Making The Move Into Real Estate Development
Reprinted With The Permission From The Real Estate Finance Journal
By Richard J. Brunelli
Richard J. Brunelli is President of R.J. Brunelli & Co., Old Bridge, New Jersey-based specialists in retail leasing.
Many real estate developers who have previously specialized in residential and office space are making the move into shopping center development for the first time. There are several good reasons for this trend, including the generally overbuilt conditions that exist in the office market and the increase in planned-unit developments (PUDs) that include a retail element. In some cases, municipalities are conditioning approval of the residential section of PUDs on the prior development of a retail or office portion.
As many developers are discovering, developing a retail shopping center is a whole other ball game from developing an office building or a residential subdivision. In spite of their professional expertise and specialized knowledge in those area—or maybe because of it—many developers find themselves initially befuddled by the intricacies and nuances of developing a shopping center.
Often, the first-time retail real estate developer approaches a leasing agent with a fully engineered and approved site plan. Too often, unfortunately, those plans are incapable of attracting anchor tenants to the center and fail to meet the needs of the satellite tenants who actually ensure the center’s economic viability. The developer’s considerable investment of time and money in those plans is wasted, and he or she is faced with the unsavory prospect of going through the entire process again.
Determining What Needs To Be Built. There are ways for novice shopping center developers to avoid an unhappy scenario. Shopping centers differ from residential and office building developments in that they require active participation by the end-users in the site-planning process. The most efficient course of action to generate that participation is the establishment of a professional marketing program followed by a market feasibility study to identify exactly what type of center should be built.
There are a number of different types of shopping centers, each designed to meet different consumer needs. Matching the center to the demands of the marketplace is the first step in ensuring its success. Shopping center varieties include:
- Regional malls—enclosed shopping centers of 500,000 square feet or more;
- Community strip centers—open-air center’s of 150,000 square feet and up with two or more anchor tenants, generally a supermarket and a discount or department store;
- Specialty centers—range in size from 40,000 to 200,000 square feet but often are not anchored by a major retailer. Such centers should have a tenant mix of strong specialty stores and very few convenience stores. Included in this category are “power centers,” centers of 300,000 square feet or more, usually anchored by a major specialty retail chain, such as Toys ‘R” Us;
- Neighborhood strip centers—typically anchored by a supermarket, up to 130,000 square feet in size and often with a drug or variety store as a second anchor;
- Convenience centers—usually 6,000 to 50,000 square feet, offering an array of convenience products and services; a larger one might be anchored by a drug store.
In cases where the retail site is in the 10-to 30-acre range, the developer may have more than one available option. A community center anchored by a discount store might work just as well as a power center, for example.
The Feasibility Study. In such cases, as part of the market feasibility study, the leasing agent should sit down with the developer’s land planner and draft several concept site plans. One might incorporate a typical supermarket footprint and discount store footprint, another a power center layout. If the market demographics support it, presentations should be made to potential anchor tenants for several different types of centers, and that should become the basis for the market feasibility study.
Too often, feasibility studies are prepared by “theoreticians” who have no hands-on leasing experience. They may conclude that a center is feasible without ever talking to potential anchor tenants. Anchors must be contacted before any site plans are finalized. It is not necessary to quote rents up front, but developers should approach potential anchors with a comprehensive offering package to see if they have any interest in the site—before the site-plan approval process is begun.
Suggestions For Achieving Success: It is difficult to generalize about what types of centers have the best chances of success. Experience in New Jersey and anecdotal information gathered from other leasing professionals around the country indicate, however, that certain types of centers have less chances of success than others.
One type that first-time retail developers should definitely stay away from is the enclosed mini-mall. That is an enclosed mall of 500,000 square feet or less of gross leasable area not anchored by at least two department stores. Another project to avoid is the internally focused open-air center, with stores facing an inner courtyard and parking surrounding the development. The latter may look great, but it seldom works.
Certain site configurations can present special problems to the shopping center developer. For instance, a novice developer with a perpendicular center, a narrow property with little road frontage, might be tempted to site the anchor tenant near the street and squeeze the satellites toward the back. This generally does not work out, since the satellites need exposure to the street at least as much as the anchor.
Certain basic site-planning techniques can go a long way in improving a center’s chances of success. The most-desirable site configuration is an “L-shaped center located at an intersection. The best plan for such a site is to locate one anchor at the end of each leg of the “L” and avoid putting a large store in the corner. The corner area of such a center is the most pressured for parking. The satellite stores on either side of a large store located there end up competing with the anchor for parking space. Anchor tenants realize this and usually will not accept such a location.
Another favorable configuration is a rectangular center facing the street. Here, again, it is best to locate the anchors on both ends. It is also important to have the fronts of the satellite stores line up with the fronts of the anchors.
We have seen many centers where an inexperienced developer had the back of the center lined up straight and the fronts of the anchors protruding 100 feet into the parking lot. While such a configuration might create more parking space, customers drawn by the anchor tenants are less likely to shop the satellite stores, and that can result in a center’s demise. If truly interested in the long-term health of the center, the developer is better served by aligning all storefronts—even if some parking space or gross leasable area has to be surrendered.
For large sites, 30 or 40 acres or more, a U-shaped center with three anchors is one of the most desirable configurations. An expanded “U,” with the base much wider than the legs are long and anchors on both ends of the legs and in the middle of the base, works best. If it is done right, all the stores in such a center front on a common parking area. Any consumer coming in to shop will park and have a 180-degree view of all the center’s storefronts.
Site Plans And Pro Formas. Once the type of center to be developed has been determined, a preliminary conceptual site plan should be drawn and pro formas prepared. These will enable the developer to negotiate rentals when the leasing agent presents the site to potential anchor tenants. After several months of presentations and site inspections, the developer should know if there is enough anchor tenant interest in the site to justify proceeding with more detailed plans.
During the normal course of lease negotiations, anchor tenants will present their building footprints to the developer, along with their plans, prototypical storefronts, specifications, and parking field requirements. The developer should incorporate this information into the site-plan preparation for the potential anchor tenants.
The importance of responding to the potential anchor tenant’s input cannot be overstated. Most new open-air strip centers today typically are anchored by supermarkets. These retailers have refined their prototype stores to the point that a change in the footprint—even by just a foot or two—can result in the chain’s real estate director rejecting a site, especially if the director knows that the developer has not yet received final approvals. Supermarkets, along with more sophisticated retailers, have developed a very scientific approach to the use of space (“planogramming”) to generate the optimum return on inventory investment. Most directors will not tolerate any deviation from that planogram.
Like supermarkets, other potential anchor tenant retailers have very specific space requirements. Discount stores, for example, often are planogrammed as tightly as supermarkets. Again, a deviation of a foot or two from the chain’s prototypical footprint can result in a rejection. The new genre of home improvement centers tends to be very large units, 100,000 square feet or more. They also require outdoor sales areas. Banks and fast-food outlets with drive-through windows, while they tend to be small buildings, require stacking lanes that can eat up as much as an acre. All these things must be factored into the site plan.
Local Approvals. Only after the site plan has been approved by potential anchor tenants should the developer approach the appropriate governmental body to set up a “workshop” or informal hearing. Unfortunately, in many municipalities it can take six months, a year, or even longer to get such a hearing on the agenda of the appropriate agency. Obviously, this increases the risk for the shopping center developer, but it also presents a risk to the potential retail anchor tenant.
After the developer reaches agreement with the anchors on the acceptability of the site plan and has initiated the necessary proceedings with governmental agencies, yet another obstacle often must be overcome. Frequently, anchor tenants are reluctant to sign a lease that locks them into a specific site unless they are convinced that site-plan approval is imminent.
Most retail anchor tenants want to sign a lease conditioned on the developer delivering an acceptable site plan approval. Too often, years pass without the developer delivering such an approval, and while the retailer has been tied up, a competitor has secured a site in a nearby shopping center or town.
So the developer should not move into the site-plan approval phase without the anchor tenant’s blessing for the plan, but the anchor tenant will not sign a lease unless approval is forthcoming shortly. What is a developer to do about this “Catch 22” situation?
Inexperienced retail real estate developers often decide that they are better off getting a site plan approved first and then trying to find anchors who will conform to that plan. As the factors outlined above make clear, such a strategy has strong potential to backfire on the developer. The added costs and time delays involved in trying to retrofit an approved site plan to meet the needs of an anchor tenant can be burdensome enough to kill the project.
Importance of Established Relationships. Experienced developers, on the other hand, strive to line up anchor tenants and pre-lease their centers based on a conceptual site plan prior to submitting detailed plans for government approval. The key to this strategy is establishing relationships with the representatives of the anchor tenants. Such relationships often allow the developer to obtain lease commitments conditioned on an approval process that has been carefully researched and planned.
The developer must secure the anchor tenants’ confidence that approval of an acceptable site plan is very likely to occur within a clearly defined time frame. The developer must be able to provide the anchors with approval feasibility schedules detailing all of the various governmental agencies that must be dealt with and the permits required for he site. It must be demonstrated to the anchor tenants that the developer knows how and when those issues will be addressed.
Take Care in Attorney Selection. Finally, he shopping center developer must give careful consideration to the selection of an attorney for the project. Contrary to popular belief, a local attorney is not always the best choice. A shopping center development requires an attorney who specializes in land-use issues. A local attorney who lacks that specialized expertise can jeopardize the economic viability of a project.
Example: We were recently involved in a 50-acre project that required 350,000 square feet of gross leasable area to make the proformas work. We testified before the planning board that this was the case, and that was truthful testimony. However, the residential developer behind this project had hired a local attorney to secure the necessary approvals. He was good at doing that, but—as is the case with many local attorneys—he was good at it because he had a tendency to give the municipality whatever it asked for.
In this case, the attorney was meeting informally with some of the municipal people before we were consulted to structure the pro formas. Basically, he agreed to a 290,000-square-foot center. Worse yet, he also agreed to about $7.5 million in off-site improvements. Under those conditions, there is no way the developer can afford to build that center. The developer will have to go to the municipality, say the attorney made a mistake, and try to get the conditions changed. The jury is still out on whether this particular center will ever be built, but it is seriously doubtful.
Summary: First-time retail real estate developers need to factor all of these elements into their planning process. Site planning that disregards the needs of the center’s retail tenants has very little chance of success in the current environment.
A detailed pre-leasing strategy has become more critical than ever before, as anchor tenants are forced to stretch rentals to their utmost limits. Physical plants and parking fields have to be designed in conformity with the anchor and satellite tenants’ requirements. Only by doing so can the developer anticipate the optimum sales and profit performance of the center’s tenants and, ultimately, the very survival of the center itself.