Outlet Centers Key Growth Area for Developers

By KRIS HUDSON - THE WALL STREET JOURNAL

Mall developers, desperate for growth, are rushing downscale to build outlet centers that hawk brand-name clothes at discount prices.

"Clearly, when it comes to retail real-estate development, the only thing that seems to be getting done for the next few years is outlets," said Gary Skoien, chief executive of closely held outlet developer Horizon Group Properties.

In October, Horizon landed mall giant CBL & Associates Properties Inc. as the majority partner in an outlet center planned in Oklahoma City. The Horizon project is the first outlet center for CBL, which owns 84 regular malls.

Taubman Centers Inc., owner of 26 upscale malls in the U.S., plans to build its first outlet center next year after it converted its Great Lakes Crossing mall near Detroit and Dolphin Mall in Miami to outlet centers this year.

Construction of traditional malls that sell full-price merchandise has come to a standstill in recent years due to market saturation, scarce capital, weak housing growth and curtailed consumer spending. Outlets, meanwhile, have grown popular with shoppers hunting for discounted designer goods and retailers wanting to reach those shoppers. For what they might lack in glamor, they make up elsewhere for their owners— namely larger rent increases, lower operating costs and stronger leasing activity than traditional enclosed malls.

The rush into the outlet market raises some concerns. Overbuilding isn't as dire a threat for shopping centers as for other property types, because lenders typically won't finance construction until half or more of a project's planned space is committed in leases. But even slight increases in the ranks of outlet centers stand to erode the format's appeal, since that appeal is based partly on scarcity.

 There re roughly 214 outlet centers in the U.S. with another 40 on the drawing board, according to the International Council of Shopping Centers, a trade group. In comparison, there are an estimated 1,400 malls, but only a handful under development, according to real-estate data company CoStar Inc.

Outlet centers are likely to play a big role this holiday season. Based on a survey of 9,234 shoppers last December, the National Retail Federation calculated that 14% of U.S. shoppers last year planned to finish their holiday gift buying at outlet centers.

Some companies are focused solely on overhauling struggling malls as outlet centers. Poag & McEwen Lifestyle Centers LLC is converting its 680,000-square-foot Promenade Shops at Orchard Valley in Manteca, Calif., to an outlet center after plans to make it a fashion mall fizzled.

In Paramus, N.J., Vornado Realty Trust converted the former Bergen Mall from 2006 to 2009 into an outlet mall with tenants including Nordstrom Rack, a Gap Inc. outlet and a Bloomingdale's Inc. outlet. The Vornado executive who oversaw that conversion, Sandeep Mathrani, could find similar opportunities after he takes over in January as CEO of General Growth Properties Inc., owner of 185 U.S. malls.

"The outlet business has proven itself to be a sustainable business model with excellent cash flows," said Bobby Taubman, CEO of Taubman Centers. "It is a natural extension of a mall company's capabilities."

Even the companies that dominate the outlet-center market don't object to the well-heeled new arrivals. Tanger Factory Outlet Centers Inc. operates 33 outlet centers in the U.S., and Simon Property Group Inc. operates 73. "If you have to compete, it's better to compete against smart, rational people who aren't going to do foolish things," Tanger President and CEO Steven Tanger said. Taubman and CBL, he says, "will build a quality product with quality tenants that will elevate outlets in the consumer's mind."

Outlet centers originated in the 1970s as shopping centers where manufacturers and clothing brands could unload at steep discounts their excess and flawed inventory. Initially, the centers were built along highways far outside of cities because mall retailers didn't want their suppliers selling the same merchandise at a discount too near the mall.

As outlets evolved in the 1980s and 1990s, mall retailers like Gap began opening their own stores in outlet centers, dropping their insistence that the centers remain far outside of town. Meanwhile, outlet centers shifted from focusing solely on excess merchandise to also offering brand-name fare produced specifically to be sold at outlets.

The format became a hit with shoppers, but it remains a "complementary" format that never will rival the size and reach of the mall industry, developers say. Mostly, people shop at outlet centers while vacationing. They will spend more at an outlet center than at the mall but visit malls more often.

"They work great in tourist locations and on weekends," said David Zoba, senior vice president of real estate for Gap, which has 2,800 stores in total but doesn't divulge how many are in outlet centers. "They're not quite the success during the week as malls are."

For developers and landlords, outlet centers are cheaper to operate because most are open-air centers. A mall, in contrast, must cover costs of heating and cooling its massive corridors and center courts.

In addition, because of a relatively limited supply, outlet centers get bigger rent increases when renewing a lease or replacing a departing tenant with a new one. That's key because rent hikes are a critical source of income growth for retail landlords.

To wit, new leases signed at Tanger's outlet centers over the past year had rates 8% higher than the leases they replaced, said Steve Sakwa, an analyst with International Strategy & Investment in New York. In comparison, Simon, which owns more malls than it does outlet centers, registered a 2.5% increase.

Observers including CoStar senior real-estate strategist Chris Macke warn that some shoppers might forsake outlet centers in favor of full-price malls once the economy improves.

Others say that not all struggling malls being converted to outlet centers deserve the transition. "You're seeing some people who are trying to cure prior sins by converting to outlets, and we don't know if that's a recipe for success," Gap's Mr. Zoba said. Such projects "typically don't attract a critical mass of good outlet tenants."