Episode 455: Curbline Properties CEO David Lukes on Redefining Convenience Real Estate

Well, certainly the current state is fantastic. I mean, it's only been 90 days and things are going well. It's hard to see a lot of difference in the first quarter and a half, but the reality is the consumer has changed their location. Work from home has made a big change, hybrid work. I think data analytics has helped us understand properties better than we ever have before. And so the company has a very unique strategy. We're focused on a very specific subclass of retail properties, and we've got the balance sheet with no debt and a significant amount of cash on hand to grow the company. So being unique and growthy are two features that I think are certainly warranted to be desired in the public markets, and that's what our goal was.

Well, any strategic action for a larger, mid-cap public company is likely the result of a combination of necessity and opportunity. The necessity part was driven by the fact that the shopping center REIT industry has a number of companies that have portfolios that are substantially similar, some grocery anchored, some urban, some suburban, some street retail, some power centers, some lifestyle centers. And when you look at all these companies, the sameness means that it's very difficult to distance yourself from the pack and become a long-term winner. It's just more complicated when, the first year or two after COVID when everyone's operations were fantastic, retail was basically entering a new Renaissance that had been largely vacant for 10 years prior. The opportunity was for us to try and distance ourselves and become more unique. So I think necessity was more about wanting to outperform, and the opportunity was the fact that we had spent some serious years, about five years, studying convenience properties and trying to really understand what makes them work. And if we could get the first mover advantage and be the largest and the only way to address that thesis in the public REIT space and list it on the New York Stock Exchange, that would be a winning strategy. And that's really what we went for.

Well, it's funny. If you look at the commercial real estate sector, it's a $20 trillion industry in the US, and retail is one of the dominant, larger food groups in that. And if you look at the amount of transaction volume of buying and selling retail properties in a 5-year period, you could see around $200 billion trade. And about 20% of that trade is in unanchored, convenience-oriented properties. But it's mostly, meaning like 96%, is being traded by local investors. Institutions have almost exclusively gone into large format and traditionally having a grocery component. So the real question is, why is that the case? Why are institutions so convicted on grocery? And there are some positive things about anchored retail: it's got strong credit, they certainly have name brands. I think people have a great understanding of being able to look through the credit and understanding who those retailers are. But the primary reason in my mind is that there's statistics, there's data. And for a large institution to make a real estate bet, it has to be more than a hunch, right? A local guy can make a hunch, but an institution putting out billions of dollars, they need to have data. And that data was historically in the form of tenant sales. If Wegmans does $1,000 a square foot in sales, if Whole Foods does $800 a square foot in sales, they're three times the national average, it must be a great property, therefore all the shops adjacent to the grocery must also be doing well. Now we have statistics, we can make a bet. What changed in unanchored is the advent of geolocation data on cell phones. And this was largely unavailable until, call it 2018, 2019. That data is so robust that you no longer have to only rely on tenant sales that are reported by the tenant. Now you can rely on customer traffic from cell phone data, which is incredibly robust and it allows landlords to have information that we didn't have before. That to me is what really crossed the Rubicon between private investors making local bets on convenience properties to now institutions. And us being the only public institution really being able to make a thesis that has math behind it that I think is convincing and durable.

Yeah, well, first of all, why is it interesting? I mean, this is to me the most opportunistic period in my career where we could do something that I think does have a lot of math behind it, but it's got a compelling story. If you think about post-World War II America and the advent of the suburbs, ring roads, US highways, suburban growth, population moving from the cities to the suburbs, there was a grand bargain that was made between tenants and landlords. And it basically went like this: the tenant gets a very cheap rent if they're a large operator, call it Kmart, Walmart, Target, etc. And for them getting a cheap rent, you're basically promised them drawing customers, right? Same thing in the malls, you had Macy's and Sears that, hey, we'll give you the land for free, but we want to build a mall next to you and we're going to use your customer traffic to feed ourselves with higher rents for the shops. So economically, the leases for shops are better than the leases for large anchors. So the question we had is, how can you separate the anchor that draws the traffic but pays economically less positive rewards for the landlord, and try and focus on the component that has higher rent growth? And the reality is that I think the data that we now have with cell phones shows us that shopping centers are actually large chessboards for all of these retailers to move around. And that ecosystem is for you and I to go shopping, right? We go shopping at a shopping center, you may park your car and go to a bunch of stores. There's an entirely different part of our world, which you can think about in your own life, which is not going shopping, it's running errands. How frequently do you run an errand? Go out at lunch and go to Chipotle, do you go to the ATM at Wells Fargo? Do you get your nails done? Do you go to the barber shop? These are running errands, these are not going shopping. For you to run errands, convenience is key. You want speed, access, and you want it in a timely manner. What we've really proven, and this is really through the data analytics, is that going shopping and running errands are two distinct, differently proper type property types. And being different property types, they deserve to have their own asset class for effectively running errands. And I'll give you some statistics: two-thirds of the customers that come onto our properties at Curbline are on our asset less than 7 minutes. That's not a going shopping experience, that's not lingering longer. We're not placemaking, we're not making a place where you linger for multiple shops. We want a place that is right up on the road, easy to your house, and you're in and out. There's a lot of customers that come to our properties multiple times a day. And the tenants will pay dearly for that access to wealthy suburban customers who are running errands. So being unique like that, it's not that we're saying there's a negative component to anchored retail other than the economics, but there is a distinctly positive attribute about running errands convenience properties, which is there's not enough of that space in the US. There's simply too much demand for the existing inventory. And for someone to build more of it, they have to charge rents that are significantly higher than our in-place rent roll. So we basically have a floor in value, and now it's really all about generating returns through renewing these tenants.

All right. Well, consumers have evolved, right? I mean, hybrid work has changed the workforce in America. Maybe it goes back to 5 days a week? Nationally, I doubt it. Does it stay at about 3 days a week? I doubt it. Maybe it ends at four. But the point is, the customer has always been, in a sense, the dual-income family. The customer's always been some part shopping, some part running errands. So if we focus on the running errands part, if you're betting on a specific retail chain as an investor, you're betting on that concept lasting. And concepts never last, right? They change. So for a real estate investor, you're betting on your location, and you're betting that it will always be desirable for whoever is in trend. So to a certain extent, we don't really care if some tenants come in and some tenants go out. What we want is a size space that everybody needs. So my favorite example is, if a Sears goes out in a major mall, and it's 200,000 square feet, and the landlord has to turn around and release that, how many tenants will take a 200,000 foot building? Somewhere between zero and zero. If Sports Authority goes away and there are 50,000 square feet, how many tenants will take that? One, two, three. If a 30 by 60 square foot shop, that's 1,800 square feet, goes vacant, how many tenants need that size? Hundreds, because it could almost be anything. It could be a nail salon, it could be a UPS Store. UPS Store is one of my favorites right now. People leave their car running to drop off Amazon packages and return them at UPS Store. So what we really care most about is the fact that our real estate is desired by the next tenant, and yet it works well for the current tenants. So one thing in retail is it's always changing, the tenant rosters are always changing over time. But there's a cost to that change, and that cost is CapEx. So one of the challenges of a large anchored property is that the cost to replace tenants over time is so expensive, it becomes like the cholesterol in the bloodstream, and that restricts your ability to have cash flow go out in dividends. The beauty of unanchored retail and in convenience is that the spaces are so small and ubiquitous that every time you replace a tenant, it's inexpensive. So the downtime is less, and you just don't have that cholesterol in the system that restricts our dividend growth. And I think over time, that is one of the most winning components of the strategy, is that we have a very capital-efficient business where rent that comes in the top line, a lot of it drops to cash flow.