Will Mills's Woes Scuttle
Its Pleasure Dome?

Samuel Taylor Coleridge was inspired to write a poem about the fabled palace of Xanadu after seeing it in a dream. Now many wonder if Mills Corp. Chief Executive Larry Siegel's plan to construct a real-life Xanadu in the New Jersey Meadowlands is also just a fantasy.

In October 2004, to sell the idea of Mills's massive Xanadu complex, Mr. Siegel threw a $2 million party featuring a ski slope inside a large tent. A snowboarder flew through the air and handed a pretend $160 million rent check to the governor. Model Christie Brinkley kissed cheeks.

Mr. Siegel described Xanadu, the most expensive retail project ever undertaken, as a "shoppertainment" center where as many as 45 million visitors a year could ride a mile-long roller coaster with views of Manhattan, hit the slopes in the first indoor ski dome in the U.S., take in a concert at House of Blues and -- oh yeah -- shop.

But the obstacles are many. The flashy components are more than just crowd attractions -- they are a requirement in a contract Mills and its partners have with the New Jersey Sports & Exposition Authority, which owns the Meadowlands site and is mandated to allow retail only if it is "ancillary" to entertainment. Mr. Siegel has to convince retailers that being part of the hoopla is worth sky-high rents. He also must get enough signed leases to get a construction loan and meet a critical deadline. All this while his company is in disarray.

Mills, a shopping-mall real-estate investment trust based in Arlington, Va., has burned investors with a series of missteps in the past 13 months. The company has restated its earnings twice, written off 10 projects and announced the layoffs of nearly 100 employees. Mills's stock is down almost 41% from its peak last summer. The company has hired two investment banks to sell Mills or some of its assets. Last week, Vornado Realty Trust of New York, which specializes in acquiring and turning around distressed properties, said it has had informal talks on buying at least part of Mills.

The instability adds to Mills's woes at Xanadu. Retailers have little incentive to lease now and are more likely to take a wait-and-see approach, says Greg Andrews, a REIT analyst with Green Street Advisors, a Newport Beach, Calif., real-estate research firm. "If you don't even know who you're dealing with, why have a contract?" he asks.

Neither Mr. Siegel nor any Mills representative would comment for this article. Previously the company has said Xanadu is on schedule to open in late 2007 or early 2008.

A change in ownership probably wouldn't squelch the project, which is in a prime location and well under way with more than $500 million invested, steel erected and a parking deck complete. "If Mills fell off a cliff tomorrow, that project stays under construction," says David Fick, an analyst with Stifel Nicolaus and a Mills chief financial officer before it went public in 1994. "Someone else picks up the pieces."

Still, the success or failure of Xanadu could go a long way toward determining the REIT's future. "There is an old saying in real estate: Typically [with] these large projects that are extremely complicated and that don't go real smoothly, it's usually the second or third owner that makes money on it," says Jay Rosenberg, co-manager of First American Real Estate Securities Fund, a Minneapolis mutual fund. If Mills fails because it can't get the high rents it needs, it may have to sell the project at a steep discount, enabling the buyer to charge lower rents and still reap a profit.

Xanadu is so crucial to Mills that it would likely sell off other successful malls to keep the project going. Analysts have long questioned Mills's claims that it could earn a 9% initial return on the $1.2 billion project, since doing so would require retailers to pay much-steeper rents than the ones to which they are accustomed. Mills's guidance to investors implies it must average $67.50 a square foot for its nonanchor space to make those projections, according to Mr. Andrews. That is double the rent retailers pay at Mills's best-performing property, Sawgrass Mills in Fort Lauderdale, Fla., which after multiple expansions is about as big as the proposed 2.2 million square-foot Xanadu.

In October 2004, Mills unveiled 23 "initial" tenants, saying they accounted for half the square footage. The list included outdoor outfitter Cabela's, bookseller Borders, music retailer Virgin Megastores, gourmet food-seller Balducci's and a 26-screen movie theater by Muvico Theaters.

Some of these tenants have since signed leases. Michael Callahan, Cabela's senior vice president for retail, said his company expects to open as planned with an indoor trout pond. SkyVenture LLC says it is proceeding with plans to build the world's biggest skydiving simulator. Muvico spokesman John Spano says the company is "really excited" about its project, which includes a 60-foot outdoor screen.

Other amusement elements, including the mile-long roller coaster and a mini race car track, are gone. Some question whether the indoor ski slope will materialize, though a Xanadu spokesman says it "absolutely" will be built. These components are crucial because there is political and legal pressure for Mills to live up to the entertainment mission of the Meadowlands, home of Giants Stadium. A competitor that lost out in the bidding process, Hartz Mountain Industries Inc., is appealing the recent dismissal of their lawsuit.

More significantly, most of the anchors haven't yet signed leases. Balducci's and House of Blues, with its proposed 1,500-seat theater, have backed out. Borders, Virgin Megastores and Circuit City all say no lease has been signed. Having this few leases at this stage is troubling, says Green Street Advisors' Mr. Andrews. Anchor leasing typically is done before construction commences and shop leasing completed as the project is built.

"If I said I wasn't concerned, you would think me a moron," says George Zoffinger, president and chief executive of the New Jersey sports authority, which summoned Mr. Siegel and other top officials last month to explain how they were going to complete Xanadu as promised. After a three-hour meeting, Mr. Zoffinger says he is convinced the project will be finished. Xanadu can draw from about 20 million people in the New York metropolitan area and will benefit from a retail market where it is difficult for developers to build new malls. "I can't conceive of anything stopping the project at this point," says Mitchell Hersh, chief executive of the New Jersey office of REIT Mack-Cali Realty Corp., a partner on the project with Mills and Mills's longtime investor KanAm Group.

Mr. Zoffinger says Mills has told him it has about $200 million on hand and is spending $10 million to $15 million a week. Still, the number of leases will affect Mills's chances of borrowing several hundred million dollars this summer to complete the project. "Without anchor commitments, it will be difficult to obtain a construction loan, and without a loan retailers may be hesitant to sign a lease," Merrill Lynch analyst Steve Sakwa wrote in a report last month.

Mills also faces a potential problem with KanAm. Although the German fund manager had contributed $340 million to the project and Mills had to invest only $165.4 million, Mills must repay that $340 million if it is unable to obtain a construction loan by a specified, but undisclosed, date.

Analysts say Mills executives likely will be distracted by financial headaches and unhappy investors during Xanadu's crucial construction-and-leasing phase. "There's a showmanship to development," says John Lutzius, president of Green Street Advisors. "It's this dream factory kind of thing, and it's just going to be harder to spin those dreams while Mills is on its heels. Larry Siegel is this showman kind of guy, and now he must be taking a lot of time to talk to investors."

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