Investors’ urban shopping spree

The move from indoor malls to</br> street retail is becoming even</br> more competitive

The Crown Building in New York command steep rents. (General Growth Properties' CEO Sandeep Mathrani)
The Crown Building in New York command steep rents. (General Growth Properties' CEO Sandeep Mathrani)

When the developers of Miami Worldcenter scrapped plans earlier this year for a 765,000-square-foot enclosed mall in downtown Miami, opting instead to create an open-air shopping promenade à la Miami Beach’s Lincoln Road, they joined a cadre of developers and real estate investment trusts making bets on street retail.

REITs such as Vornado Realty Trust, SL Green Realty and Realty Trust have been savvy street-retail players for years, but others such as General Growth Properties and private developers have jumped into the game recently. They are buying up retail properties and helping to drive up prices across the country from New York and Chicago to Miami and San Francisco, as well as in smaller cities like Boston, Seattle and Savannah, Georgia.

“There has been an explosion over the past decade of retailers gravitating toward opening up on high streets,” Alexander Goldfarb, REIT analyst for the investment banking firm Sandler O’Neill, told The Real Deal.

Indeed, with millennials, foreigners and retirees alike plunging into urban neighborhoods to live, work and play, retailers are planting storefronts on heavily trafficked city streets where restaurants, cultural attractions and nonstop commerce attract both affluent tourists and locals with time and money to spend. And investors are eagerly cashing in.

It’s all about “eyeballs and footfalls,” said Paul Schlesinger, a senior vice president at Buxton, a Fort Worth, Texas–based consulting firm that helps retailers and restaurateurs select sites. City streets have more of those commodities than the typical suburban mall, he said. “People are moving back into cities and that presents opportunities.”

Still, there are signs of a possible slowdown for high-end retailers as Wall Street bonuses shrink and well-heeled foreigners limit their spending, putting a crimp in stores’ ability to pay rents that are already in the stratosphere in premier locations in New York and other cities.

In 2015, investments in street retail in U.S. primary and secondary markets added up to $12.5 billion — 25.5 percent of the total investment in retail real estate, according to JLL.

The Streets of Manhattan

Longtime urban player Vornado, which claims to be the largest owner and operator of street retail in Manhattan, last year spun off its three malls and 79 strip shopping centers in 10 states and Puerto Rico into a separate, publicly traded REIT, Urban Edge Properties, and unloaded all its retail properties outside Manhattan.

“Three years ago, anticipating secular change  — note the current softness in retail — and recognizing that with only a handful of malls, we were in no-man’s land, we decided to exit all non-Manhattan retail,” CEO Steve Roth told analysts in a February earnings call. “I believe this decision will look better and better and better as each year goes by.”

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In addition, Vornado has picked up some key Manhattan sites, including 150 and 265 West 34th Street in Herald Square, adding to its extensive holdings around Penn Plaza. Those buildings along with another recent acquisition — a retail condo in the St. Regis Hotel and the townhouse next door (bought with partner Crown Acquisitions for $700 million in 2014) — bring the REIT’s stake in Manhattan retail to 2.6 million square feet in 65 properties.

Another urban retail veteran, SL Green, which by the end of December owned more than 800,000 square feet of retail property in New York City, announced over the summer it had bought a 90 percent interest in the $255 million, mixed-use Soho Building at 110 Greene Street. That investment with its ground-floor space expanded the company’s retail footprint in Soho, where it owns five other properties; one houses online eyeglass seller Warby Parker’s first brick-and-mortar store.

But it was General Growth Properties, a relative newcomer to street retail, that set the record last year for an urban retail acquisition: GGP and Jeff Sutton’s Wharton Properties paid $1.3 billion in April 2015 to purchase the retail portion of the Crown Building at one of Manhattan’s storied intersections: Fifth Avenue and West 57th Street. The Crown Building, whose tenants include Mikimoto (and will soon include Ermenegildo Zegna), commands some of the highest retail rents in the city. That includes Bulgari’s new lease, which exceeds $5,000 per square foot in a corridor where the average ground-floor asking rent last fall was $3,397, according to the Real Estate Board of New York (REBNY).

The total purchase price, $1.75 billion, set a record for the price paid per square foot for an entire office building ($4,564) with ground-floor retail. Predominantly an owner of shopping center properties, GGP started to become involved with street retail three years ago. Since then the company has bought properties in San Francisco and Chicago as well as New York City, where it also owns four buildings on Upper Fifth Avenue and one in Soho. (Earlier this year GGP did sell its 10 percent interest in a 522 Fifth Avenue retail condo it had purchased in 2014.)

Street retail is attracting investors to other parts of the country as well. Rye, New York–based Acadia Realty Trust added to its Chicago properties in 2014, with the $144 million purchase of an 88 percent interest in a four-story retail building along  the Magnificent Mile. That North Michigan Avenue deal represents the most Acadia has paid for a Chicago retail property since first venturing into the Windy City in 2006, according to Crain’s Chicago Business.

Paul Schlesinger: It's about 'eyeballs and footfalls.'

Paul Schlesinger: It’s about ‘eyeballs and footfalls.’

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With more than 1 million square feet of urban retail (mostly in Chicago and metro New York) on its books by the end of 2015, Arcadia headed last year to San Francisco. From October to January, the REIT purchased interests in five properties for $53.3 million. One property is on a Geary Street block that sports high-style brands including Jimmy Choo, Chanel and Saint Laurent.

In February, Arcadia announced another deal, with Tucker Development, to redevelop 10 buildings in Chicago’s Fulton Market district, an industrial neighborhood that’s becoming gentrified with art galleries, trendy restaurants and a boutique hotel. Other investors are betting that district is ripe for retail too: Two New York real estate investors, Thor Equities and Madison Capital, have also recently bought stakes in Fulton Market.

Street retail now accounts for 45 percent of the estimated gross asset value of Acadia’s portfolio, a spike from 13 percent five years ago. In 2015 the firm’s street-retail portfolio delivered higher same-store net operating income growth than its suburban properties, CEO Ken Bernstein told analysts during a February earnings call. He expects the same this year, adding, “We believe that focusing on owning the kind of retail locations that support this urbanization … will continue to create superior value for our stakeholders.”

Miami’s Storefronts

Another retail hub where developers are rushing to invest in posh outdoor shopping districts is Miami. In an urban outing in September 2014, GGP paid $175 million for a 12.5 percent interest in a partnership that has turned Miami’s Design District into a high-end shopping destination. The company paid $40 million for an additional 2.5 percent stake last year.

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A little more than a year ago, an affiliate of Brooklyn’s Red Sky Capital and London-based JZ Capital Management purchased a building in Miami’s Design District for $29 million, nearly 100 times its $300,000 selling price in 2004. In January, the two companies bought from Thor Equities another eight sites for $128 million, increasing their total investment in the district to $233 million.

Street Retail in Smaller Markets 

Developers’ soaring interest in street retail has surfaced even in smaller cities. In 2014 a joint venture between Ben Carter Enterprises and Acadia purchased 24 properties on Savannah’s historic Broughton Street, restoring them for high-profile retailers such as Michael Kors and Victoria’s Secret.

In Boston, Related Beal, a partnership between New York’s Related Companies and Boston’s Beal Cos., is turning five buildings along a lackluster stretch of the financial district into office, residential and ground-floor retail space. And in Seattle, Regency Centers, a REIT with grocery-anchored retail centers, spent $43 million for Broadway Market, which includes 111,000 square feet of retail in the densely populated and affluent Capitol Hill district.

Is the Trend Sustainable?

But open-air retail may have a ceiling and the enthusiasm witnessed 18 months ago may start to cool as retailers grapple with ever-rising rents, analysts said.

On Broadway in Manhattan’s trendy Flatiron district, median ground-floor asking rents climbed last fall 39 percent over that stretch the previous year, and in Lower Manhattan’s financial district they rose 42 percent, according to REBNY. In San Francisco’s prestigious Union Square, rents in 2015 spiked 30 percent from 2013, according to CBRE.

“You reach a point,” Goldfarb told TRD. “Is $3,000 going to be $6,000-per-square-foot rent?”

Indeed, Bulgari’s more than $5,000-per-square-foot rent notwithstanding, Manhattan rents have started to soften in prime corridors such as Upper Fifth Avenue, where the average asking rent for ground-floor retail space declined 8 percent by the end of 2015 compared with earlier in the year, according to REBNY. Landlords are becoming more realistic about the rents they can command, according to the trade association.

Vornado’s Roth struck a similar note during his February earnings call. “In Manhattan, as I’ve said before, momentum investors have driven retail asset prices too high,” he said. “Landlord-asking rents are also too high, exceeding retailers’ willingness and ability to pay.”

Clarification: A previous version of this article stated that General Growth Properties paid $888 million for its interest in the Crown Building in April 2015. GGP and Jeff Sutton’s Wharton Properties paid $1.3 billion for the retail portion of the Crown Building. Due to the joint ownership structure and additional debt and equity positions, exact dollar amounts may have changed over the course of the deal.