By Matt Valley
The second half of May was an especially busy time for DDR Corp., the Beachwood, Ohio-based real estate investment trust (REIT) that owns and manages a portfolio of primarily large-format power centers in 39 states and Puerto Rico.
DDR hosted more than 1,000 meetings with retail real estate executives and assorted shopping center industry professionals at the Bellagio Hotel in Las Vegas during RECon 2014. The three-day convention, which took place May 19-21 at the Las Vegas Convention Center, attracted more than 33,000 attendees from across the globe.
“The overriding theme for me coming out of RECon was the continued robust demand [for space] we’re seeing from the best-in-class retailers, specifically in the power center format,” said Paul Freddo, senior executive vice president of leasing and development for DDR Corp. during an investor presentation at REITWeek 2014 in New York City in early June.
Added Freddo: “The question we get from these retailers who obviously we are dealing with on a daily basis is, ‘How can you help me grow? How are you going to find me space in your centers, the centers I want to be in, and how do you get creative in doing it?’”
On May 29, just a week after the shopping center convention, DDR announced the launch of a multi-year lease termination initiative, known as Project Accelerate, which seeks to recapture high-quality anchor store locations across its portfolio. DDR currently owns and manages 396 shopping centers totaling 108 million square feet.
Specifically, DDR is collaborating with retailers in the books, electronics, toys, office and traditional department store categories to “rightsize” their real estate footprints by regaining control of locations in advance of lease expirations. This initiative enables DDR to remerchandise its prime assets with “market-share-winning tenants” while realizing mark-to-market rental upside of 30 to 40 percent.
During the first phase of this initiative, DDR has identified 90 anchor locations, representing 3.3 million square feet of prime retail space that meet the company’s criteria for accretive recapture. Of these leases, DDR has finalized terms to recapture 21 locations, representing 550,000 square feet primarily located in Boston, Cleveland, Denver, Orlando, Phoenix, Raleigh and San Antonio.
Demand for new store growth from retailers such as Nordstrom Rack, Sprouts Farmers Market, Ulta, Whole Foods, Five Below, HomeGoods, Fresh Market, Marshalls, Trader Joe's, White House Black Market, Gap Factory, Shoe Carnival, PetSmart and Carter's represents a select group of merchants that DDR is in discussions with to backfill the recaptured locations.
REBusinessonline.com sat down with Joe Tichar, DDR’s senior vice president of corporate operations, early on the opening day of RECon 2014 to discuss the company’s dominance in the power center category, its near-term strategy and the health of the American consumer. An edited transcript follows.
REBO: Joe, you believe DDR has a unique story to tell in the shopping center industry. Please explain why you feel that way.
Tichar: We are a pure-play power center REIT. We have simplified our story and focused our portfolio during the past few years. There aren’t a lot of other retail REITs that can say they are pure-play power center REITs. That makes us unique.
There are a lot of other retail REITs out there that are focused on aggregating assets. They own some unanchored strip centers, power centers and grocery-anchored centers. Our portfolio strategy is focused exclusively on power centers.
REBO: DDR goes to great lengths in its investment presentations and marketing materials to define a power center as an open-air shopping center that houses multiple national big-box anchors such as discount department stores, off-price stores, warehouse clubs, organic grocers and other retailers that offer a wide selection in a particular merchandise category at value prices. Why does DDR invest so much time in defining power centers for investors and the media alike?
Tichar: The reason we go to great lengths to define our property type is that too often all open-air retail property types get lumped together and are referred to as one asset class by the media when they cite operating metrics, performance of the asset class, or demand for retail space. When you lump it all together, it doesn’t really tell the story about what’s happening in our portfolio with power centers.
We read that vacancy rates for retail are 12 percent, but among powers centers the vacancy rate is about 5 to 6 percent. As you dive into it, you realize that there is a delineation between power centers and other types of open-air retail. As we convey our story to the investment community, we want them to understand what we own.
As a company, we have also evolved. We used to own enclosed malls, we used to own industrial properties, we used to own a lot of different property types. Today, we are very focused on the power center segment.
This table contained in an updated DDR investor presentation shows how the REIT's portfolio and vital signs have evolved. Click on the image to see a larger version of the table.
REBO: As an asset class, how are power centers performing overall?
Tichar: The asset class has been very resilient. There is more capital coming into the sector. That’s why you’ve seen cap rates compress for our property type, and you see large capital allocators (pension funds and other institutional investors) coming to market to buy power centers.
The tenant demand for space continues to be very strong. DDR leased 48 million square feet during the last four years, and we leased 3.1 million square feet in the first quarter of 2014, a period that typically experiences a slowdown after the holiday shopping season and when some retailers close their doors. We’ve seen more demand for our product type than other segments of the retail real estate sector.
We're meeting with a lot of retailers in Las Vegas during RECon, and we’re expecting to hear that they are trying to open 20, 30, 40, 50 or 80 stores a year. Retailers will be looking to power centers to open these stores. Such strong demand for space in an environment where there is very little supply and new construction makes the power center asset class very attractive.
REBO: Were organic grocers always a part of power centers, or is that a relatively new phenomenon?
Tichar: Well, organic grocers themselves are still relatively new. Since they are going into a very competitive segment of the retail business, they are forced to grow where they have options and where they see the most value long-term for their business model. Power centers provide that vehicle to grow. If you are a specialty grocer, you are not going to open a store next to a traditional grocer in a grocery-anchored center.
REBO: Whole Foods Market recently stated that competitors such as Trader Joe’s have cut into its sales. Should announcements like that make investors hesitate to invest in the grocery sector?
Tichar: One quarter doesn’t make a trend. The grocery business overall has always been very competitive, and now you have the specialty grocers entering the fold, which makes it even more competitive. In the grocery business, if you are the third or fourth grocer in a market, it’s going to be very tough because there are many more options for food today. You don’t have to go to a traditional grocery store to buy food.
REBO: What is different about the power centers of today versus 10 years ago?
Tichar: The credit quality of the retailers and the cash flows that power centers generate today compared with five or 10 years ago is unparalleled. The retailers that are winning market share have great balance sheets today. They understand the consumer’s preference for value and convenience. As a landlord, the durability of our cash flow is dependent on the credit quality of the retailers we do business with.
The traditional grocery-anchored center is under pressure because it has competition from specialty grocers. The mall business continues to have its own issues, particularly with regard to Class B and C malls as department stores lose market share. Power centers have taken market share from both grocery-anchored centers and from malls.
REBO: We read a lot about the financial pressures on the American consumer, including relatively stagnant wage growth, rising food costs and an elevated level of underemployment. Yet DDR has a slide in its presentation that boldly states, “Never Underestimate The U.S. Consumer.” The slide points out that the long-term annual growth of retail sales in the United States is 4.5 percent. How stressed is the American consumer today in your view?
Tichar: That’s a really good question because many times people look at the U.S. Department of Commerce reports concerning retail sales, and they draw conclusions about micro performance at the asset level based on macro reports.
The reality is that market share is shifting as retailers are gaining and losing their slice of the pie. Therefore, it is important to look at where the sales are occurring, and where they are growing the fastest.
At the end of the day, it all comes down to the merchandise that the retailer offers. Retail sales as a whole might be flat, or they might be down or up, but who is winning those sales is dependent on the merchandise that retailers offer.
American consumers must be incentivized to shop. If you give them a reason to shop and they are incentivized by the right merchandise at the right price at the right time, the results will show up in sales.
The Department of Commerce reports don’t necessarily reflect what’s happening in a particular shopping center, or a given unit of a shopping center. Some people like to talk about the financial stresses consumers face and maybe bet against them. It hasn’t really played out too well for the people who have done that. Over the long term, you have demographic trends that continue to support retail sales growth.
Click on the image to see a larger version of the chart on U.S. retail sales growth.
Source: U.S. Census Bureau
REBO: Department stores are losing market share at more than 2.5 percent annually, according to DDR. Is it simply that the alternatives are more appealing to consumers today, or is it a confluence of factors that has caused department stores to lose market share?
Tichar: There are a few things at play here. You had the era of category killers — retailers that specialized in a particular product segment, had economies of scale and offered better pricing to the consumer. Today, you have a lot of retailers that offer branded goods at discount prices, and you no longer have to go to the department store to purchase branded merchandise.
The consumer has been trained and now expects that he or she can get great value and still buy name brands at discount prices at T.J. Maxx, Marshalls, Nordstrom Rack, SAKS Off 5th, those types of retailers.
The consumer is very focused on value, and value means different things for different segments of the population. It can be the right merchandise that the consumer is looking for, it can be the price that makes them feel that they got a good deal, or it can be the convenience and ease at which they obtained their merchandise.
REBO: Data from the International Council of Shopping Centers and company reports shows that power center anchors have operating margins ranging from 9 to 12 percent versus 2 to 3 percent for grocery tenants. Can you explain why power centers stack up so well when it comes to operating margins?
Tichar: Part of it is the operating structure, the rent structure provided in power centers versus malls. Power centers are not burdened with the level of common area maintenance (CAM) charges as malls.
Click on the chart to see a larger version of retail sector operating margins.
Source: ICSC and company data
REBO: How intense is the competition among investors to acquire power centers?
Tichar: You are starting to see very competitive pricing in our asset class. Quite frankly, we’ve missed deals because prices were too steep. You are seeing more pension funds and private equity firms and other asset allocators look to power centers because of the durability of cash flows and the performance of the asset class over time.
REBO: In 2013, DDR was a net buyer, acquiring $1.9 billion in properties. Do you intend to be a net buyer again in 2014?
Tichar: We remain very optimistic about our ability to source attractive acquisitions. Given the pricing environment, we also increased our disposition guidance this year to $400 million from $200 million. We continue to see opportunities to prune lower-quality assets in our portfolio that have limited growth potential by taking advantage of very attractive pricing and demand for that product type in the market. As we continue to do that, we will recycle capital and trade into higher-quality assets. We continue to be very active on the acquisition and disposition front.
Click on the chart to see a larger version of DDR's annual acquisitions, dispositions volume.
REBO: Who is buying the properties that you are selling?
Tichar: It depends on the asset, but we’ve done business with the private REITs on the single-tenant asset side. We also do business with a lot of private, one-off buyers of properties in local markets where they can be the local sharp shooter. They understand the market. They are willing to take more risk.
REBO: You are co-head of the portfolio management department at DDR. What is the purpose of that department?
Tichar: We established a portfolio management department a little over a year ago. We established a proprietary ranking system to score every asset in our portfolio. Previously, we had a bifurcated designation system in place, which meant that an asset was either considered prime or non-prime. We put more quantitative measures in place to rank our assets.
We’ve toured every asset and have underwritten the entire portfolio to better understand both the risks and opportunities that exist to ensure we are making the proper capital allocation decisions for long-term growth.
REBO: You were already familiar with the assets. What does this scoring process enable you to do that you couldn’t do before?
Tichar: It helps us forecast, understand potential risks and identify opportunities to maximize growth. For example, it may not be an issue today, but what are we going to do to maximize the value and take advantage of under-market rents, or tenants that are coming into a particular market or leaving that market? These are the things we are considering as we take a longer-term view of an asset.
We look at the asset itself in terms of its performance and its cash-flow growth. We also look at the market and where the asset is located within that market and how market-dominant it is, tenant sales performance, employment growth, etc. Then we look at the return potential from a capital allocation perspective, and where we can create value at the asset level. So, it’s a lot of different factors that play into the asset review process.
REBO: Why did DDR opt to set up shop here at the Bellagio at RECon 2014 versus the Las Vegas Convention Center, where the International Council of Shopping Centers is hosting the convention? What was the impetus for the change?
Tichar: We’ve had great support from our clients, our retailers, our partners and our investors with this decision. There were a lot of reasons, one of which was economic most importantly. There are significant cost savings to being here, and that influenced our decision. And because we have had great support from retailers, that has made the decision easy.
REBO: What’s the main point you want to impress upon our readers about DDR?
Tichar: To the extent that you can help readers understand why power centers are different than grocery-anchored centers, different than malls and different than unanchored strip centers, that would be helpful. We’re still fighting that battle. We want our story to be well understood.
DDR’s stock price closed Thursday, June 5, at $17.80 per share, up from $16.93 a year ago.