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Can This Mall Be Saved? Elements Needed for a Turnaround Include Lower Debt, Deep Pockets

Despite Major Risks, Some Gutsy Owners and Investors Are Hoping To Cash In On Value-Add B-Mall Turnarounds and Repositionings
October 10, 2012
Last week, CoStar News reported on the daunting challenges faced by hundreds of outmoded malls in remaining relevant in a increasingly Darwinian retail environment. In this, the second of a three-part series, we look at the signs that may signal a mall's days may be numbered, and how some gutsy investors are taking on the challenge of reviving moribund properties.

According to retail property experts, changes in a couple of key vital signs often provide the first signs that a mall may be in trouble.

Consistent declines in retail sales per square foot over an extended time is one big warning sign, according to Gerard V. Mason, veteran retail specialist and executive managing director of Savills US. Higher quality class A malls should take in at least $400 per square foot, while a decent B-class mall will yield about $350 a square foot. Any time a mall's sales fall below $300 per square foot, it's likely in very serious trouble, according to Mason.

Likewise, a healthy mall anchor store should log $200 at least per square foot, and any anchor that falls below $100 a square foot is probably in imminent danger of closure.

Another critical factor is a store’s so-called health ratio, also known as occupancy cost, which is calculated by dividing the annual rent by total sales for the year. Healthy mall store ratios average about 11% - 12%. Any ratio above 15% will likely land the store on a landlord's tenant watch list, and above 20%, the store is probably destined to go dark.

Once one or more anchors or junior anchors close, it sets off a chain reaction of reduced shopping traffic, increased financial pressure on smaller in-line stores and decreased revenue for maintenance and operations that can quickly send a mall -- along with many surrounding businesses that benefit from mall traffic -- into a death spiral.

"The retail business is very Darwinian. Formats come and go, and right now is a very dangerous time to be invested in B malls," Mason said. "A lot of them will survive, but the competition has become almost overwhelmingly stronger than before the downturn."

Cavernous Gap Between the Have's and Have-Nots

On paper, U.S. regional malls are among the strongest performing types of assets for real estate investors. Total returns for publicly traded regional mall companies increased 48.5% at the end of the third quarter from a year ago, the highest among all retail types, according to the FTSE NAREIT US Equity REIT Index.

But a cavernous gap divides the performance of top-tier malls that attract the trendiest retailers and rents are on the rise, and older, lower-grade enclosed properties that struggle to attract foot traffic. Only about one-third of the 1,300+ malls in the U.S. qualify as high-growth, investment-grade properties, according to Savills' Mason.

"The recovery has been uneven across mall quality types," said Mason. "In the Midwest and other lagging areas, the second mall in a three-mall town may be on the brink of not being worth its debt. The recession has exacerbated the gap between the mall haves and have-nots."

As retailers review their sales performance per store with an eye on trimming costs, the under-performers at have-not malls are especially vulnerable to a round of closings.

The ongoing trend among retailers toward smaller stores also contributes to the widening gap. Mall staples such as Old Navy, which used to occupy 25,000-square-foot stores, are now comfortable in 10,000 square feet. Even the mall in-line tenants have downsized to smaller, more productive stores.

Vacancies from down-sizing retailers are often welcomed at successful malls as they provide an opportunity to sign more retailers at higher rents. But for a struggling mall, the empty spaces just reinforce a negative perception among shoppers. Meanwhile some retailers are simply foregoing B mall locations altogether, including Lululemon Athletica, a company specializing in high-end yoga-style exercise apparel.

"We have focused on only being in very strong malls," said Christine M. Day, president and CEO, of Lululemon Athletica during a recent conference call with investors. "We've had a real estate strategy of not bundling or taking weaker malls, and we go to [lifestyle] centers or streets, which allow us to really drive our business through community."

Sifting the Viable from Lost Causes

In many cases, the prospects for reviving a dead mall as a viable retail property are not good. The best option may be to demolish and start over with a different use that does have demand, such as residential apartments.

However, in cases where an older property has been over-shadowed by new competition, and the location continues to enjoy strong demographics capable of supporting a large retail presence, investors have been successful in repositioning former failed malls. In general, these successful turn-arounds appear to involve a combination of three main elements: deleveraging, 'de-malling' and deep pockets.

Buying over-leveraged but otherwise viable malls out of foreclosure can provide investors with an opportunity to acquire the property at a basis low enough to justify paying for capital improvements and attracting retailers with lower rents.

Rouse Properties Inc., (NYSE: RSE) and CBL & Associates Properties (NYSE: CBL) have both stepped up to buy B-class suburban malls, particularly where they can find so-called "only game in town"-type properties.

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Earlier this year, Rouse acquired Grand Traverse Mall, a 590,000-square-foot enclosed mall in Grand Traverse, MI, out of receivership for $66 million. The mall was formerly owned by the upstart REIT's former parent GGP, which handed nearly a dozen malls back to its lender last year.

In another recent example, West Manchester Mall, a 742,000-square-foot enclosed center built in York, PA, in 1981, recently sold to M&R Investors after spending more than a year on the market for $17.5 million -- less than $24 per square foot and far below the price the previous owner, The Lighthouse Group, paid several years ago.

Mason, whose firm represented the seller, said the sale involved "a classic de-malling scenario."

The 62% occupied mall faced competition from York Town Center, a CBL & Associates-owned power center that opened a few miles away. After the power center opened in 2007, JCPenney and Value City stores went dark at West Manchester, but Lighthouse was able to lease the spaces to Wal-Mart and Kohl's.

A Macy's department store and Regal Cinemas theater also anchor the center. However, sales at the in-line shops gradually fell and several national chains left the mall. The remaining shops have been converted to month-to-month leases and the in-line space will likely be demolished and converted to a big-box power center.

"It was a classic case of too much mall GLA [gross leasing area] in a one-mall town," Mason said. "But it still had a reason to exist, with an excellent location, and there was a need for big box stores in the area."

Many malls haven't aged very well and shoppers want to go where it's shiny and new. Any successful turnaround often requires a major property makeover. This may be even more true in highly competitive retail markets, such as Santa Monica.

Before Macerich Co. removed the roof and completely remodeled and re-tenanted with interesting shops and restaurants, Santa Monica Place located at the bottom of the Third Street Promenade in Santa Monica, CA, was one of those old-school B malls with B tenants, noted Southern California retail property expert Steve Jaffe, executive vice president and general counsel with BH Properties.

"Macerich has deep pockets and spent a lot of money and was able to raise the stakes and go upscale, but they already owned the mall," Jaffe said, conceding that new ownership might have a difficult time obtaining financing for such a venture.

"It’s one thing if you already own it and want to demolish, it’s another to step into it as a new owner. Until the financing market heats up across the board, lenders won’t readily finance what effectively would be vacant retail rehab projects without tenants lined up."

NEXT WEEK: CoStar spotlights 'have-not' malls that are using innovative strategies and drafting unconventional tenants to revive former troubled mall properties.

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