A MORTGAGE IS ALMOST ALWAYSPREFERABLE TO PAYING CASHBruce M. Bird, Noyan Arsan, and Eugene Poindexter

A series of simulations compares the costs of mortgages to thereturns of investments in similar risk classes.

DEALING WITH APPROVAL CONTINGENCIESIN AGREEMENTS OF SALEGlenn D. Blumenfeld

Protecting the interests of the sellers who are removing their propertyfrom the market and the buyers who are investing their time andmoney.

THE LODGING PROPERTY INDEXJohn B. Corgel and Jan A. deRoos

A new index that does for hospitality investors what the NCREIFindex does for investors in other types of commercial properties.

IMPROVED HOTEL MARKET FORECASTSMarvin L. Wolverton

THE SHOPPING CENTER PERCENTAGE LEASE:PART 2

3 Mitchell Y. Herman 58The rewards of well-drawn clauses relating to percentage rent.

PRORATING REAL ESTATE TAXES AT CLOSINGOF SALE OF SHOPPING CENTER PROPERTYDan F. Nicol and D. Albert Daspin 62

12 Resolving the dispute about whether taxes should be prorated on a"payable" or on an "accrual" basis.

TAX RULES PUNISH VICTIMS OFMORTGAGE FORECLOSURESRobert Vincent and Nathan Oestreich 67

20 Homeowners are whipsawed by regulations that recognize"discharge of indebtedness" income but no losses.

REAL ESTATE REVIEWSummer 1991 Vol. 27, No. 2

NONRECOURSE CARVEOUTS:How FAR IS FAR ENOUGH?Joshua Stein

A tool to reduce lenders' risks can reduce their competitiveness.

COMMERCIAL REAL ESTATELENDING:FROM RATIOS TO THEOPTION-PRICING MODELWilliam C. Handed and J. Minor Sachlis

A survey of the underwriting standards being used by the agenciesthat rate mortgage-backed securities.

UNDERWRITING RESIDENTIAL PROPERTIESTODAY: A PRIMERRichard T. Garrigan and Rosemary C. Kehr 72A survey of the new underwriting criteria for apartment loans.

25

USING "AVERAGE OCCUPANCY"TO COMPUTE LANDLORD'S COST RECOVERYTed Hew 78A mathematical note for those who bill tenants for their prorates

35shares of common area expenses.

POINT OF VIEWINCOME SOURCES FOR REAL ESTATE OWNERSAllen Cymrot 82

H9 PEOPLE AND PROPERTYMAGIC WORDS

theEmanuel B. Halper 86

LAW AND TAXATIONSCARED ENOUGH? How OVERT OR IMMINENT

45 MUST THE THREAT OF CONDEMNATION BE?Edward I. Foster 88

EXECUTIVE COMPENSATIONREIT EXECUTIVE COMPENSATION

51 ACCELERATESCarl Bruno 91

The use of REVPAR enables analysts to forecast with confidence tinexpected cyclical nature of future revenues.

CATALOG STORE USEAND EXCLUSIVE CLAUSES: PART IEmanuel B. Halper

The giant reawakens.

NET LEASES AS REAL ESTATE INVESTMENTSPhillip S. Scherrer and Timothy J. Mathison

This lease structure has special advan tages over other lease forms.

CATALOG STORE USE

AND EXCLUSIVE CLAUSES:PART 1

The giant reawakens.

EMANUEL B. HALPER

he Catalog store sounds like an oxy-moron, a combination of words conjuringvisions of divergent retail paths: home

shopping and store shopping. However, homeshopping and store shopping aren't alwaysrivals. Some merchants have found and continueto find success by combining aspects of both.1

Why is this journal devoting so much spaceto an analysis of catalog store leases? After all,the heyday of America's general merchandise cat-alog stores has passed. The Sears Roebuck andMontgomery Ward catalog stores and their cat-alogs (the industry's giants) vanished in the late-1980s and early-1990s.2

Why worry about the remaining catalogstores? Three categories of good reasons makeworrying about catalog store leases imperative.

The Catalog Store Idea Still Lives. Retail con-cepts, like so many other human designs, don'tdie irrevocably. Although many general mer-chandise catalog stores disappeared in corporatedownsizings or found their way to the bankruptcycourts, other general merchandise catalog storessurvive, and specialized catalog stores are thriv-

Emanuel B. Halper is a Greenvale, New York attorney and real estateconsultant, as well as an Adjunct Professor of Real Estate at New YorkUniversity. This article is a revision to parts of Chapter 9 of his book,"Shopping Center & Store Leases," which was published by Law JournalSeminars Press. Mr. Halper wants readers to log into his Internet homepage at http://members.aol.com/EIH/index.html and to send e-mail tohim at elh@aol.com .

ing. The conditions that made general merchandisecatalog stores useful in the first place mayreemerge. The old new idea may become excit-ing in a new technological environment. (Indeed,I've heard rumors that Sears is thinking aboutreissuing the big catalog.)

Many Catalog Store Leases Executed Years AgoAre Still Alive and Can Cause Big Trouble ForToday's Landlords. Catalog store executives havedemanded (and landlords have conceded) the rightto sell any catalog item from the store. Because land-lords have no control over the catalog, a shoppingcenter catalog store's right to sell all catalog itemscan be used to drastically expand the kinds of mer-chandise the tenant is permitted to sell in the store.That right creates the hazard that the catalog storewill decide to sell merchandise prohibited by othertenants' exclusive clauses. If the catalog store ten-ant's use clause permits sales prohibited byanother tenant's exclusive clauses, the landlord isvulnerable to lawsuits from both tenants.

Catalog Store Exclusive Clauses Can UnwittinglyExclude Other Desirable Merchants From the Shop-ping Center. Many catalog store exclusive clausesbar any other catalog store from locating in thesame shopping center. These broad restrictionsexclude stores that are so unlike each other thatthey could easily occupy neighboring downtownstores or coexist in the same shopping center with-out harming each others' business one bit.

CATALOG STORES

45

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alog sales business in 1870 in Augusta,Maine. Aaron Montgomery Ward, for-merly a traveling salesman, published hisfirst catalog (a single eight-by-twelve-inchpage) in 1882. R.W. Sears Watch Com- •pany issued a catalog in 1887, and in •1893 Sears & Roebuck in 1893 launchedits first general merchandise catalog.

Catalogers prospered despite theabsence of facilities and services we takefor granted today. Many years passedbefore Sears, Roebuck & Co. routinelyprovided home delivery to catalog customers. Ear-lier on, customers had to travel to a distributioncenter to get what they ordered.

The mail order catalog industry eventuallybecame a powerful distribution engine. In its hey-day, the Sears catalog contained 1,500 pages,weighed six pounds and reached twenty millionpeople. Two big factors in the industry's growthwere significant improvements in postal service(rural free delivery started in 1893 and parcelpost in 1913) and the ethical business practicesof the major catalog houses. The Sears catalogoffered a full satisfaction guaranty. A dissatis-fied customer could get a refund merely by return-ing the merchandise at Sears' expense.

Catalog operations and retail store operationsbegan to overlap. Retail store merchants observedthe new selling method and were quick to issuetheir own catalogs. Tiffany tried mail order in1870. R.H. Macy distributed a catalog in 1874.Conversely, catalog merchants were not shy aboutopening their own retail stores. Wards experi-mented with retail units in its mail order plantsas early as 1921.

Catalog stores that sell the same merchandiseas the retailer offers in the catalog blend the homeshopping and store shopping concepts. They per-mit consumers who would otherwise prefer tobe store patrons to save time by selecting mer-chandise from the catalog instead of hunting fortheir needs on the sales floor.

THE MANY KINDS OF CATALOG MERCHANDISINGNevertheless, the label "catalog store" hasalways been confusing. Originally, there were fourcompletely different kinds of catalog merchan-dising in shopping centers:I Retail outlets of major general merchandise

chains that conducted both department

I E W

store operations and mail ordercatalog operations;

I Retail outlets of a novelty catalogorganization;

I Franchised catalog desks in retailstores unrelated to the catalogcompany; and

I Consumer electronics stores tiedto a catalog operation.

Today, three additional kinds ofcatalog stores compete for the con-

sumer's favor, namely:I Instant pickup catalog stores;• Upscale specialty catalog stores; andI Specialized hard goods catalog stores.

Now, let's take a quick look at each of theseseven kinds of catalog stores.

Retail Catalog Outlets of Major GeneralMerchandise ChainsSears, Roebuck and Montgomery Ward storesare prime examples of retail outlets of major gen-eral department store chains that also carried oncatalog operations. Both firms operated (1) cat-alog stores that were separate from their regu-lar retail stores and (2) in-house catalog desksin the department stores. Although many leas-ing professionals think the stores came first andspawned the catalogs, the reverse is true. Today'ssignificant Sears, Roebuck and Montgomery Wardretail stores didn't exist until the 1920s. Untilthen, except for brief experiments, Wards andSears were strictly mail-order companies.

The earliest Wards outlet stores opened in 1921.They were located in its mail order plants in Auroraand Springfield, Illinois and were initially intendedto dispose of distress merchandise. Wards had somuch distress merchandise in 1921 that itexpanded the outlet store program. To avoid sul-lying the good name of Montgomery Ward,they named some of the outlet stores George LaneStores. (Who was George Lane, and why didnobody care about George Lane's good name?)

Ward's General Merchandise Manager, VicePresident Robert E. Woods, who conceived theoutlet program, was convinced that Ward'sshould further expand retail operations. Whenthe company failed to act on his views, hemoved to Sears in 1924 and quickly convincedhis Sears' bosses that his way was the way of the

47

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nient personal computers scatteredabout the showroom), were waiting,boxed in the storeroom. Shortly afterfilling out an order form and paying thepurchase price, customers could pick upthe merchandise and carry it home.

The stores featured name-brand hardgoods, appliances, and jewelry, and theirlow-price policy spurred rapid growth andhandsome profits. Until they arrived onthe scene, the public could find bargainsamong the private labels featured in theretail store catalogs or they could find low pricesat discount stores. But the new instant pickup cat-alog stores emphasize brand name labels.

Instant pickup catalog store chains made hand-some profits because they used space efficiently,kept real estate expenses down, and held downthe payroll. Their overhead was reported to be one-half that of a traditional department store.

The catalog played an important role in keep-ing catalog showroom overhead low. It was sub-stituted for both display space and sales personnel.For example, Best's 500-page catalog depicted around8,500 items, and in 1984, Best's shipped catalogsto about 10 million prospective customers in addi-tion to featuring those catalogs in the showroom.

In addition to saving on showroom space andpersonnel, instant pickup catalog store chains saveby their carefully selected merchandise mix. Theyhave concentrated on jewelry, luggage, andnationally advertised hard goods like electron-ics and housewares, avoiding merchandise thatis subject to markdowns because of changes infashions and seasons.

The original scheme worked well for a while,and catalog store chains spread rapidly acrossthe United States and Canada. They were reputedto be the cheapest guys on the block and con-sumers flocked to them.

In the late 1970s and early 1980s when theyrealized that their own stores were losing marketshare and potential profits to the catalogers, dis-count department store executives undertook tworesponses. Some were able to negotiate restrictivecovenants in their shopping center lease exclusiveclauses that barred catalogers from cotenancy,while others found ways to compete more effec-tively against instant pickup catalog stores.

The discount department store people figuredout that their discount price policies are uselessif consumers can get a better deal elsewhere. So

IEW

they lowered their prices on merchan-dise usually carried by instant pickupcatalog stores, and they increased the

• • amount of brand-name merchandise one their gondolas and shelves.

Later, a former discount depart-ment store chain CEO, Saul Price,popularized an entirely new kind ofstore: the warehouse club. 3 Warehouseclubs offer brand-name merchandise.Because the stores are as big as ware-houses and sell "club price" quantities,

their selections and prices are terrific.By the late 1970s, many shoppers were dis-

enchanted with the catalog showroom style ofshopping. The catalog showroom routine hadbecome tedious. The shopper had to fill out forms,wait on line, pay for the merchandise, andstand on line again to wait for it. The waitingwas sometimes irritating. Worse, waiting didn'tguarantee that the shopper got the merchandise.Sometimes the store was out of stock.

Both discount department stores and members-only warehouse clubs had become appealing alter-natives to catalog showroom shopping. Theinstant pickup catalog store chains responded bybecoming more like the discount departmentstores. They changed store layouts and appear-ance and they increased store size. Larger storesgave them more space to display merchandise andto carry merchandise categories other than theirtraditional hard goods lines. They added house-wares, sports equipment, consumer electronics,and jewelry. They even entered the seasonal cloth-ing business.

These moves increased sales volume, but theyalso increased operating expenses. They couldhave expected no less. When you look like adepartment store and act like a department store,you're bound to have expenses like a departmentstore. Although the catalogers' moves led toincreased market share, they didn't lead tolong-term stability. Instant pickup catalog chainsand their investors have suffered. Some chainshave visited the Bankruptcy Court; others, tooweak to operate independent organizations,have been acquired. Some of the acquirers weresubsequently acquired themselves, and someacquirers subsequently made their own trek tothe Bankruptcy Court. By 1991, even Best's filedfor Chapter 11 protection.

49

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