phase is completed next summer, the Orlando center will offer nearly 1 million sq. ft. of shopping at as many as 180 stores. Across the nation, developers are expanding existing outlet centers and increasing the average size of new projects, luring shoppers with brand-name stores in ever-increasing numbers.
“Ten-plus years ago, it would be considered a very unique prospect to have an outlet center over 500,000 sq. ft.,” says Michele Rothstein, senior vice president of marketing for Chelsea Property Group. “Today it's the way we're looking at new projects.” Roseland, N.J.-based Chelsea is a division of Simon Property Group and owns the Premium Outlets brand.
Since the early 1990s, outlet centers have experienced a shift that squeezed out many small properties and rewarded larger ones with increasing sales. In fact, the number of outlet centers in the United States has plunged 30% from 324 in 1990 to 225 today, reports the International Council of Shopping Centers (ICSC).
Factory outlet centers operate differently from regional malls in several ways that may seem disconcerting to new investors. Leases tend to be shorter, averaging about five years, and outlets lack the anchor tenants that are an important source of advertising and traffic generation at malls, according to Gary Skoien, president of Rosemont, Ill.-based outlet center developer Horizon Group Properties Inc.
“Those issues sometimes scare investors and individuals doing financing,” Skoien says. “But in fact, good outlet centers are probably more productive and more stable than some of their [mall] competitors.”
Outlet centers require active management and more employees than a traditional community retail center, says David Ober, general partner of PA Outlet Management in Lancaster, N.J. Instead of competing against their wholesale accounts, manufacturers pay the outlet center a premium in rent for advertising and staff that promote the entire center.
“Our center, Rockvale Outlets in Lancaster, Pa., gets more than 4,200 tour buses a year, and those people have to be greeted and given coupon books,” says Ober, president of industry trade group Developers of Outlet Centers & Retailers.
The outlook for factory outlet center fundamentals is positive, owing to robust demand for space and limited supply growth, according to a May 18 report by Banc of America Securities International about Tanger Factory Outlet Centers. Overseas markets are also embracing the outlets concept and providing expansion opportunities for U.S.-based developers. There are approximately 400 outlet projects open or inoutside the U.S., according to the Developers of Outlet Centers & Retailers (see sidebar).
What does the future hold for these oversized outlet centers? All retail is vulnerable to changes in consumer spending, which could wilt under the continued pressure of rising energy costs. Risks for retail property owners can include tenant bankruptcies, rising interest rates and a general economic drag from the slowing housing market. Whether or not those conditions will reach a point that crimps outlet center performance remains to be seen, but for now the industry is growing.
Large and in charge
While the total number of U.S. outlets is down, the industry is expanding by four to six projects each year. Unlike previous development waves characterized by small, remote centers, developers are attracting visitors with more stores at larger destinations. The four outlet centers opened in 2006 averaged 362,850 sq. ft., compared with a 250,901 sq. ft. average among existing centers, reports Value Retail, a publication of ICSC.
Indeed, Chelsea now develops 400,000 sq. ft. to 425,000 sq. ft. in the first phase of its projects. That's 100 to 120 stores, roughly twice its initial store count at projects a decade ago, Rothstein says. The company is considering expanding some new properties beyond 500,000 sq. ft.
Chelsea's largest center is the 844,000 sq. ft. Woodbury Common Premium Outlets in Central Valley, N.Y., which has grown from 90 stores at the end of its first year in 1985 to 220 stores today. Amassing that many manufacturers willing to open direct outlet stores would have been impossible when Woodbury Common first opened, Rothstein says. “There simply weren't enough brands out there in the business.”
Chelsea's Woodbury Common grew with the industry, but Tanger, a factory outlet real estatetrust, is developing a center that will measure nearly the same size when it opens next year in Deer Park, N.Y. “Probably five or 10 years ago, the average size [of an outlet center] was 100,000 sq. ft. to 150,000 sq. ft.,” says Steven B. Tanger, Tanger's president and COO. “The properties on average are getting larger. As with any other sector of retail, there's been an evolution.”
Big savings, big returns
Roughly 40% of U.S. consumers shop at outlet centers, similar to the number of consumers shopping at regional malls. Today's outlets sell the hottest name brands and current fashions, minus a retailer's markup. And while items on sale at regional malls may be lower, outlet prices average about 40% less than retail, says Ober of PA Outlet Management.
The 225 outlets generate about one half of 1% of U.S. retail sales, Ober says. Given that U.S. retailers number about 36,000, that's a hefty contribution from a relatively small number of properties.
The modern outlet center is raking in the dough, judging from dominant industry players. Tanger is projected to increase funds from operations (FFO) per share (calculated by adding depreciation and amortization expenses to earnings), from 6% this year to between 10% and 14% over the next few years, according to Banc of America Securities International. The company reported comparable tenant sales of $344 per sq. ft. for the 12 months that ended March 31.
Simon now owns two former outlet center REITs — Chelsea, acquired in 2004 for $4.8 billion in cash and assumed debt, and The Mills Corp., purchased this spring for $9.5 billion in cash and assumed debt. Mills earlier disclosed it was in danger of having to file for bankruptcy protection, but in June, Simon told analysts at RBC Capital Markets that it had successfully integrated The Mills and identified significant opportunities to improve leasing and performance. Chelsea is expected to continue generating annual returns of 12% to 14%, and will likely exceed comparable sales of $500 per sq. ft. in the near future.
Prime Retail, which owns 9 million sq. ft. of space in 29 centers, had sales of $353 per sq. ft. in 2006, up 7.1% over a year earlier, according to ICSC's Value Retail News.
Learning from the past
In the 1970s and 1980s, manufacturers recouped the cost of factory seconds by selling them from converted production facilities, often with labels removed to avoid retail competition. “Twenty years ago, you'd have conversations [with manufacturers] where the whole goal was to recoup 90% to 95% of the cost of manufacturing their product,” Ober says.
Outlets proliferated in the 1990s, but poor site selection and insufficient numbers of stores led to widespread failures. “I don't think developers truly understood enough about what made a successful outlet center,” Skoien says. “They've come a long way toward understanding that.”
What makes a project successful? As with all real estate, a chief determinant is location. Manufacturers have always been reluctant to open outlets in locations that compete with their retail partners, so most factory-direct centers are outside metropolitan areas and away from the nearest regional mall. Developers are still learning just how much of a buffer is required and are gradually taking locations closer to urban areas.
“Fifteen years ago, we tried to space them 50 miles from a regional mall,” says Tanger of Tanger Factory Outlets. “About 10 years ago that dropped to 25 miles, five years ago that probably dropped to 15 miles, and now it's [as little as] five to 10 miles.”
Aside from tourist markets like Las Vegas or Orlando, most outlets are an hour or more from the nearest regional mall. For that reason, a critical mass of stores is essential to make the drive worthwhile.
“A lot of these centers were being developed with 75,000 to 150,000 sq. ft. of stores,” Skoien says, referring to outlets that were closed or converted to other uses in the 1990s. “Unless you're in a really unique location, that's not enough critical mass for shoppers to travel to.”
Should the economy falter, it's difficult to predict whether consumers will curtail trips to the outlet mall. Yet large, well-located outlet centers have proven resilient during periods of economic stress. Tanger Factory Outlet Centers, for example, has never ended a year with average portfolio occupancy of less than 95% in its 26-year history, says Tanger, the president and COO.
“The business model of the outlets is simple and elegant, and has not been repeated,” Tanger says. “It's brand-name manufacturers selling directly to the consumer. That's why we've survived.”
Matt Hudgins is an Austin-based writer.SMALL CLUB DOMINATES OUTLET CENTERS
More than half of the nation's retail outlet centers belong to a handful of market leaders. Here are the nation's five largest portfolios as of Dec. 31, 2006:
|Developer||Centers in portfolio||Gross leasable area sq. ft.|
|Chelsea Property Group||36||13.9 million|
|Prime Retail||29||9 million|
|Tanger Factory Outlet Centers||30||8.4 million|
|Craig Realty Group||10||2.8 million|
|Prescott Group*||5*||1.1 million*|
|*Prescott Group also owns the 256,000 sq. ft. Preferred Outlets in Laughlin, Nev., which is a value-oriented center with a significant outlet tenancy, and in January acquired 244,748 sq. ft. in Lake Park, Ga.|
|Source: Value Retail News|
Factory outlets gain international appeal
The factory-direct retail model is establishing a foothold in markets around the globe with 400 outlet projects open or in development outside the United States, according to the Developers of Outlet Centers & Retailers, an industry trade group. This summer Chelsea Property Group, a division of Simon Property Group and owner of the Premium Outlets brand, opened its first outlet mall in Seoul and its sixth outlet center in Japan.
The Roseland, N.J.-based company launched an international program after noticing large numbers of foreign visitors at its 36 U.S. properties, particularly properties in or near gateway cities of Orlando, New York and Boston.
After researching various markets, the company established joint ventures with local developers to enter Japan, South Korea and Mexico, according to Michele Rothstein, senior vice president of marketing at Chelsea.
“We have a group that is looking at other countries as well,” Rothstein says. “We've seen that this concept of Premium Outlets works in every country we've brought it to.”
The outlet industry has only begun to take hold overseas in the last 10 years, says David Ober, general partner of PA Outlet Management in Lancaster, N.J. and president of the industry trade group. Beginning with England and then Western Europe, retail outlet centers have now spread to Eastern Europe, China and the Middle East.
“Because [developing countries] still have manufacturing, they're more open to allow an outlet center in Europe where there would be strong opposition to what we would consider a North American-style regional mall,” Ober says.
Developers don't need to leave the U.S. to tap international consumers, however. Some outlets in southern border states draw shoppers from Mexico in droves, including Rio Grande Valley Premium Outlets, which Chelsea opened in Mercedes, Texas, last November. The 400,000 sq. ft. center is expected to draw 7 million tourists a year to the town of 13,000 residents.
Rosemont, Ill.-based Horizon Group Properties Inc. is counting on cross-border business to drive sales at The Outlet Shoppes at El Paso when that project opens in October, according to Gary Skoien, the company's president.
“There are a couple of centers built in border areas that are doing unbelievably well,” says Skoien, “because the Mexican shopper is desperate for brand names, reasonably priced.”
— Matt Hudgins