Sell for More News is a weekly blog series with interesting information from the world of commercial real estate.
Increased store closures are sure to create co-tenancy challenges for retail owners. Certainly, some tenants will not be able to re-open. Some brokers optimistically foresee a swift recovery while others see a future filled with mass store closures. One outlook from UBS forecasts 100,000 store closures by 2025.
Reality will likely be somewhere in the middle. Many property owners are encouraging retail tenants to focus on lease restructures rather than vacating. Why? Because retail centers with permanent store closures will suffer co-tenancy issues.
Back-filling space gets harder
Retail tenants use co-tenancy clauses to mitigate competition within a retail center. For example, a cosmetics company’s lease may not allow any other cosmetics companies in the same property.
While they often make sense, these clauses can also create an obstacle to backfill a retail space when there are store closures.
Restaurants will be the hardest hit in this downturn. Restaurants rarely have co-tenancy clauses. Smaller, local businesses are also less likely to have co-tenancy clauses in their leases. If most store closures come from smaller boxes, some landlords may be spared.
The mid-term and long-term economic impact from these unprecedented events are just not known. If reasonable consumer demand returns, it may behoove landlords to work out arrangements for tenants to restructure their leases to allow them time to catch up.
Ultimately, lease restructures will help retailers survive the closures and will help landlords avoid challenges back filling spaces. These restructures will likely include forward-looking clauses to handle similar events in the future. These kinds of events, with the risk of loss of life and over-burdening of health care systems, could re-occur and we can expect that governments will not hesitate to more quickly impose social distancing protocols in response. Tenants may also consider alternative lease terms that would apply upon the occurrence of similar events.
Smaller tenants will vacate or demand lower rent payments
America will emerge from the coronavirus pandemic with fewer department stores. That’s a problem at a lot of retail centers. Here’s why.
First the department store closes…then the in-line tenants, such as Gap or Victoria’s Secret, use the co-tenancy clauses in their leases to modify their lease terms. These clauses give companies the ability to demand rent relief, or to break leases early, when anchor space sits vacant. That pressure could be what puts some malls and shopping centers entirely out of business. This is a one-two punch that could trigger a wave of properties shutting for good over the next 12-24 months.
More than 50% of the department stores anchoring America’s malls are going to close permanently by the end of next year, a new report from Green Street Advisors predicts. There are about 1,000 malls still open in the U.S. And roughly 60% of those have department store retailers, such as Macy’s, as anchor tenants. JC Penney makes up about 19% of mall anchor space…Macy’s is about 18%…Sears is 4%. And other department store operators (i.e. Nordstrom, Dillard’s and Lord & Taylor) make up another 20% of America’s mall anchor space.
The coronavirus pandemic lock downs that have slammed the U.S. economy is speeding up the demise of department stores. As government lock downs forced the likes of J.C. Penney, Macy’s, Nordstrom and Neiman Marcus to shut shops temporarily, the circumstances became even more dire for these already struggling companies. Slumping sales and an overhang of debt could push some into bankruptcy. Strained for cash, these retailers are scrambling for additional liquidity. More department store closures are inevitable. And that will put another level of pressure on mall owners.
Many malls will now be faced with multiple anchor vacancies, a tough place to come back from, especially in an environment where demand for space is weak.
Foreclosures come next
Mall owners’ finances are also being strained, as a number of tenants including Gap are not paying rent during the pandemic. That could mean some landlords aren’t able to make their own mortgage payments, and end up having to hand the keys back to their lenders.
Some, like Simon Property Group, have better balance sheets to weather the storm. Others have less time to spare. Green Street is predicting that retailers’ rent-paying ability will be impacted for years because of the pandemic lock downs.
The only certainty is that there will be far fewer department stores in the future and malls will need to adapt.
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About Beau Beach, MBA CCIM
Beau is a tenacious Commercial Real Estate Broker, author and adoring father of four. His clients appreciate his no-nonsense demeanor and his legendary work ethic.
Beau leads Beachwood which is a commercial real estate broker for sellers in the Nashville, Milwaukee and South Florida markets.
He’s the author of the books The 3 Reasons: Why Most Commercial Properties Don’t Sell and True Wealth: What Every Seller Should Know About 1031 Exchanges.
Beau can be reached at 800-721-3287, click to schedule a call or Beau@BeachwoodSells.com