Reprinted by permission from REIT WRAP Special Report dated October 20, 2010. Editor's Note: David explains that with respect to the design and retailing elements, Macerich (MAC) did a spectacular job rennovating Santa Monica Place. For investors, however, he concludes, the all-in results will likely be less than spectacular.
by David Shulman
Santa Monica Place is a 524,000 square foot regional mall anchored by Nordstrom and Bloomingdale’s. it is located four blocks from the beach in the heart of downtown Santa Monica.
What is striking about the renovation completed in August of this year is that it represents the conversion of a 1970s fortress mall into an open mall fully integrated into the thriving street scene of the very popular 3rd Street Promenade thereby creating a four block long urban retail environment.
Aside from being open, Santa Monica Place differs from suburban malls in that it sits on a very compact 9.9 acre site and instead of having six parking spaces per one thousand square feet it only has four spaces per one thousand square feet.
The 2000 space parking structures are owned by the city and are included in the 9.9 acre site. Given the tight urban environment, it makes for difficult traffic and parking during peak times. This situation is partially mitigated by nearby city parking for the 3rd Street Promenade.
Because the site is so close to the ocean, about half of the trade area is in the water. The other half of the trade area consists of some of the priciest real estate in America.
My own history with the project goes back to the public hearing held by the Santa Monica Redevelopment Agency in 1974. Two competing designs were presented at the hearing: one by The Rouse Company and the other by The Hahn Company. Both firms CEO’s, Jim Rouse and Ernie Hahn, appeared at the hearing.
The project was initially envisioned to be much larger, five more acres, and it included another whole block to the west where hotel, office and residential uses were contemplated.
The Rouse Company, breaking Hahn’s near monopoly on California mall redevelopment projects, won the competition with a Frank Gehry design for the full mixed-use project. Nevertheless, after the project was scaled down to its current size, Rouse brought in Hahn for their construction expertise and made them a 50% joint venture partner.
That was before Frank Gehry became the world famous architect that he now is today. Gehry was not happy how the project turned out. For example in Barbara Isenberg’s, “Conversations with Frank Gehry,” (2009) Gehry said “… we designed it as a mixed-use project, not just a dumb shopping center. Then for reasons beyond my control, the city wouldn’t support it, and so it ended up being just a shopping center.” In Joshua Olsen’s “Better Places Better Lives: A Biography of James Rouse,” (2003) Gehry was more succinct, “It’s not something I go show people.”
What was my role in this saga? In 1974, I was a graduate student at UCLA. I was also a community activist in Santa Monica. The city attorney called us a bunch of long-haired – I wish I still had the hair and my politics have moved to the right -- hippies who dressed up in suits to impress various regulatory bodies.
I was a leader in the opposition to the mall, first before the City, then before the California Coastal Commission and we were allied with a parallel law suit brought on behalf of clients of the Legal Aid Society of Los Angeles. We were opposed to the project on the following grounds:
1. We fundamentally disagreed with the notion that government could take property from a private owner and then turn it over to another private owner. A precursor to the famous Supreme Court case, Kelo v. New London.
2. We argued that the property in question was not blighted. (The city’s newspaper was located in the redevelopment area) and therefore the redevelopment was not lawful.
3. We believed that the $15 million of tax increment bonds issued by the redevelopment agency was a flat out subsidy to the development that expropriated tax dollars that rightfully belonged to the school district and the county. If Santa Monica wanted a shopping center, the private sector should build it. I was quoted in the local newspaper saying, “I don’t believe in subsidizing department stores.”
4. We believed that the mall project was part in parcel with the city’s other redevelopment project in Ocean Park which was designed to remove lower income people from the city. In a word, “gentrification.”
5. Finally, if a mall were to be built, it should be open. Why have an enclosed mall in the most temperate climate in the U.S.? Our design ideas included a “parasol” roof which Gehry was sympathetic to.
We lost and the original mall opened in 1980 at a cost of about $60 million for Rouse/Hahn and $15 million for the taxpayer. The Coastal Commission did require a small open air viewing deck as a condition for a permit and the law suit required the city to come up with about one million dollars for a grab bag of public benefits to fund housing and park projects. That piece was funded by Rouse/Hahn.
Ultimately Rouse bought out Hahn’s 50% interest and then sold the entire project to Macerich in 1999 for $132 million. Analysts at the time estimated the deal was done at a 9% cap rate and to keep the arithmetic simple I am assuming the initial NOI to be $12 million. Just as an aside, in 2000 as Lehman Brothers REIT analyst I conducted a Los Angeles property in 2000 and we toured both Santa Monica Place and the adjoining Promenade. The highlight of that property tour was a cameo appearance of super-model Cindy Crawford.
Macerich knew that Santa Monica Place has issues when it bought it. It was an obsolete fortress mall with middle market stores in a high income area. Meanwhile right next to it was the edgy and newly revitalized 3rd Street Promenade attracting hoards of locals and tourists.
Though the mall was generating about $400 a square foot in sales for its occupied space, its days were numbered. It is likely that the mall’s peak NOI occurred in the first year Macerich bought it.
Now let’s look at the development economics. Macerich stated that it expects Santa Monica Place to generate initial sales of about $800/square foot soon rising to $1,000/square foot - making it a Super-A mall. Net rents are in the $70-$100/square foot range and common area maintenance charges are anticipated to be $27/square foot. MAC is telling investors that it expects to generate a stabilized return of 9- plus percent on its incremental investment of $265 million, or about $25 million a year. Within a few years MAC expects to be generating $27 million a year. A more than successful outcome for a mall headed for the graveyard.
In order to achieve those targets, MAC assumes that it will achieve its leasing targets for the 50,000 square feet on the mall’s third level encompassing the former third floor of the Bloomingdale’s space. Trust me; this represents a leasing challenge because the mall’s third level is devoted to high-end restaurants, a farmer’s market-type retail operation called “The Market” and public open space. If this space were easy to lease, it would have been leased already.
Further, if we start with the original purchase price of $132 million and an initial NOI of $12 million, the returns don’t look so great. All-in MAC now has about $400 million in the project, including some capital expenditures made for the old mall. An initial return of $25 million on that equates to 6.25% and the incremental return on the renovation costs amounts to a low 4.9%. ($25million-$12 million)/$265 million)
If significant value, from the stand point of the 1999 acquisition, is to be created Santa Monica Place would have to be valued a cap rate well south of 6%. This comment should be viewed as a criticism, but it just goes to show how capital intensive the mall business is.
I would be remiss not to point out that MAC will receive a very important intangible benefit from the renovation; it will have a show case asset just a few blocks south of its corporate headquarters.
As for me personally, I feel vindicated that my efforts of over thirty years ago have finally born fruit. A very successful open mall was built and the renovation was accomplished without the contribution of public money.
David Shulman was formerly the Senior REIT Analyst at Lehman Brothers. He is now affiliated with Baruch College, the University of Wisconsin and the UCLA Anderson Forecast. He can be contacted at:firstname.lastname@example.org