Since 1986 the number of power centers increased at about 20 per year. New development is expected at a similar pace through 2000, according to the ICSC. The average size of power centers increased from 332,000 to more than 400,000 square feet in 1994.

Investment Characteristics

Institutional investors are attracted to the power center format by the long-term quality-credit leases. On the downside, power centers have limited potential for rent growth. With in-line stores only a small percentage of GLA, forecast rent depends on the anchors, whose rent levels are set for a period of time. In addition, their breakpoint for percentage rents is high.

Going-in cap rates tend to be higher on power centers than on other retail properties because of the limited income growth potential. The smaller the potential for increase, the higher the cap rate. As the split between anchors and in-line stores shifts toward anchors, the discount rate tends to decrease because the credit risk diminishes. The greater the percentage of anchor space, the lower the discount rate.

Survey Results

To quantify these tendencies, we conducted a special survey of shopping center investors. A summary of the findings is set out in Table A. The range of free and clear equity cap rates is from 8.50% to 12.00%; the average is 9.90%. The range of free and clear equity IRRs is from 8.00% to 13.00%; the average is 11.03%. An IRR in the low end of the range--8.00% to 9.00%--would apply only to high-credit deals with "bond" leases in markets with very strong fundamentals.

Most power center buyers rely on DCF analysis. Although they consider it important, they use the going-in cap rate only as a test to determine whether an initial cash return threshold can be achieved. All participants agree with the following principles:

	The higher the tenants' credit rating, the lower the IRR; the lower the credit rating, the higher the IRR.
	The higher the expected income growth, the lower the initial cap rate; the lower the expected income growth, the higher the cap rate.

Investors generally consider power center acquisitions as credit deals; therefore, they may analyze the investment like a bond. They look at the anchors' corporate bond rating by agencies such as Standard & Poor's and Moody's, and they may add a premium for real estate risk.

Because investors in power centers focus on the IRR rather than the going-in cap rate, they often base their price on a specific IRR target. The IRR is built up, beginning with a risk premium based on the anchors' credit rating. The investor analyzes the lease structure in place to determine the degree of risk for the entire project (e.g., a bond lease may have less risk than even the best triple-net lease) and may add basis points in relation to how strong or weak the leases are. Additional risk factors include illiquidity in the market and any particular market risk. For credit risk, the basis-point range can be from 50 basis points for a "top notch" credit rating with a bond lease to 300 basis points for a Bbb rating and 400 basis points for a "junk" bond rating. The result is that the discount rate rises in relation to risk.

An interesting approach to pricing power centers, used by one of our participants, involves developing the going-in cap rate by treating the investment as a fully amortizing loan. The debt service rate, predicated on amortization over the average term of leases at the average tenant bond rate (plus 20± basis points for administration), becomes the cap rate. The residual property value (maybe land only) at the end of the leases is "gravy."

As on other property types, initial cap rates on power centers are affected by income risk and potential income growth. Both the risk and growth potential decrease as the percentage of space occupied by a national credit anchor increases.

Our survey results demonstrate that cap and discount rates move in relation to space distribution and credit quality. Comparisons of typical cap and discount rates that can result from various combinations are shown in Table B.

For example, in a good property with a 75% to 25% split between credit anchors and in-line stores, the IRR may be 11.50% and the cap rate may be 9.00%. As the proportion of anchor space increases, the IRR goes down and the cap rate goes up. At the typical 85% to 15% ratio, the IRR may be 11.00% and the cap rate may be 9.50%. When 100% of the property is leased to big-box high-credit tenants on long-term leases, the IRR and cap rate may both be 10.00%.

Table A
Power Center Investor Survey
July 1995

Outlook

The future of power centers is only as bright as that of shopping center retailing in general. The ICSC estimates that shopping center-inclined sales will rise at 4.1% compound growth rate.

Actual retail sales during 1995 do not match this rate, but analysts expect that the power center share of retail sales will continue at recent levels. Net profit increased 15.0% since 1993, while it declined 6.4% at regional malls according to the ULI. Nevertheless, since the major draw to power centers is the perceived saving in money and time, competition from outlet centers and alternate shopping formats is a serious concern.

Even as big boxes cluster in complexes, there is scant evidence that consumers will shop at more than one destination retailer in a center. And although power centers are often located near regional malls, customers tend to favor one format over the other.

The greatest concern among investors is that many anchors are following the pattern of warehouse clubs. To gain market share, they are saturating markets. "They build a big box, a bigger box, and go down the street and build an even bigger box," says one participant. "These retailers may be at the top of their box size." Consolidation among big-box retailers is only a matter of time, many analysts believe.

The big-box phenomenon may be approaching its peak. However, for now investors are still interested in both the power center format and the investment type.

Table B
Typical Equity Cap Rate and Equity IRR Relationships

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