Outlet Centers Take on Malls, and Each Other

CRE Finance World, Winter 2014

Outlet Centers Take on Malls, and Each Other A publication of Winter issue 2014 sponsored by CRE Finance World Winter 2014 49 ith U.S. retailers expanding into new store locations, and with almost no new mall space being built, outlet center development has prevailed in recent years (see Charts 1 and 2). As development activity increases, markets that were once considered off limits for outlet centers due to proximity concerns, are witnessing renewed life. Retailers appear to have lifted radius restrictions, which prevented outlet stores from being located too close to an existing full-line location. For example, Colliers International estimates that about 64% of Nordstrom Rack stores are located within five miles of a full-line Nordstrom, and 42% are within one mile. At the same time, there have been more instances of outlet centers popping up in competing markets and targeting the same shopper. It is our view that outlet centers will continue to flourish in the current value-driven economy. Shoppers’ desire for discounted prices--as well as retailers’ and developers’ appetite for expansion opportunities--is driving the industry’s growth. However, looking further out, there could be challenges as additional outlet center supply comes on line. As outlet centers continue to invade each other’s space, as well as a traditional mall’s trade area, we expect there could be operating casualties and principal write-downs in oversaturated retail markets. That is because there are only so many retail slices an existing trade area pie can be cut up into. Outlet Centers’ Recipe for Growth Outlet center openings quadrupled to eight per year in 2012 compared with a rate of two per year in 2009, 2010, and 2011. In 2013, 11 have opened or are scheduled to open by year-end. As outlet center owners/borrowers search for financing proceeds, commercial mortgage-backed securities (CMBS) have been playing a role in this growth. Retail tenants continue to look to participate in the outlet format and capture shoppers searching for value in a struggling economy. Value-starved shoppers who might not be able to afford full-price designer labels have been venturing to the outlets for custom designer outlet product lines. Developers have found outlet centers to be profitable, largely because of their strong sales levels and low operating costs. In addition, developers like that outlets might be somewhat less sensitive to competition from e-commerce than full-price stores are, as most retailers today are not selling their made-for-outlet goods on the Internet. With strong tenant and shopper demand, developers have been building new centers, expanding existing ones, and converting other retail formats into outlet center properties. Historically, outlet centers have not always been the retail segment of choice. About a decade ago, there was industry consolidation, failed operators, and CMBS outlet center collateral that was liquidated at significant losses due to cut-off situations. A cut-off event typically occurred when a developer introduced an outlet center that was between a rural-located center and one that was closer to the permanent population. These infill located centers took business away from existing outlet centers because they were new, usually larger, and a shorter drive from major metropolitan areas. In recent years, however, outlet center performance has been strong. Based on an analysis that we performed using 2006 vintage year (a relatively large year for outlet center originations) outlet and traditional mall center loans from securitization through 2012, outlet center net operating income (NOI) increased by 41% compared with NOI growth of 9% for traditional malls. Chart 1 U.S. Outlet Center Openings *Completed or scheduled for opening by end of year. Source: Value Retail News W Tamara Hoffman Associate Standard & Poor’s Ratings Services Deegant Pandya Director Standard & Poor’s Ratings Services Larry Kay Director Standard & Poor’s Ratings Services


CRE Finance World, Winter 2014
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