Sullivan: u201cWith retail coming back from the abyss, there's a much brighter light now for the sector.u201d

IRVINE, CA—The retail sector is in a much better place now than it was a few years ago, to be sure. And Larry Sullivan, president of Passco Cos., says that consumers hold a lot of pent-up demand for new products that could be unleashed with the right economic fundamentals. We caught up with Sullivan recently to discuss this phenomenon, as well as where retail investments are heading and some of the newer trends in the sector. What trends are you seeing in today’s retail investment market?

Sullivan: It’s somewhat difficult to talk about retail investment on a macro basis because, at the end of the day, it’s a very local-market business. But it all drives off of the economy—be that national, regional and/or local. In our view, we’ll see a little more of the same as what we’re seeing right now: good news on some days, not-so-good news on others, a bit of a give-and-take economy that moves slowly forward, growing, but with some fragility around the edges. Our model says to stay closer or more centric to nondiscretionary types of spending, sticking with tenancies and centers that are more aligned with that, and Internet-resistant-type tenancies like grocery stores, pharmacies, services and life necessities—things you have to have as opposed to things you want to have. We also go for smaller rather than bigger: more neighborhood-style centers as opposed to regional malls.

On the flip side, we still have measured concerns about bigger-box retailing and what turn it might take as the trend for continued Internet sales takes on more strength and these retailers are reducing their footprint of physical stores. We’re watching it to see how it might shake out. If the economy is not running on all eight cylinders, we’re not going to go into that on a macro basis.

With retail coming back from the abyss, there’s a much brighter light now for that sector. Having gone through some very rough economic times, there’s somewhat of a pent-up demand for product; retrenchment creates the need for products that are wearing out. As an example, automotive sales are strong, in part, because the average age of a car on the road was peaking at 11-12 years. The average car is now seven years older after the recession, so there’s a pent-up issue that consumers have that could be unleashed if the economy and job growth excel. Are there any markets Passco is targeting in terms of retail investments?

Sullivan: When you’re in a retail environment, it becomes so local you have to understand the local dynamics. The kind of properties we like tend to be very localized—more like a 1-to-3-mile trade area as opposed to the broader trade area of a mall. We have an embedded investment strategy we call “Next X” (next 10). We’ve been using that strategy for the last five years, looking for markets we think will excel over the next ten years, not necessarily those that have been strong in the ’00s, ’90s or ’80s. We’re focused on how the underlying economics are changing. We’re very active in areas that are biotechnology and technology-based and/or possess economic workforces, which is why we like areas such as the Research Triangle in the Carolinas and are active in Southern states such as Alabama. With their right-to-work attitudes and sought-after colleges nearby, these states are attracting serious job providers such as large automotive-manufacturing facilities located in places like Montgomery, AL, and Spartanburg, SC.  We like all those things, which led us to markets that are using past standards and not Next X standards, considered non-traditional.  But we moved into those markets five to six years ago. Institutional capital has moved into many of those markets now, and they have proven to be pretty resilient thanks to the new strategies in place. Our early entry strategies have paid off. You’ve mentioned in the past the idea of the convenience center and the strength of these retail centers. Do you see this strength continuing in the coming year?

Sullivan: We do. Our baseline economic outlook is still positive. However, these centers are not without their pitfalls. They are thinner and smaller and more susceptible to development swings, so you have to be really careful about tenancies in these centers. As an example, the restaurateur with a local base or following is not as susceptible to new development, but rent-sensitive tenants may move from one location to another. These are some of the drawbacks when you deal with smaller markets and tenancies. Experience-based retailers and centers seem to be another trend this year. Have you seen this trend materializing in our own retail centers, and is this trend affecting which centers you choose to acquire?

Sullivan: Yes, there’s absolutely a shift in the marketplace to more entertainment-type centers. That may be the physical offering of the center or the specific tenancies of the center. We’ve definitely seen that. Some assets in our portfolio that we’ve had for a while are more in that ilk and have done well. There are centers like Fashion Island in Newport Beach that are not entertainment centers in the classic sense, but you can’t tell me you’re not half entertained just by being in that location. Plus, the ones in good locations have the international tourism effect that hits them; they’re not only dealing with the impact from their embedded consumer base, but the adjunct of international tourism. Crowdfunding is a hot topic in the industry. As an investment firm, how do you see this changing your business over the next several years?

Sullivan: Crowdfunding is a very interesting arena. Does it have potential, in my view? Absolutely yes. The question for it will become how efficiently it operates and how self-policed it is to maintain credibility and quality. That’s the rub for crowdfunding. If it’s done by rock-solid players and high-quality, high-ethic crowdfunding sites, then it has a really bright future. If it’s attacking the next great use of a computer or the Internet without an investor-first focus, it will go through some serious growing pains. As with anything embryonic, it’s a great concept, but it will have to survive a shakeout period. The conceptual aspect of it, however, I like.