Appraisal Matters

Marketability

An inline-only mall has very different marketability than an anchor-owned mall. Large mall owners and REITs have less interest in this type of investment vehicle and it does not fit into their acquisition strategies. National mall owners do not consider this type of investment, generally limiting the market to local only. Most of the market is gone.

There are typically two groups of potential owners for an inline-only mall. One type is the “liquidator”, the group that will buy the space for a rock-bottom price. The other is a local investment group. Since typically most of the space in a mall is part of anchor space, the acquisition price without anchors can be reduced to the level that a local investment group can afford.

The obvious problem from the above is the amount of time it takes to market inline-only mall. Typically, it is two to four times longer than a typical regional mall, if a new owner can be found at all. The price may also be negatively impacted because market value will be less for limited-market properties. It’s simple supply and demand.

Another trend that impacts on the marketability of an inline-only mall is market tier and age of the mall. This trend has occurred primarily in second or third tier malls that are older, often referred to as “local malls’ by area residents. As a second or third tier mall, it typically has fewer national tenants, may have food courts that have some degree of functional obsolescence and it may need an interior and/or exterior renovation. The financial feasibility of renovation given these tendencies and the potential for sold anchors to not renovate their exteriors or parking areas can make interior and/or exterior renovation financially infeasible.

Making It Work

Given the potential disadvantages above, the inline-only mall can be profitable if structured in such a way that the mall owner has a moderate level of control over the anchors. Since anchors are currently in the better negotiation position, many have been able to structure deals that are clearly in their favor. In some cases, there is no reciprocal operating agreement in place after the sale and no agreement for them to contribute to the mall’s common area maintenance. They are usually not required to contribute into the mall’s common marketing fund; most anchors prefer to do their own marketing. In many cases, there is no agreement that limits the type of business the future owner/user of the store is in or any requirement for them to cooperate by renovating their space in the event the mall is renovated.

There are several ways these deals should be structured.

• Since the anchor contribution to common area maintenance typically makes up a substantial percentage of the reimbursable income to a mall owner, an agreement that provides the anchor to contribute their proportionate share should be arranged. This is typically done thru the reciprocal operating agreement.
• Deed restrictions – restrictions should be created that limit the future owner/user of the anchor space to those that are compatible with the mall and its desire to maintain mall traffic. Incompatible industries should be listed in the restriction.
• Reversion clauses – if the mall anchor does not want to renovate their space when the inline-only portion will be undergoing its renovation, a clause in the deed restriction requiring them to do so can be a valuable way to elicit their cooperation.
• Right of first refusal – the owner of the mall should maintain the first right to purchase a property back at market from the anchor.

If the above are not acceptable to the anchor owner, there are two other forms of ownership that may be acceptable. Putting the entire mall under condominium or cooperative ownership may solve these problems. The mall anchors would then be required to contribute to a common fund that could include a reserve for parking lot resurfacing, building exterior renovation, marketing fund and CAM. All anchors sold in this way would still have a vested interest in the mall and the mall owner would still retain the degree of control stipulated in the condominium or cooperative documents. For malls that have already sold anchors, however, this form of ownership would require the cooperation of every anchor, which is not likely.

Valuing the Inline-Only Mall

It is unlikely that an appraiser will be able to value the inline-only mall with any approach to value other than the income capitalization approach. The cost approach suffers from the fact that individual sold anchors would not have been constructed save for the fact that the inline space exists. Another problem is land size and parking. If most or all of the parking is owned by the anchors, the inline-only mall would not have enough land size and parking to meet the necessary parking requirements and may have a higher floor to area ratio than zoning allows. This would make the assignment hypothetical in nature and warrant a major assumption that variances would be granted. Perhaps most importantly, market participants do not consider the cost approach to determining value given that these properties already have income streams that are the basis for determining value.

The sales comparison approach can rarely be used due to the simple lack of comparable sales. In relation to the number of malls in the country, this investment vehicle is still rare. If the property is a partial inline-only mall (i.e. not all anchors were sold), in the unlikely event that sufficient data were available, adjustments for partial anchor ownership are highly subjective. Since inline-only malls tend to be second or third tier, the lack of interest by REITs, a primary owner of malls, further constrains the market and the number of potential comparable sales.

The income approach is the most applicable, market supported, and reliable approach to value an inline-only mall. If the mall is stabilized, direct capitalization can be used, although the lack of comparable sales will not provide a market derive capitalization rate for the appraiser to rely on, necessitating judgment. If the mall is not stabilized due to a decrease in occupancy, a decline in the number of national tenants, the need for renovation, the effect of newer first tier malls, etc., a discounted cash flow will be especially relevant and important.

Income and expense projections used in the discounted cash flow will be based on historical trends and the appraiser’s perception of how the mall will fare given its condition, competition, etc. No adjustments for the inline-only ownership status need to be made to these projections. The discount rate and terminal capitalization rate is where the inline-only mall differs from traditional rental-only malls. As discussed earlier, there are elements of risk from this type of ownership structure that results in premiums in both the discount and terminal capitalization rate. In addition, the decreased marketability of the inline-only mall is often due to not being the type of investment REITs and other large mall investors prefer. They favor results in longer marketing times and an additional premium to the terminal capitalization rate. Regrettably, there will be no analog in the market for measuring these items, so comparison to secondary market sources will be necessary with premiums to reflect the above.

Another area of risk that the appraiser should consider is the ability of the mall owner to pass on future changes in common area maintenance charges and the inability of the owner to obtain sales percentage revenue into the future. Having sold the anchor space results in a weakened negotiation position and if the terms of the sale are structured incorrectly, the inline-only mall owner bares the burden of the increasing costs but may not increases in percentage sales revenue from improved market conditions and increased sales volumes. The result can be an above-market operating expense ratio toward the latter years of the discount cash flow projection period and a lower terminal sale price as a result.

Conclusion

The inline-only mall is a riskier investment vehicle than a typical mall. They are very difficult to reposition and the degree of control the mall owner has over the next owner/user is typically limited. Their market values are negatively impacted because the least risk components have been sold off and if one or more anchors go dark, inline occupancy in those wings suffers.

As the mall ages, it may need a facelift or a full renovation, but without any control over the anchors, it is not typically financially feasible to do so. The future resale market is greatly constrained and therefore it typically takes much longer to sell them. Although selling the anchors results in a cash influx in the short-term, the long-term position of the mall may be compromised. It all depends on how the sale of the anchors is structured.

John Simpson, MAI