DDR's David Oakes

The credit crunch and crash of the CMBS market has, to put it lightly, made it more difficult to get funding for project construction. In many cases, planned developments by smaller firms just aren’t getting built, and investors are cutting their losses. But some ambitious developers are contacting their well-capitalized peers to get help with project funding. Cleveland-based Developers Diversified Realty is often on the receiving end of those requests. David Oakes, the shopping-center REIT’s chief investment officer, says that though his company has often partnered on joint ventures with smaller outfits, the number of requests he has seen for those types of developments has “increased dramatically.” Oakes recently spoke with GlobeSt.com about this aspect of the industry and the general real estate market.

GlobeSt.com: Is there a most common scenario for when a private developer approaches you?

Oakes: They all end up being pretty unique, and even the way we source them ends up being unique. In some cases it’s developers we’ve known and worked with in the past. In other cases it’s people who have contacted us knowing that we have been involved in these sorts of deals in the past. In some cases, though, it’s retailers pointing to a site where they would like to have a store open, but they know the developer they started working with had tied up the land but doesn’t necessarily have the financing in place to be able to move forward with the project. For the right site, the tenant is very concerned about being able to open on the schedule on which they originally budgeted. In some cases we’re seeing banks come to us where they’ve made a land loan and now the local developer isn’t able to put together the same sort of construction financing that they were planning to take out that land loan.

From the sourcing of the deals, there’s nothing standard, but in general, the sort of deals we’ve had the most success with in the past are developments where there’s some sort of level of distress but deals that we would normally want to do. But a year or two ago, our capital was too expensive relative to the returns that some smaller private-company developers were willing to accept. So now it’s an opportunity for us to find transactions that would have been priced way too aggressively.

At this point, a number of these local developers need our help in some way. They’ve tied up one of the anchors, but they need help with some of the additional leasing. Or they’ve been unable to obtain financing despite a good amount of leasing they have done. That’s a situation where we think we can add a lot to the project in terms of our expertise in development. We definitely know we have close relationships to many of the largest tenants for open-air, larger format retailer centers. We also have banking relationships that are probably a little bigger than the average local developer that traditionally had one good bank that they knew they could generally rely on.

But at this point, if that’s a bank that made too many aggressive mortgage loans, they’re simply saying, “We’re not making loans right now, or not on the terms you were expecting, at least.” The goal is oftentimes not to find that extreme level of distress because many of these projects are distressed for a reason – there’s not retailer demand. That’s not a problem we can fix through a financial partnership. In other cases, they paid too much for the land. There’s nothing you can do with subordinated returns if the price they paid was off by too much.

We look at a huge volume of deals and say no to a very significant number of them. But we are still finding a decent number of situations where everything lines up. It’s a developer that we know and trust, either because we’ve worked with them in the past or because they have a reputation from other projects we’ve seen them do. Even for some of the very successful developers out there, our sort of projects, which generally have a cost of $50 million to $100 million, the equity required of $20 million to $40 million is pretty significant. Even the guys who have it don’t necessarily want to pledge everything they have as well as offering a recourse on their personal fortune to be able to move forward with those projects. The goal is not to work with truly distressed developers.

GlobeSt.com: Are there specific property types that have less risk than others?

Oakes: The core of Developers Diversified is large-format open-air community centers. That continues to be the most significant portion of the deals that we’re going to do. We are involved in all forms or retail, but I think the power centers and large center community centers represent the largest portion of our portfolio and in general represent the largest portion of transactions that we’re looking at. We’ve always tried to stick pretty close to what we’ve thought is the best business and what we knew the best. We’re reminded why that was so important because our typical centers that are anchored by the largest, best-credit-quality discount store still make a ton of sense in the current economic environment. Even if we do see a slowdown of the consumer, the value proposition offered by our largest tenants will fare well in that type of environment. That being said, we understand there is a business cycle, particularly for some of the more cyclical portions of retail real estate. Right now we’ve seen that the most in lifestyle centers, where 12 months to 24 months ago, there was no hotter retail asset out there. We’ve seen a huge change in that. The format still makes sense, but there probably didn’t need to be as many of those projects planned as there were 12 months ago.

GlobeSt.com: Is the best way for you to avoid high risk, going with the product you know the best, or are there other strategies you employ?

Oakes: Part of it is to do what we know the best in building the centers and also where we know the tenants the best because we have relationships and are the largest landlord to most of the tenants in our centers. You can reflect all of these risks in your underwriting and that ends up being very important to us. Financial discipline becomes incredibly important in an environment like this. It’s not the time to stretch and do something completely different than we’ve done in the past. We can still take on some risk, it just needs to be appropriately underwritten where we know we’re going to make appropriate returns.

GlobeSt.com: Have any of these partnerships helped you gain a relationship with a major tenant that you hadn’t had before?

Oakes: It’s less so on the tenant side. Given our size, with 740 centers, we’re going to know all of the big guys. But in terms of geography, we think there are huge advantages on a national scale that DDR has in a lot of ways. But there is truth to the fact that real estate is a local business, and some of these local entrepreneur know their local market, politicians and the entitlement process much better than we do. It’s been especially important to use in entering new markets.

GlobeSt.com: Have the store closures lately had much of an impact on your firm?

Oakes: It hasn’t been a major impact relative to the fact that there’s some volume of store closings every year, and this year’s activity has not been outside the norm in terms of what we’ve seen happen so far. Our product type and largest tenants have fared fairly well given their value focus. It hasn’t been a major issue for us. Every year there are stores that go out of business because of a corporate bankruptcy or closing a certain site in even the strongest of economies.

GlobeSt.com: Any prediction on when the economy could turn around?

Oakes: The financing environment is one where no one is immune. But where we stand today is a somewhat much better position than the market was in only three to six months ago. We’ve seen some small signs of improvement there that have been encouraging recently. But for us, instead of waiting for it to improve, it’s being prepared for any environment that could show up next.