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The JCPenney / Sears Effect Part I: Retail REITs Target Malls for Pruning Portfolios

As These Major Anchors Become Outdated and Outmaneuvered, Retail REITs Struggle to Reposition Their Portfolios
April 30, 2014
There was a time not so long ago when no self-respecting mall would consider opening without JCPenney or Sears as one of its major department store anchors. Today, the nation’s major shopping mall/center REITs are doing everything possible to dump as much of their holdings containing the once unstoppable retailers in favor of what they see as higher-producing properties with growth potential.

As a result, the market is now flooded with opportunities to pick up B- and C-rated malls in secondary and tertiary markets across the country.

The REITS don’t come right out and say they’re discarding their JCPenney/Sears holdings. They couch it by using such terms as "non-core," "Tier 3," "bottom-half" and "underperforming." But make no mistake, they’re largely talking about malls anchored by the two troubled retailers.

For Part II of our JCPenney / Sears Effect story on individual malls and who potential buyers are, please click here.

Glimcher Realty Trust this month announced plans to sell three to four of its malls to raise $200 million to $300 million of capital. The REIT hired Eastdil Secured, a subsidiary of Wells Fargo & Co., to list and market 13 of its regional shopping malls with the goal of selling three or four. They identified the 13 properties that will be listed for sale without publicizing their retail anchors. According to CoStar's information, 10 of the 13 malls have both JCPenney and Sears as anchors; two have one or the other and only one has neither.

"The idea behind listing the larger portfolio is that we don’t want to guess or assume which properties the market will be most interested in," explained Michael Glimcher, chairman and CEO of Glimcher Realty. "By offering a larger selection, we believe that we’ll be in a best position to maximize the element pricing and execution of our strategy."

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The 13 retail centers combined generate average sales per square foot in the mid $300s.

"We would like to have a portfolio doing in excess of $500 a foot delivering 3% to 5% growth," Glimcher said.

Could it sell more of the 13 properties than three or four? Sure.

"We are evolving; we are more than midway through our evolution; and it’s step by step. This is a very measured process, so it’s three to four assets, it’s not a massive portfolio today but if it gets a little bit bigger, it’s certainly something we would consider but don’t have to do," Glimcher said.

In addition to the 13 malls that Glimcher will start marketing, the REIT has been shopping another one since the start of the year: the Eastland Mall in Columbus, Ohio. It too has JCPenney and Sears as anchors.

In the case of this property, if the REIT doesn’t find a buyer in the next month or two, it plans to allow the mall to go back to the loan holder on $40 million note. The lender could then pick it up for about $28 per square foot.

"We believe dispositions represent an important part of our three-tiered approach to remixing our assets and establishing a higher quality mall portfolio," Glimcher added. "We are optimistic about the current market environment and believe this disposition plan allows us to continue to build upon our success, ultimately making us a stronger company."

Aging Population, Aging Malls

So what’s gone wrong with once-celebrated retailers of a bygone generation that their landlords want to ditch them as fast as they can?

"There are a few factors, in my view, that impact the current [mall] repositioning trend," said Jim Carr, president and CEO of Vistacor LLC, a real estate services firm in Norfolk, VA. "In the 1970s, Sears and JCPenney pushed the growth of shopping malls, which were mainly attended by post WWII families. By the early 1980s, Sears was the largest retailer in the world."

"But in the second half of the1980s and into the 1990s the Baby Boomers were growing up and at the peak of their consuming activities," Carr continued. "They influenced the 'category killers' like Toys R Us or Best Buy and discounters like TJ Maxx, which collectively laid waste to Sears - as did upstart Walmart."

"It also laid waste to the enclosed shopping malls that were part of the Sears/JCPenney growth plan and ushered in the era of the ‘power center,’ " said Carr.

"Add to this the loud ‘thunk’ everyone heard in 2008 as total retail sales fell off a cliff (in relative terms), dropping about 10% for the first time in anyone's memory. That really shook the markets for retail space. That caused everyone from Nordstrom's to Family Dollar (to) look hard at their business model. Even the most recent phenomenon, the ‘lifestyle center,’ is losing tenants like Coldwater Creek and others," Carr said.

Steven Blair, senior vice president of Strategic Property Associates in Foothill Ranch, California, said that the major factor driving the repositioning, either through spinoffs or dispositions, of retail shopping centers is the rapidly changing retail landscape.

"Shopping center owners, especially those owners with large mall holdings, realize that the malls which are not centrally located in their respective retail markets are becoming rapidly out dated," Blair said. "A number of these malls are anchored by tenants such as JCPenney or Sears."

And softening retail sales among such aging retailers is bad news for shopping center owners.

"In a number of cases," Blair said, "these tenants are not owned by the shopping center owner but owned by the company themselves, or have extremely favorable long term leases, leaving the owner with little control or options for these spaces. Some of these non-owned anchors can take as much as 40% of the net rentable space."

The Market for B- and C-Rated Malls

Another reason why the big mall owners are choosing to sell off Class B- and C-rated malls, is that it appears now is a good time.

According to data from CoStar COMPs, the number of 3- and 4-star rated (i.e. mostly Class B) shopping centers sold in 2013 was the highest in years, totaling $50 billion in volume, up from $35 billion in each of the previous two years.

Prices on those properties have bounced around quarter to quarter from a low of $100 per square foot to a high of $160 per square foot. The average sale price for such properties in the first quarter of this year is about $140 per square foot.

Sales of CoStar’s 1- and 2-star rated (i.e. mostly Class C) shopping centers are following the same pattern. Sales volume soared in 2013 to $35 billion from around $20 billion in each of the two previous years. Sales prices in this group also bounced around quarter to quarter from a low of about $75 per square foot to a high of $175 per square foot. First quarter 2014 sales averaged about $125 per square foot.

According to the REITs, there is quite a bit of investor interest in B mall segment.

To attract those investors, Glimcher, in particular, identified malls that have average retail sales of approximately $300 per square foot, noting that such malls are easier to finance and can be refinanced through a CMBS securitization. Below that retail sales threshold, financing options are still available but more limited, the company said.

The strength of the investor activity may not be favoring Sears and JCPenney-anchored centers, however.

According to CoStar COMPs data, sales of malls with one or the other or both of these two tenants have held fairly steady at around $1.5 billion a year for each of the last two years, well down from the sales of such properties in 2011.

The average price per square foot has fallen dramatically, from $189 in 2011, to $85 in 2012, $76 in 2013 and $72 in the first quarter of this year.

This week, CBL & Associates, a Chattanooga-based retail REIT announced that it contracted to sell its 489,030-square-foot, JCPenney- and Sears-anchored Lakeshore Mall in Sebring, FL, for $14 million, or just about $29 per square foot. The mall also includes Kmart as an anchor, another Sears-owned company. The buyer was not identified and the deal is expected to close in May.

In January, a CMBS loan holder foreclosed on another CBL-owned property: the 1.08 million-square-foot, Sears- and JPenney-anchored Citadel Mall in Charleston, SC, for $65 million or about $60 per square foot.

The type of buyers interested in malls anchored by the two tenants has changed over the past couple of years. In 2011, major institutional investors represented the bulk of the buyers. However, as prices have come down, private individual investors have made up the bulk of the buyers since 2013.

Assessing at Risk Space

REIT analyst Ki Bin Kim of SunTrust Robinson Humphrey, estimates that U.S. mall REITs have 16.6% of their gross leasable area leased to JCPenney and Sears, but only 8.9% of that space is considered to be ‘at-risk,’ according to Kim.

"Assessing the quality of the of ‘at-risk’ JCP/Sears space is more important than simply summing the quantity of GLA (gross leasing area) because having a JCP/Sears lease in a high quality center can be an opportunity to create value vs. risk," Kim said. "Many of the Sears/JCP leases pay practically minimal rents of $2 to $4 per square foot. If this space happened to be vacated (and re-leased) at a higher quality mall, it could provide measurable upside."

"Overall, we estimate that U.S. malls are well situated to absorb JCP and Sears store closures, as long as it doesn’t occur at the same time, overnight," the SunTrust Robinson Humphrey analyst said.

Kim considers mall REITs that have the lowest ‘at-risk’ exposure to be Taubman Centers, Westfield U.S., Simon Property Group, Macerich and General Growth Properties, in that order. In assessing their exposure, the majority of JCP/Sears leases in their portfolios are generally located in higher-quality malls, in space that has a higher likelihood of being re-leased at a better economic rent.

"Conversely, Kim added, "We estimate that CBL & Associates, Rouse (a GGP spin-off), Washington Prime Group (Simon Property Group's selection of malls to be spun off) and Pennsylvania Real Estate Trust are at relatively more risk, in order of most to least risk," Kim said.

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