US Retail Real Estate with Acadia’s Ken Bernstein (Part 1)

As the country continues to reopen, how will the retail real estate landscape change?

In part 1 of this two-part episode, Trademark CEO, Terry Montesi, joins his long-time friend, Ken Bernstein, President and CEO of Acadia Realty Trust, to discuss his background and how he started Acadia. Ken explains his diverse portfolio and how targeting both open-air centers and urban assets has led to success, even through the pandemic. The two explore the unique effects of COVID-19 on retail real estate and debate which trends are here to stay.



Terry Montesi: Ken, share with us your background and your journey toward co-founding Acadia Realty Trust.

Ken Bernstein: Sure. And thanks for having me, looking forward to the conversation. I graduated law school in 1986 and started as a real estate lawyer and did that until 1990, when a few important things happened. First of all, I married my law school sweetheart, and that meant two lawyers in one family, which is arguably at least one too many lawyers. Second is the real estate market, as you may recall, collapsed in the late 80s, early 90s. And so, there was a fair amount of distress out there, and I sensed it was a good time to get on the principal side, and a client of my law firm I had done a lot of work with was starting up his business and was looking for someone to come and help him. So, it was a great entry level.

Montesi: As a matter of fact, I do recall, I started Trademark a year after what you’re talking about. So, I absolutely recall that time.

Bernstein: It was during the time of the RTC. There was unbelievable an amount of bankruptcies and opportunities. It was scary. It was scary. But thankfully my wife was practicing law, so we could pay the rent off of her salary, and it was a great time to get started. That was the predecessor company to Acadia, and it was backed by a handful of high-net-worth individuals. Over the upcoming years, we started to attract institutional capital on a private basis. And then in 1998, we made the fateful decision to do a reverse merger take under of a troubled shopping center REIT and effectively became public in August of ‘98, just in time for the REIT market to collapse. So that was our first of many cycles. Then there was the GFC and obviously now COVID. So, we’ve been around for a while, or I prefer to think of it as we are cycle tested. And that’s true for you, and it’s true for me.

Montesi: Absolutely. Tell us a little about your portfolio and what y’all are doing and what your strategy is right now.

Bernstein: Sure. So, for a variety of reasons, starting in the late 90s and then through to today, we have operated in the public market under what we refer to as a dual platform. And so, the two key areas of differentiation between the Acadia Realty Trust, the public REIT, and other open air shopping center REITs is, number one, we also operate a series of private institutional funds, and that really speaks to our history before we went public. And those are highly opportunistic, it really depends where we see opportunities at any given time. That meant at different points in the cycle, we were developing assets in the major cities. At other times, we were buying real estate from retailers. We were part of the group that bought Mervyn’s, part of the group that bought Albertsons supermarkets. And the last few years, we were buying out a few of our favoshopping centers. So that’s the fund business that continues to do well. It is contrarian and it gives us a wider scope of opportunities than if we were just a publicly traded REIT. The REIT is differentiated because over the last 20 years, we gravitated towards more higher barrier to entry, more street and urban assets, and thus, our portfolio today is about half open-air suburban shopping centers, and the other half is either street or urban assets. And those range from Target-anchored shopping centers in major cities to properties like M Street in Georgetown or Greene Street in Soho, Boston, Chicago, San Francisco, LA.

Montesi: Having just gone through this pandemic, what did you observe and see and learn from those two different types of properties? We’ve heard a lot about suburban versus urban and people bailing on urban areas. Obviously, you’ve heard and read a lot about that. And what have you learned and how does that inform how you’re thinking about those markets today?

Bernstein: The first thing I think we all learned, or I certainly did, was humility, because here we are, we have all of these grand plans and views of how we’re going to make 50 basis points here and where there’s slightly higher growth. And then a global pandemic hits and shuts down some of the major cities. At which point, thank goodness, we had those supermarket-anchored shopping centers, or those Target-anchored shopping centers. Thank goodness we had a diversity of tenants because it was really hard to predict at any stage of this crisis what was going to work and what wasn’t. Now in hindsight, we learned a few things. First of all was this shifted in store shopping almost exclusively during the early days of the shutdown to the essentials, necessity based. And so that’s what did well. Secondly, the cities shut down, and people fled to other locations, suburbia, their second homes, their third homes, it all depended. And so at least until today, it really has been more about essentials than about discretionary. The good news is we are now seeing a reopening. We are now seeing a shift. And I’m not sure that what you learn from what worked during a pandemic necessarily translates through to what might work over the next five, ten, or fifteen years. Again as I started this, we should bring a big dose of humility because who the heck knows what’s next?

Montesi: Well, you’re the smart guy. I have you on here because you’re supposed to know.

Bernstein: Yeah, okay. Well, so let me be very clear, I don’t know. I don’t know.

Montesi: Dang! We’ll keep the interview going anyway. That’s a big disappointment of course. But I know there have been some learnings during the pandemic, and there are some things that you think probably will stick. So, tell me about what some of those are.

Bernstein: One of the more overused terms is COVID was an accelerant, but in many ways it was. And so pre-COVID, retail, especially bricks-and-mortar retail, was facing a host of headwinds, and those headwinds accelerated. And it knocked out a bunch of weak retailers, a bunch of weak properties faster than we otherwise would have expected. It also pulled forward a bunch of technology. So, the conversation around the rise of e-commerce, it’s here. And the first lesson is for a variety of retailers, more often than not, Omnichannel is what is occurring today, what occurred during COVID, and most importantly, is going to be here in the future. And we could spend time talking about those retailers that are still very successful and only offline – the off-price retailers, for example, like TJ Maxx, Trader Joe’s. But more interesting is watching how Target has thrived, how some of the digitally native, whether it’s Warby Parker, Allbirds, a variety of tenants of ours, used their digital connection with their customer to enhance that relationship, to navigate through COVID, and now are continuing to grow both online, but very importantly, with stores as well. So, the first lesson of the acceleration from COVID is just the rise and my hunch is the permanent existence of Omnichannel, and best in class retailers thrive that way.

Montesi: Well, I have no disagreement there. I think Omnichannel is here to stay, and it is the future. And fortunately, one of the Omnis is bricks-and-mortar. That’s a good thing for guys that are trained to do what we do.

Bernstein: And what I think is important for people, not like you and me because you and I live this day in day out, is that the store is still almost without exception the most profitable channel for Omnichannel retailers. The store also is one of the better ways for retailers to reduce their customer acquisition costs and differentiate themselves. So, it’s not just that it’s multiple different channels and stores are part of it – that is true – but the stores appear to be a critical channel for so many of these retailers in ways that it wasn’t clear to us a couple of years ago that that was how it was going to play out.

Montesi: Couldn’t agree more. And you look at Amazon and they still have a hard time making money on the e-commerce only business, and they’re really heavily working on expanding their brick-and-mortar presence. So very interesting comments. Open-air, you’ve stayed away mostly from malls and really focused on open air, whether it’s street or like you said, suburban community and daily needs centric retail. When you look forward and you think about open-air versus enclosed malls and types of open-air, tell me about your strategy going forward and has the pandemic and what you’ve learned during the pandemic changed it, or is it mostly how technology has changed it?

Bernstein: So, let’s start with the enclosed portion, which I have tremendous respect for those groups who can successfully operate in closed malls. It’s just not been our expertise. I know you have navigated it successfully. And my hunch is that you’re going to have to be of scale, and it’s an expertise that we just may not have within our core competencies to compete with the big guys. So that’s really our view of enclosed malls, so those that are likely to survive and thrive. For the de-malling, buying enclosed malls and turning them into something else, we have over the decades done a dozen of them. They’re really tough. One tenant can hold you up for a lifetime. And so, what I caution my team is sometimes it looks alluring because the land underneath the mall is worth more if the mall’s gone than if it’s sticking around. And there are times we can do those and they’re really profitable, so I won’t say we never do, but I do caution my team to not confuse covered land plays with what I call covered land mines, meaning you think it’s going to work, and three years later, you wonder what you got into. So, that is my view on the enclosed space, but you look at some of the pricing, and boy, it looks tempting.

Montesi: The control is the premium that you have to just price so conservatively, because if you only have a portion of the control and you’re guessing as to what gaining the rest of the control is going to be from a timing and pricing standpoint, boy, there’s a lot of variables there and it can really change your success material.

Bernstein: With all deference to those people who are going to succeed in the enclosed space, there’s plenty of room in the open-air for us to figure out how to create value and make money. But it’s tricky, too. So, within the open-air, there’s a variety of ways. The one thing I guess I’d say, the lessons climbing out of COVID is things might get really expensive to build. So, I also happen to like buying assets at a discount to replacement cost because that’s just one more lever of advantage that we could have, especially as inflation kicks in.

Montesi: The only problem there is we’ve got potentially a supply-demand imbalance, who knows how long that might take to catch up. If the supply and demand were in real balance long term, what you say is definitely right. Discount to replacement costs usually, things come around full circle and is reasonably dependable, but that’s the $24,000 question right now in retail, it is the supply and demand side. So, I’m going to ask you about that with e-commerce and its cannibalization of brick-and-mortar, and now it’s solidification of the long-term need for brick-and-mortar, but the supply, how much less brick-and-mortar will we need? And when you think about the supply and demand, and you think about these retailers continuing to lighten their fleets or trim their fleets to what they need to serve as an Omnichannel environment, what is your forecast as you think about supply and demand and how you’re looking at what brick-and-mortar will be needed going forward and how much of it and what might need to just be completely demoed or repurposed?

Bernstein: 27.5% over supply. I’m joking. Remember what I said before. I don’t know. We are oversupplied. And I think you will see a continued separation between the have and have-nots. So, some shopping centers are going to do fine, they’ll have some level of pricing power. But this overhang, both due to e-commerce, due to just too many redundant shopping centers, causes me some level of pause if there are no barriers to entry, if there’s no supply constraints. That being said, COVID was an accelerant. We’re seeing this play out. If you have the right retailers, the right location, if you’re comfortable with the rents where they are today, and the sales support those rents, then I think you can count on a level of stability. But stability means TJ Maxx, if they’re doing well, will likely renew their lease, same for a variety of other retailers. They may just not be able to or willing to pay you more rent, and that’s where we just have to be disciplined as to what our thoughts are as to rental growth in overbuilt markets where there are not supply constraints. So, we’re pretty careful that we either want to buy assets in the pathway of growth, where there’s strong population growth or where they’re the only show in town, meaning it’s that one shopping center, we are at a discount to replacement cost, and we are the only show in town, or where there are true barriers to entry, supply constraints, such as in the major markets where it’s really hard to create more retail and we own the right stuff. But it needs to be in one of those three categories, otherwise, I think it will be tough to have any level of pricing power.

Montesi: Yeah, that’s a great point because there’s a lot of suburbs in this country where there’s a shopping center on three or four corners. Like you used to- TJ Maxx, they have an expiration coming up. If there’s a vacant box across the street, they’re just going to price you maybe below market, because you’ve got costs to replace them. So, you may not even get market rent, but you still might be better off. And that’s a great point. So, staying in areas that aren’t oversupplied and areas with supply constraints or air markets that have tailwinds is, I think, going to be more important than ever these next few years as retail square footage shrinks appropriately in this country, because we had just gotten pretty substantially overbuilt.

Bernstein: To your point of if there’s four shopping centers in a community that really only needs three or two, we try to avoid those. I used to joke that it felt like the average American wasn’t willing to make a left-hand turn, and that’s why we had four of them rather than two of them, but now that is being rationalized. And you’re right, it will be an arm-wrestling match with those retailers to make sure you’re holding onto the right retailers at the right rent.

Montesi: Along those lines, as we think about supply constraints and barriers to entry, or why would somebody go to our center versus the other three on the other corners, that sort of doesn’t take into account the experience piece. And I know you have a lot of street retail, you’ve got some mixed-use stuff, and I know you pay attention to that piece of our business. So, how are you thinking about the importance of delivering experience as opposed to just sort of merchant quality and supply constraint being how you make sure your projects are successful?

Bernstein: So, you’re referring to, with experience the curation of the assets of the right experiential tenants?

Montesi: Creating an experience, what the developer can do, creating an experience – that incorporates a lot of things – but how important is creating a unique destination with a unique experience to getting people off their couches and coming to our places?

Bernstein: It varies location by location. And in some of the cities that we’re dependent on the city being our anchor, and we can’t re-anchor that, and there are multiple landlords, but many of those streets or the neighborhoods like Soho rebound and thrive, and consistently do so, there it’s a different situation than in a more suburban setting where we have control overall. And sometimes those work and sometimes those don’t as well, but the need to make sure that you have multiple tenants that complement each other, that speak to who the customer is, and that you both curate it well, but then overall have an attractive place to do more than just run an errand, I think is going to be a critical component of differentiating your assets within a range. Our retailers seem to get that. Ten, twenty years ago, retailers are like, look, we don’t necessarily care where we are because our shopper knows how to find us and that’s all that matters. I think you’re seeing that shift. It’s taking a while, but they are embracing food and exercise and a variety of other components, even in the open-air environment.

Montesi: Let’s talk about what you’ve seen this year, and particularly the last couple of months, as many of the places in the country have started to open up a great deal more, March and April sales and traffic, and what you’re learning from that. So, tell us what you’ve seen and what you’ve learned so far these last few months, as we slowly start to come out of the grips of the pandemic.

Bernstein: It’s worth reminding ourselves as we were heading into this and all crawling into our bomb shelters, that we said, oh my gosh, here comes a very scary time for the country, a scary time for the world, a health crisis, and an economic crisis. And we all tend to revert back to what was the last recession, and what did the playbook like there? And this is looking very different than the last several recessions you and I have played through.

Montesi: I haven’t played, neither of us have played through a pandemic induced recession before.

Bernstein: So, if anything, I said, I thought the GFC was once in a lifetime bad, and this could be worse. And let’s separate out the personal loss, because that is far more tragic this time than the GFC. But from an economic perspective, from a consumer strength perspective, it became clear several months ago, a few things. One, the speed with which the vaccination occurred gave a chance for a rebound far more powerful than what we would have expected, or certainly what we feared during the darkest of the dark days. Two, the consumer is climbing out of this recession so differently than the consumer climbed out of the GFC or any of the other prior recessions in your and my professional life. So, their savings rate, their stock portfolio, their home values, and for that portion of the economy where the consumer’s job turned out to be more mobile, meaning they were able to work online, for that portion of the economy, the consumer is showing up now in much stronger position than any prior recession you and I have been through. For those who are out of work, those people who went into this recession living paycheck to paycheck, it’s gut wrenching, but we have seen more intervention, both fiscal and monetary, during this crisis than GFC or any of the others. So, what that is starting to set up for is, as cities, as communities, as the country reopens, the pent-up demand is showing up in sales. And we’re seeing that even in some of the cities that are still locked down and just opening now, when we look at our sales reports, it’s pretty encouraging already, and it’s only just beginning. And when we talk to our retailers and see the leasing demand, we’re busier today, our leasing team is doing more activity today, than pre COVID. Terry, I don’t know what you’re seeing, but I assume it’s similar.

Montesi: It is pretty amazing. Our leasing people are very active, and we were just barely off budget in 2020, even, which is kind of crazy. So, you’re right.

Bernstein: So, we’re forgetting 2020, because at least the second half of it was really painful.  So, we were more than barely off budget. Half of our tenants stopped paying us rent when COVID hit.  

Montesi: Yeah, and I meant, to be clear, off budget on leasing. What we’ve budgeted for leasing fees, that wasn’t very off, but obviously, we had lots of deferrals. And it’s not even worth talking about that because we’ve all sort of worked through that. Along that note, how are your deferrals collections going this year versus what-?

Bernstein: Fine, thank you. And you?

Montesi: Ours are going very well.

Bernstein: Yeah. So first of all, when I said half our tenants stopped paying us, the majority that were not paying us turned out to be high quality credit tenants that were able to access the capital markets. And again, give the fiscal and monetary intervention credit, because that certainly helped. And so, any deferrals we entered into were with high quality tenants and they’re doing just fine. So, it turned out in hindsight, what looked like a 50% collection rate was really closer to 80 or 90.

Montesi: Yeah, we are having the same experience.

Bernstein: Now, why you and I had to make interest free loans to high quality credit tenants is a discussion for another day, but that piece has passed now. And we’re really, I think, in a position where subject to supply and demand, subject to everything else, based on our leasing data that we’re seeing, based on a variety of other components, there’s a chance that we could see some very nice growth and rebound, top-line sales because of pent up demand, and then a stronger consumer, and then longer term growth as well because the weaker assets have gone away and the weaker retailers have gone away.

Montesi: That’s optimistic. Because one of the many knots in my stomach is that sort of what about the period after the stimulus wears off and after the pent-up demand to re-do your closet, and once, we’ve just gotten, “I am going out again, I need some new stuff, I’m tired of wearing all that stuff,” once we’ve kind of gotten through that season, is that kind of through holiday this year? I don’t know for sure. But I’m concerned that we may have robust sales increases for some period, and then followed by reasonable decreases a year later because you had this fiscal stimulus and pent-up demand combining to sort of overly inflate consumer sales. So that’s one of those things, like you said, neither of us knows, but that is something that I’m sort of looking forward to with a little bit of anxiety.

Bernstein: Yes. What happens when the painkillers wear off? I think that’s a legitimate concern. And I guess I would caution all of us to, one, remind ourselves we don’t know, that the range of outcomes is wide, that we should not get too far over our skis, we should not confuse short-term stimulus, short-term growth with any of the longer-term issues. However, the consumer is in stronger shape today than pre-COVID. That’s not a stimulus check, that’s just their savings rate and a variety of items. If we can avoid painful inflation, which is an if, stagflation or any other combination of the stuff that when you and I were kids we saw, and if we can avoid a recession, whether it’s Fed induced or otherwise, I think we are in a position right now where I am more bullish than when we had this significant oversupply of retail, uncertainty of who was going to make it, who’s not. There are some components of retail that still concerned me, but I am more optimistic today than I certainly thought I would have been during the dark days.

Montesi: What are the components that concern you?

Bernstein: Movie theaters. Gyms and restaurants, I am feeling more and more confident about their rebound. But movie theaters because it’s a content issue as well. And so, it’s not just the consumers desire to get out and go to the movies, which I think will come back, but also the issue of how do the studios choose to release, and you and I looked at it deal together in fact, that guessing as to the outcome of the movie theater was a big piece of how you price a deal. And I still don’t have clarity around that piece.

Montesi: If you think about pre-COVID, the power and allure and connectivity of the consumer to these streaming services, it was just in a completely different position. The streaming services may be the biggest winner, long-term winner, that I know of from COVID. People were sort of forced there and they found out, you know what? This content is good, and this is easy. And think about the competition the movie theaters now have from all these streaming services that have the consumer subscription base to produce outstanding content that I’m guessing you and I and our families both have watched some of.

Bernstein: Absolutely. Now, I could also make an argument for why a certain number of screens are going to be essential, why the content providers, the talent, etc., and the same studios are going to want to have a certain number of movie theaters thriving. How many weeks they thrive for or what the business model looks like, time will tell. That’s one segment we should watch. There’s a host of others we should be concerned about. And then, ultimately, the small business component of our shopping centers, which is critical to our growth. When we talk about supermarket-anchored shopping centers, the supermarket is just fine. But remember that the majority of the growth comes from those satellite tenants and thank goodness they got through this storm in general with more government support and better painkillers, so to speak, then during the GFC, when lenders weren’t there for them, inflation, recessions, a whole host of other items to create headwinds there. And so, we need to watch that as well.

Montesi: It’s interesting you say that, that is a very real concern. But I also feel like the wealth has been built up and people made money, whether it’s on their stock portfolio or their cryptocurrency investments or their savings, etc. It seems like this is a period where we could really spawn a huge entrepreneurial move into franchises, etc., where people have been on the sidelines for fifteen months, and they’re just saying, I’m ready to get back in business, or maybe I got into a new business and I’m no longer working at the big company, but I want to do something. And I kind of feel like we may have a little explosion in entrepreneurship here the next eight to twelve months.

Bernstein: Yeah, I hope you’re right, and I hope it works. And I think it might; I think there’s a lot of reason for us to be optimistic on all of those fronts. We just need to be rational about what your and my role as a landlord should be in those businesses because we can love restaurants as tenants, but we need to make sure we’re their landlord, not their partner.

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