COVER STORY, OCTOBER 2009

CHICAGO HOLDS UP IN TOUGH MARKET
Retailers, developers give a snapshot of activity in the city, while looking at nationwide trends.
Roundtable moderated by Jerrold France and Randall Shearin

Heartland Real Estate Business recently held a Chicago Retail Roundtable, hosted by law firm Levenfeld Pearlstein LLC, at its offices on LaSalle Street. Despite a lackluster year for retail, turnout at the roundtable was robust and the discussion was again lively, offering a snapshot of activity within the market, as well as a view of general industry trends. In attendance this year were: Adam Secher, Baum Realty Group; Peter Eisenberg, Clark Street Development; Peter Caruso, Intercontinental Real Estate & Development; Lew Kornberg, Jones Lang LaSalle; Marlon Stone, Katz & Associates; Richard Kahan, KB Real Estate; Marc Joseph, Brian Kozminski and Keith Ross, Levenfeld Pearlstein; Terry McCollom, McCollom Realty Ltd.; Ben Wineman, Mid-America Asset Management; Jim Schutter, Newmark Knight Frank; Robert Rowe, Sierra Realty Advisors; Marc Siegel, SJS Realty Services; Ryan Murphy, SRS Real Estate Partners; Tim Thanasouras, Thanasouras Commercial Properties; Aaron Gadiel and Jonathan Payne, The Jaffe Companies; James Turner, The PrivateBank; Sy Taxman, The Taxman Corporation; Richard Dube, Tri-Land Properties; Glen Todd, U.S. Cellular; Camille Julmy, U.S. Equities; and John May, May Center Advisors.

HREB: How are retailers viewing the Chicago market as a whole?

Murphy: We are still busy. We have a pool of tenants that are active. The large box tenants — JC Penney, Lowe’s Home Improvement Warehouse and the like — have slowed down. They are still looking but they are not as active as they were. Discount Tire, Famous Dave’s and Tilted Kilt are expanding. We are looking in multiple markets for them. Verizon is looking at some deals, as is Genghis Grill.

Stone: The economic reset has influenced site selection from the standpoint of asset class, gross occupancy, and opportunity. There is no new development. Therefore, the older shopping center once bypassed has become relevant again. At the same time, our long overbuilt industry is now feeling the impact of fewer retail concepts to absorb a substantial inventory of space, and as a result, the supply-demand curve has shifted, and rents have compressed. Having a tenant who can take existing space is driving the business today. A retailer may very well secure a rare first tier location where high occupancy had prevented them in the past.

HREB: How is Chicago faring versus other national markets? Is it doing better or worse?

Kornberg: Historically, Chicago has fared better, and it continues to do so during these times. Chicago is healthier than most of the markets I’ve been to.

Left to right, Lew Kornberg, John May, Marlow Stone and Peter Eisenberg share ideas and strategies at the Chicago Retail Roundtable in Chicago.

Stone: I’ve always described Chicago as the ‘anchor’ of the Midwest. We have an MSA approaching 10 million with significant growth projected. The economy remains diverse with employment generators that keep the city and suburban areas vibrant. The retailer understands the purchasing power of this marketplace and while store openings may be limited temporarily, Chicago will always be on the radar for those companies seeking market share within the midwestern United States.

HREB: Are tenants looking more at urban areas?

Stone: There has been more focus on the urban trade areas throughout the country — and in Chicago — versus the greenfield, high growth suburban areas. Most of the greenfield areas were built and sold to retail companies on high growth. That growth has been curtailed. You don’t get a full bang for your buck in those areas. The areas that have sustained themselves over the years have density.

HREB: We’ve heard that a lot of retailers who are getting relief are causing their co-tenants — who are doing well — to ask for relief. Some think that because one gets it, everyone is entitled to it. Have you found that true?

Taxman: Unless a tenant has been with us a number of years and unless they can provide us financials, they won’t get it. On the other hand, if we are dealing with a local tenant that has been with us for a number of years, rent relief is granted almost automatically. We talk about this in theory. The problem is that those of us who actually own these properties know that these leases have been assigned as additional collateral to the lenders. Modifications of leases are not just a matter of calling your landlord. This is a process. There are many situations where the mortgages have been sold and you have no one to talk to about lease modification. Even though you may want to grant a modification to the tenant, technically, you’d be under default in your mortgage. As a general rule, we as a company will provide relief for local tenants if we know the tenants, if they’ve been with us for a number of years, if they are not in default, and if they come to us before they are in significant trouble. If they default on their lease, don’t pay their rent and then want modifications, we won’t even talk about it. Our occupancy rate in the properties we own, is just under 94 percent. That requires a lot of hands on work.

HREB: On the legal side, are you seeing issues like this from your clients?

Joseph: We are not seeing as much leasing work. We are seeing some restructuring work, and some times we see some concessions in leases while we are restructuring the rents. Landlords are bending a little bit right now, but they also want to get something out of it. They want to help their stability and extend the lease terms to get something in return.

HREB: Are you seeing activity in the Chicago area improve?

Schutter: From October to May was probably the deadest I’ve seen in my 20 years in the business. In the last 4 or 5 months, we’ve seen activity and we’re getting leases done. We’re sitting on 10 letters of intent that we’re negotiating right now. The activity is very much discount oriented. Location-location-location is still the bottom line.

Secher: In some of the outlying secondary and tertiary markets, there is certainly a lot of inventory. In some of the prime urban markets, whether that’s downtown Chicago or some of the regional markets like Old Orchard, Naperville and Schaumburg, there is still demand for space. Some of the deals that we are seeing are placeholders. We are not seeing any big, long term leases at market rates. We are seeing tenants take advantage of market conditions or signing short term leases with options so they can get in the market and test the waters. Landlords would rather have someone occupying the space, even if it is at a discounted rent.

HREB: Are there areas of the city where retailers are taking advantage of the lower rent rates and higher vacancy? Maybe somewhere that they wouldn’t have been able to go 3 years ago, but now they can afford to look?

Eisenberg: Aldi is going crazy right now. Landlords who would not have considered Aldi are looking hard. Aldi has strong credit as well. Needs based retailers are doing well. Jewel has also opened some new stores, like at 119th and Marshfield, and it is redeveloping a store near Southport and Addison.

Kahan: The stores who are expanding are being very selective. The locals, surprisingly enough, are strong; they have a lot of cash. There are a lot of independent grocers expanding. If you have a business that is not reliant on a bank, you can expand. Landlords are financing some retailers. It is a result of the economy. We are digging deeper into our pockets and we’re doing things we wouldn’t normally do. It is a reality we are going to have to deal with for a year or two. Expansion is going to be a joint venture between the retailer and developer.

HREB: Do local tenants have the financial staying power?

Gadiel: We will see. There are a lot of good local tenants that can operate a business as well, if not better, than some national tenants. They may not have the same credit rating. Right now, you have to think out of the box. You have to take a risk. We do our due diligence and we look at how long they’ve been in business and what their management is and who is behind them. We have a strong group of local tenants.

HREB: Rob [Rowe], you are working with one of the biggest needs-based retailers who is making a push into Chicago.

Rowe: CVS is making a push here. CVS is trying to make deals. They scrutinize things a lot. They are one of the best credit tenants out there who’s making deals now. They are trying to buy more rather than do ground leases, as they did in the past. That change was driven by the change in the net-lease sales market. To keep the coffers filled, they would rather make purchases today. The main targets are urban areas — the dense areas where the people are. We have a site in Bucktown we never would have gotten before. There would have been five banks going for these corners before. They are out of the market. We are doing deals in the sticks, and we are land banking because we’re buying at a discount. Another client who is very active is Export Fitness. They have a new model they call their Express model. This is 10,000 to 12,000 square feet. We’re going into some of the areas where the population isn’t enough to do a 45,000-square-foot club. The payback is quick because they don’t have to put as much money and the landlord contributes. The biggest challenge I have today is co-tenancy. Some retailers are restricting health clubs.

Kahan: Using the health club as an example, there are very few businesses that are bringing the same customer back to the same location two to five times a week. They are also active early morning to late at night.

HREB: As a retailer, how do you see the economic climate in general?

Todd: Perception is a huge thing right now. I have a lot more people touching our deals. The perception is that we are going to get rent reductions on every new and renewal deal we make right now. I have someone a few levels above me measuring my ability to make lower rent deals today than I made a few years ago. That’s part of our approval process. You’ll see deals are getting slower because everyone is being more cautious about the decisions that we’re making. I am doing renewals where I can’t get a rent reduction, but instead of taking a 5-year option I will take 3 years.

HREB: John [May], how are buyers looking at the retailers in the properties that you are selling?

May: Buyers are looking at [retailers’] credit, but they are also looking at rent levels. Whether it is a small center or large center, it doesn’t matter. The people at this table that did such a good job negotiating those $35 to $50 per square foot small shop rents; the investors are marking those down, even if the tenant is in there doing well. If you look at the junior box anchors, those rents were approaching $18 per square foot a few years ago. The most recent deals are being done in the single digits with big landlord contributions. As investors look at these assets, they are not accepting the rent roll as something they can count on for the next 10 years. The second item they are looking at is the capital stack. The retailers drive the financial side, but now we are going to see the financial side drive the retail side. Grocery-anchored centers were trading at low 6 cap rates 3 years ago. Now, they are at 10 cap rates. We just did the largest transaction in the Midwest, and we were right at 10. This was a 6-cap asset in years past. Also, the financing world has changed. You can’t get 80 percent interest-only financing or non-recourse financing unless you are coming with a very high equity stake.

HREB: James [Turner], what are the equity requirements today?

Turner: I’m hearing a lot of things that are affecting the rates. If you want me to be at an 80 percent LTV [loan-to-value] ratio, I’m fine: let me trend down your pro-forma rents by 30 percent per year and then apply a 10 cap. You’ll get 80 percent on that value.

Taxman: You have to have cash. If you want to be in this business going forward as a ground-up developer ,you better have cash. When you talk about a 70 percent loan, 30 percent of the project costs are being contributed by the developer as cash, not as attributed value. What’s happening in the financial world may be a benefit to all of us. We have to eat up a significant amount of excess inventory that’s out there. In order to do that, we need to have less development going forward. The concept of having to be in business with cash is not unique.

These rules are not new. We need to get some stability back into the market. I don’t think we will see a recovery in retail until we see a significant recovery in employment. We also need to get the banks on board. The last time I went to see the doctor for a physical, I didn’t have to hear about his problems. I thought the doctor was concerned about my problems. I don’t want to hear the bank’s problems when I go in for help.

Payne: We keep using the term ‘think outside the box’. What we are really saying is that we were so far from the fundamentals of retail that today, thinking outside the box is returning to the fundamentals of retail. Ultimately, we are going to return there because, at the end of the day, to get the financing I will have to require retailers to sign a permanent lease, not something with a 1-year kickout or at 30 percent below market rate. What we are seeing is a return to the fundamentals of retail. That is exactly what the Export Fitness Express concept is — driving traffic and generating sales. We build shopping centers: what else is more fundamental to a center than having traffic and generating sales?

HREB: We have seen a lot of alternate uses pop up that have really been good traffic drivers to centers.

Gadiel: We lost a Circuit City, and we put in a gymnastics academy. It has been the biggest success at The Arboretum, hands down. It generates so much traffic.

McCollom: We always put cash into our deals. If you don’t have your sweat and blood in the deal, what are you doing? It is that simple, in my opinion. I am doing some due diligence for a bank right now. I am examining a group of dollar stores for them. The properties are in horrible condition. If you don’t have a landlord taking care of these properties, what is the broker and the retailer getting themselves into? Brokers have to make sure they are talking to good landlords. We are a small company. It is interesting how we have survived with the big guys [as competitors]. We have always kept to the basics and we’re still sitting here. I am the president of the Chicago Association of Shopping Center Owners (CASCO). We have 35 members, all owners of centers in the Chicago area. We’ve only lost one member recently, and we’ve added two new members. That says something about where our industry is.

Dube: I want to compliment James [Turner]. He is the only banker here. We have taken advantage of the tax increment financing programs available in the different areas where we are active. With regard to CMBS and the financing system, you must have some insight on how much capacity is in the system?

Turner: The banks have been spending the past 10 years figuring out how not to use the balance sheet [to lend]. That led to the creation of the CMBS market and collateralized debt obligations. The banks didn’t do long-term mortgages; all of that paper was being pushed off. Now, to change the mentality of the banking system to utilize the balance sheet heavily in this economic environment — I don’t think it’s going to happen. The banks will not be there to replace the CMBS markets when those maturities come.

Julmy: That’s the perfect storm.

Turner: There has to be some answer created for the CMBS program, and it will come out of people in this room. There are smart individuals who still understand that there are values in these properties.

HREB: As a bank, what do you see in the future?

Turner: The big question is: When are people going to start shopping again? When retailers can expand again and can pay a market rate that makes sense and pays for the land, construction and gives a fair return to the owner. Once that all happens, banks will be right back in there. Until it happens, we are shooting in the dark.

Julmy: The capital system, as we knew it, died about a year ago. Who would have done a project with 30 to 50 percent of equity then? Now, we have an added problem of the rents going down, or the perception that rents will go down. We received our loan for MetraMarket on August 27, 2008, and, frankly speaking, if we had waited 2 weeks, we would have said, forget it. We would not have put 50 percent equity in that deal. It’s not a large project. It’s 100,000 square feet that makes sense.

Schutter: It is a difficult environment. If you work hard, there are opportunities. It is about positioning yourself to take advantage of the opportunities. We are finding what is unique about every project and capitalizing on that unique opportunity.

HREB: How is Michigan Avenue faring in this economic climate?

Julmy: Michigan Avenue is still one of the great avenues of the world. It is going through a tough time. The sales are down anywhere from 10 to 30 percent or more. The retailers aren’t happy, but the avenue is crowded. People are not spending. Hopefully that will change when employment picks up. The occupancy is still high.

HREB: Tim [Thanasouras], you’ve started a new company during this time. How have you weathered the storm?

Thanasouras: I looked at the facts and the fundamentals of our business. The industry has been operating with a dual income [household] economy for a long time. For a lot of families, the primary income is gone. When I meet with my clients, I tell them the fundamental thing we must do is keep the lights on in the stores. Having dark tenants doesn’t help the tenants next to them. A full center is better than a vacant center. This economy will also wash out a lot of competitors. I went to a party a few years ago and someone asked me what I did. I told them I was in commercial real estate. The attorney that I was talking to also mentioned he owned some shopping centers. A restaurateur also said he owned some buildings. I think now people like that have been burned and they don’t want to be in the industry anymore. Those were the people who went to the bank for cheap money without knowing the fundamentals of the industry. They will be gone sooner or later.

Taxman: We also need the washout to happen in the product. After the Savings and Loan crisis, we had the creation of the Resolution Trust Corporation, a clearinghouse for excess properties. We are going to need that again.

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