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Investors Still Willing to Bet Big on Mall Turnarounds, Even at Those Hit by Triple Anchor Closures

Flurry of Dept. Store Closures Forcing Mall Owners to Adapt, Reinvest or Die
March 30, 2017
While owners of shopping malls have been grappling with department store closings for several years, the pace of closings has recently accelerated, marking a turning point in the speed of the fundamental changes reshaping the traditional mall sector.

Chains such as Sears, Macy’s and JCPenney are no longer closing a handful of underperforming stores at a time. Over the last three months, they have all embarked on a new round of aggressive store closures involving a hundred or more locations each.

As a result, some malls are taking multiple hits. About 100 malls are to see at least two of their department store anchors closing at the same time, while a handful have store from all three retailers set to be closed.

"The spate of store closures does not portend the end of brick-and-mortar retail as we know it," said Ross Forman, managing director in BDO’s Corporate Real Estate Advisory Services and leader of Real Estate Strategy and Portfolio Optimization.

What it does indicate, Forman said, is a new chapter in the ongoing evolution of the shopping landscape, where everything from the 'de-malling' of shopping centers to a much stronger emphasis on the 'experience' of shopping and the convenience afforded by technology is forcing retailers to revisit their real estate portfolios and squeeze out every square foot of under-utilized space.

[Editor’s Note: This is Part 2 of a two-part look at department store closings. Last week, CoStar published Part 1 examining how Sears' disclosure that it may not survive marked latest blow to department store/mall sector.]

REIT analysts at Canaccord Genuity Group see a similar trend in their latest quarterly retail tenant sentiment survey.

While retailer expansion sentiment has certainly diminished following the latest round of store closure announcements, the financial service firm notes the number of publicly held retailers planning expansions still outnumber those planning to contract.

But for both sets of retailers, Canaccord Genuity said the focus is no longer about having the largest number of stores in the most locations. Now, it's all about locating better-performing stores in higher-rated malls or centers, even if that means having much fewer overall stores.

Top performing malls have no shortage of healthier retailers eager to locate in those top-performing malls and centers, including H&M, Zara, Francesca’s, Skechers and VF Corp.

Others, such as Urban Outfitters, Cheesecake Factory and Starbucks, are investing in larger store formats, resulting in a rising share of capex targeting the most productive markets and malls, Canaccord noted.

New Retail Environment Doubly Challenging for Struggling Malls


However, with fewer retailers looking to expand in malls, and those that are increasingly focused on the top-performing properties, owners and investors facing the prospects of an out-of-favor property that has lost anchor stores are finding it harder than ever to turn such a property around -- even when investors are willing to take a big chance with a new crop of tenants and new uses.

Consider the recent experience of three of the six malls with the unfortunate distinction of having a triple-whammy - each having three of their anchors as Macy's, Sears and JC Penney, and all slated for closure: Vallco Shopping Mall in Cupertino, CA; Gallery at Military Circle, Norfolk, VA; and Gulf View Square, Port Richey, FL.

A common strategy for owners of mostly empty malls that nevertheless have a strong location in a prime trade area is to partner with local governments to help forge plans for a long-term turnaround, especially jurisdictions interested in restoring revenue from lost retail sales taxes. Such was the case in Cupertino and Norfolk.

To evaluate the relative strengths and weaknesses of specific retail locations, CoStar research has developed a proprietary Location Quality Score (LQS) based on the characteristics of more than 1.5 million retail properties in the CoStar database. The 0 to 100 score can offer insight as to whether a store closure is warranted by a location in a poor trade area, or whether it is in a good trade area but just too close to another of the retailer's stores, in which case the location could support a different retail user.

In California, the Vallco Shopping Mall in Cupertino, CA, which carries a strong CoStar LQS of 99, attracted the interest of Sand Hill Property Co., which was working with the city on a large-scale redevelopment of the former mall.

In Virginia, The Norfolk Economic Development Authority achieved recent success in its effort to turnaround The Gallery at Military Circle, a mall which carries an LQS of 87 even while the property is still held as an REO asset by its lender.

And in Florida, the new owners at the Gulf View Square near Tampa are shooting for a quick turnaround with the help of several other investors willing to back them up. That mall carries a much lower location quality score of 41. The average mall score across the US is 77. Class C mall locations average an LQS of 61.

Vallco Shopping Mall


After Sand Hill Property Co., a Menlo Park, CA-based real estate investment and development firm, purchased the 1.2 million-square-foot mall in late 2014 for $120 million from four separate owners, it revealed a $3 billion project to raze the outdated mall and replace it with a range of new uses and community amenities.

The proposed mixed-use town center has been named the Hills at Vallco. The defining component of the project is a 30-acre elevated park that will serve as the largest 'green roof' in the world. Beneath the rooftop park, Sand Hill planned a 15-block, mixed-use street grid with 625,000 square feet of retail, 2 million square feet of office and 800 residential units.

The plan requires the site to be rezoned, and in Cupertino that requires voter approval. Despite heavy promotion by Sand Hill, voters turned down the first rezoning attempt last November.

"Today, traditional regional malls are losing market share, and only the strong survive,” Sand Hill argued. “For the last many years, Vallco has been ranked last amongst all regional malls in the South Bay and Peninsula and been unable to compete with other malls in the trade area. Vallco has become irrelevant in today’s market and remains a tired eyesore that doesn’t serve our community.”

The rezoning application is currently on hold. It remains unclear if Sand Hill will seek to negotiate a new Vallco deal, possibly with lower office density.

The Gallery at Military Circle


The Gallery at Military Circle was Norfolk's first indoor shopping mall and once the region's premier retail destination. Today, many of the storefronts in the mall lie vacant and the attached former Doubletree Hotel is an abandoned black eye on the property.

Although the retail atmosphere at the mall is mostly grim, the surrounding area features several bright spots, such as major employer Sentara Medical Group, and other office buildings nearby, ULI noted. Additionally, the recent construction of the nearby Military Highway light rail station has the potential to attract more workers and shoppers from across Norfolk.

After its foreclosure in August 2015, city officials approached the special servicer for the trust with a novel concept. After studying the market, city officials believed they could serve an unmet need in the market for office users looking for extra-large floor plates to house all their operations on one floor.

The Norfolk Economic Development Authority offered to buy the former JCPenney anchor location and surrounding 1,400 parking spaces for $2.5 million in 2014 and invest $18 million to convert it into office space.

This month, Sentara Medical Group subsidiary Optima Health leased 45,000 square feet in the former store for a new customer support and operations center. That lease follows the previous commitment by Movement Mortgage to relocate from Virginia Beach to take 90,000 square feet in the converted anchor store space.

Gulf View Square


Late last month, Washington Prime Group sold its troubled Gulf View Square in Port Richey, FL, to Namdar Realty Group of Great Neck, NY, for $15 million or about $20/square foot. Washington Prime listed the 756,098-square-foot as being 92.1% occupied as of Dec. 31, 2016. The property carries a CoStar LQS of 41.

Namdar Realty, a privately held commercial real estate investment and management firm, owns more than 15 million square feet of commercial real estate. With a special interest in distressed retail property, Namdar has been especially busy lately. Since 2013, it has purchased more than 11.3 million square feet paying more than $436.7 million or about $38.65/square foot.

About half of its square footage could be considered in some sort of distress with high vacancies, deferred maintenance, purchased in foreclosure, etc. The company’s strategy is to buy at a bargain, quickly improve the properties, and then lease them at below-market rents.

While inherently risky, Namdar's real estate strategy has won investor backing. Namco Ltd., an affiliate of Namdar, this past December completed a public bond offering in Israel raising about $115 million. Standard & Poor’s Maalot, an Israel-based bond rating agency, gave the firm’s offering a rating equivalent of a BB.

While noting Namdar’s “aggressive” acquisition strategy, S&P Maalot said the company has a proven capability in upgrading such properties in a short time, which helps mitigate the risks.

S&P Maalot expected Namco to maintain an adjusted EBITDA to financial expenses over 4x and debt to debt and equity to 55%.

For more information on the CoStar Location Quality Score, please contact:
Suzanne Mulvee, Director of Research and Senior Real Estate Strategist or Ryan McCullough, Senior Real Estate Economist.

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