Simon Says: Bring It On. I Think He's Wrong

| About: Simon Property (SPG)

Clearly the big bad mall REITs are getting somewhat more aggressive with development plans of late. As I wrote a few weeks ago in A Bargain In Chesterfield: Two Outlet Centers For The Demand Of One, Simon Property Group (NYSE:SPG) and Taubman Centers (NYSE:TCO) have said publicly that they plan to build competing outlet centers in the town of Chesterfield, MO is a second-ring western suburb of St. Louis. As I wrote:

If both projects get built, I suppose consumers in Chesterfield will have plenty of options for finding a bargain. I'm just not sure how investors will benefit from owning real estate in a market that appears to be soon over-supplied with an abundance of outlet space. I guess the best location wins and maybe we can learn from Walt Disney when he said "the difference in winning and losing is most often, not quitting.

During an earnings call last week, Taubman's CEO, Bobby Taubman, explained his company's strategy relating to Taubman Prestige Outlets Chesterfield, a 450,000-sq.-ft. center project proceeding ahead of schedule:

Well, obviously, if two projects are built that's going to fragment the market, it will reduce sales productivity, which would modestly impact the returns. But the returns would still be attractive. St. Louis is a terrific market; it's the 18th largest market, as I said, in the country. When you look at the top 40 markets and you look at the key tenants, it's the only market in the top 40 with most of the key tenants where they all have at least one, if not two, if not three, outlet centers. So this is a terrific market. Our project is moving forward very quickly.

As we said, we accelerated our date to August the 2nd, the walls are going up. I encourage you all to check out the website. I encourage you to go see it, that's even better, because it's sitting there for over half a mile on the freeway. It really is an amazing, amazing site. But if competition activities do move forward, then there is risk to our returns.

In a response to possible over-building (in the outlet sector), Simon's CEO, David Simon, offered the following response (from an analyst on the company's third quarter conference call):

Well, look, I can only answer from our perspective. We will not make any outlet mistakes, okay? The reason we won't is because we're the leader in the business. We have 70 Premium Outlets in the world. We have the best franchise in this business and I just know that we won't make a mistake. So I can't say the same thing for others. That's not my job to worry about what others do.

Undoubtedly, there will be development mistakes made. They've been made in the lifestyle business, in the power center business, in the mall business; but they won't be made by us. And I have said this for the last year or 2, I do not think there will be as much built as people think. There's been a list of 50 potential deals that have been kicked around, and there are still going to be 3 or 4 of these things built a year, maybe, and not as much as you think. But I'm not -- it's not my responsibility to opine for others. They'll make mistakes; we won't. And we are not going to -- you can lease something, too, if you give away the building. We're not going to do that either just to get something built.

More Bargains for the Queen City

Simon's outlet business and its expansion into the southern U.S. occupied a large part of the unscripted air time on the company's Oct. 25 third-quarter earnings call. For Charlotte, N.C., where the company is looking to develop a new center, Chairman and CEO David Simon predicted a similarly tight competition scenario, involving a small number of very experienced outlet developers: Paragon Outlet Partners and Tanger Factory Outlet Centers (NYSE:SKT), which is also planning its own Charlotte outlet center, in addition to Simon Property itself. As Simon said,

At the end of the day, it will be a competition of who gets the retailers. And the experience will ultimately dictate that somebody will get the project, and somebody won't, and there will be one built.

Simon downplayed potential negative effects of the new development on its Concord Mills property:

I don't think, given where the locations of both are, …it's going to have an impact on Concord Mills at all. If it does, it will have a marginal one.

The first several analyst questions addressed the company's outlet business and the prospect of competition in other emerging outlet markets in the U.S. To the competition, Simon said, in effect, "Bring it on." Simon went on to say:

There's potential for a couple more of these situations to arise. … If we didn't think we could lease and produce quality projects, we would not do it. We have all the confidence of our track record and our team to continue to produce the results the market - and more importantly what I - have grown accustomed to. And if there are one or two of these things that might pop up, so be it. That's the nature of real estate development for 60 years.

At another analyst's prompting, president and COO Richard Sokolov offered some finer detail on tenant demand in the company's various segments:

Tenant demand is pretty much across the platforms. We're seeing very good demand in the malls, in the mills, in the premium outlets. Premium outlets, you're having a number of retailers that have traditionally not been in that sector, wanting to get involved in that sector in a pretty large way. We've got some tenants coming over internationally that are getting more aggressive with their U.S. presence.

My Take on the Big Bad Wolf

A few years ago I had a site under contract to build a large grocery anchored shopping center. The site my partner and I had under control was an A+ site on the corner of "main and main". However, the cost of the land was high and we had to relocate a school and pay for considerable grading and demolition costs.

Another much larger developer owned a site nearby. The site was less desirable since it had limited frontage; however, the land cost and site preparation costs were much less than the site we had under control.

After months of negotiating and renegotiating a lease with our anchor tenant, I was shocked to find out that the competing developer had made an offer (to lease) from the same tenant at an absurd low rate and one that we could not compete with. The tenant informed me that we had to accept the low rent or the hard-nosed tenant was going to proceed with the less desirable site.

After I went home to ponder my next move, I went back for the ninth inning of negotiations and I told the tenant that we could meet in the middle, and that meant a considerable reduction in our proforma rent. The tenant accepted the offer but our final return was reduced by around 25 percent.

The moral to the story is that "the best site usually wins" and the one who has the gold is not the developer, but the tenant.

Simon can certainly flex its muscle when it comes to competing with other REITs; however, as an investor, I would be much more comfortable owning shares in Taubman Centers or Tanger. It is interesting to note that Taubman is celebrating its 20-year anniversary as a REIT in November and the stalwart REIT has NEVER cut a dividend in its history as a REIT. Conversely, Tanger has NEVER cut a dividend and, in fact, the company has ALWAYS increased its dividend for the 19 years it has been a public company.

Warren Buffet said it best when he said,

If we can't find things within our circle of competence, we don't expand the circle. We'll wait.

Buffett took the idea of the Circle of Competence directly from Benjamin Graham who was Buffett's mentor and finance professor while Buffett was a student at Columbia University. Graham always talked about doing what only what you know. If you are good at something, that's what you do, that's what you become the expert at.

I have made my share of mistakes in development and, at the end of the day, my failures have often been the result of losing focus and not concentrating on my core of competence. Maybe investors can learn from these mistakes and maybe Simon can learn from one of my often used mantras. That is, the big bad wolf does not always win and often,

The Raised Nail Gets Hammered

See recent Articles on Tanger (here) and Taubman (here)

Source: SNL Financial

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.