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The JCPenney / Sears Effect Part II: Retail Center Owners, Tenants Seek Out Growth Opportunities Through Repositioning

Mixed-Use Centers and Gateway Markets Represent the Future for Owners and Tenants
May 5, 2014
Like other major retail REITs across the country, The Macerich Co. (NYSE:MAC) has moved aggressively to dispose of its JCPenney- and Sears-anchored centers. Over the last several years, the one-time retailing pioneers that drove the spread of shopping malls have been hit hard by changing consumer preferences, shopping patterns and shifting demographics around their locations.

"Although we had already substantially improved our portfolio, we decided in 2013 to pursue a strategy of further upgrading our asset base by disposing of additional non-core assets, those with lower sales productivity and slower-growing net operating income (NOI)," Arthur M. Coppola, chairman and CEO of Macerich, wrote to stockholders this spring. "We successfully disposed of eight malls and one office complex during 2013 and generated gross sales proceeds of $856 million."

RELATED ARTICLE: For the first part of this series, The JCPenney / Sears Effect Part I: Retail REITs Target Malls for Pruning Portfolios, click here.

Unlike competitors GGP and Simon Property Group, Macerich decided not to separate its core and non-core malls through a spin-off or corporate reorganization.

"We elected not to follow this strategy because we wanted to retain the proceeds from our non-core dispositions to benefit our stockholders by investing those proceeds into our proven centers and new centers," Coppola said.

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With respect to JCPenney and Sears, Coppola believes his company has substantially reduced the relative risk from JCPenney and Sears stores in its portfolio through the recent disposition program.

During the past quarter, Macerich sold Lake Square Mall in Leesburg, Florida (with JCP and Sears as anchors); Rotterdam Square in Schenectady, New York (Sears); and Somersville Towne Center in Antioch, California (Sears and Kmart). The total sales proceeds were $34.1 million. The average tenant sales-per-square foot of these centers was $244.

Following the dispositions, 89% of Macerich’s net operating income (NOI) is now generated from properties that average sales in excess of $600 per square foot and are located in some of the most densely populated and fastest-growing markets in the U.S.

The profile of Macerich’s current portfolio is described as the prototype of where some in the industry see as the future of the shopping mall market.

The second largest loan in a new CMBS this spring from Goldman Sachs (GS Mortgage Securities Trust 2014-GC20) is on the Greene Town Center, an open-air, mixed-use lifestyle center in Beavercreek, Ohio, about 10 miles southeast of the Dayton central business district.

The retail property backing the $90 million loan measures 566,634 square feet of retail space and includes 143,343 square feet of office and 206 residential units. The center is anchored by a Von Maur department store, which signed a 130,000-square-foot ground lease, and Urban Active Fitness, which leased 51,414 square feet.

According to Fitch Ratings in its presale CMBS report, this retail center is considered to have a competitive edge over its primary competitors: The Dayton Mall and The Mall at Fairfield Commons, both of which have Sears and JCPenney as anchors.

Retail tenants have been fleeing the competing malls. The following stores have closed at one or both of those competitors and remained open or relocated to Greene Town Center: Eddie Bauer, Stride Rite, Talbot’s, Express, Gap, Ann Taylor Loft, Chico’s and CJ Banks.

The movement among popular retailers toward mixed-use and lifestyle centers is likely to continue and possibly accelerate. According to the popular eatery The Cheesecake Factory, virtually every shopping center landlord wants to put restaurants in their centers.

"I know that some of the larger groups out there are remodeling at least 20% of their spaces," said Cheesecake Factory David Overton chairman and CEO. "They are adding on, there are lots of things happening, they are adding condos, they are adding businesses, they are adding offices. A lot of these centers are going to be multi-used and they are going to be perfect for a restaurant like ours."

However, Overton added, "The B and C malls are another story. We are not in them, thank goodness, that’s not our problem."

Weeding Out Faltering Malls

Some of the lower-quality properties anchored by both JCPenney and Sears are leaving owners, potential buyers, lenders and existing retailers with a lack of confidence in properties with few attractive options for re-leasing the space.

REIT’s try to sell them because their low sales drag down the sales numbers they report corporately and more importantly, the cost of re-leasing them creates a huge strain on the portfolio where higher rents in Class A properties are otherwise achievable.

However, that doesn’t mean that the big REITs are abandoning or neglecting all such properties. Analysts at Morgan Stanley Research noted that Simon Property Group recently refinanced West Ridge Mall via a $53.9 million loan securitized in a new CMBS loan this spring (COMM 2014-CCRE16 Mortgage Trust). The mall is one of the first among those Simon previously identified to spin off to be refinanced, making it an interesting case study.

"This is especially true since our previous analysis suggested that West Ridge Mall may be difficult to refinance," Morgan Stanley analyst Richard Hill said.

West Ridge Mall was previously encumbered with nearly $65 million and Morgan Stanley had previously projected a valuation of $68.9 million. The mall was subsequently re-appraised at $67.8 million, which suggested $20 million or more of equity would be needed to refinance on a standalone basis, Hill said. Instead, Simon used a creative strategy of pooling the property with another nearby strip center it owned (West Ridge Plaza) that was previously unencumbered.

"This refinancing strategy may demonstrate a commitment by (Washington Prime, Simon’s newly formed spin-off company) to certain assets that fit their target profile. Consider that the West Ridge Mall property is the only traditional regional mall within approximately 45 miles of Topeka, Kansas,” Hill said.

Finding Emerging Buyers

"The solution owners of these slow-dying centers must be searching for is a significant player coming along to purchase the spinoff, or a select portfolio of properties that has the ability to execute a different retail strategy or other use for the property effectively changing the real estate play," noted Steven Blair of Strategic Property Associates." Not an easy task and one that will take innovation, not a greater fool."

So what prospective buyers are most likely to take on the challenge?

Gerald Divaris, chairman and CEO of Divaris Real Estate in Virginia Beach, Virginia, said it could still be other REITs.

"There are various REITs in the market, some of whom look for acquisitions in tertiary markets," Divaris said. "Depending on cap rates, they could be buyers for some of these properties.

In particular Divaris said there are 'value creation' buyers who acquire properties that no longer fit the required profile of their owners.

"These buyers purchase properties to re-position and re-tenant the property, before taking it back to market," he added.

In those cases, the location of the real estate still may be attractive to other users, such as specialty food, medical, education and service businesses. These are the types of companies that are most actively back-filling these properties, he added.

Other retail executives and industry analysts said many of these centers can be adapted to fill a need for mixed use space housing local or regional tenants within a smaller or less populated trade area. Some of these properties are true de-malling projects and may only have a future as something totally different.

In such cases, prospective buyers are most likely private equity 'value-add' or 'opportunistic' real estate funds. The exact nature of the buyer for any given property will depend on the risk associated with the specific property, which will depend on the business health of the remaining tenants and attractiveness of the center’s location.

"For example, if the center is entirely reliant on Sears for drawing traffic, then a total re-positioning may need to be contemplated," said George A. Pandaleon, president of Inland Institutional Capital Partners in Oak Brook, IL. "In fact, the real estate may be better off converted to another use like education, medical, or even self-storage."

However, if Sears or JC Penney is one of four to five otherwise strong anchors, then the repositioning effort may be less intense. "In fact, to the extent that a landlord has the ability to re-capture a slower Sears or JCPenney box within an otherwise vibrant center, this could be an opportunity to boost the center’s long term rate of return," Pandaleon added. "In that case, replacement tenants could include discount stores such as Target. If the opportunity appears attractive enough, the REIT may decide not to sell the center and instead re-position the mall itself."

The Case of Southlake Mall

One such buyer with that in mind is Vintage Real Estate of Los Angeles, which acquired the 1 million+ square-foot Southlake Mall in Morrow, Georgia, a suburb of Atlanta, last month for $37.1 million or a little less than $37/square foot. Anchored by Macy’s, Sears and the Morrow Center, the city’s events venue, the mall posts annual sales of over $100 million.

General Growth Properties, who filed for bankruptcy in April 2009, bought the mall in 1997 and renovated it in 1999. In 2007, General Growth Properties placed $100 million of debt on the property. The lender foreclosed on the mall in February 2013.

Southlake Mall was initially appraised at $80 million in July 2012 with an updated appraisal in May 2013 of $58 million, according to David Ro, a director with Fitch Ratings.

“The wide-range of values speaks to the difficulty in pricing distressed, second-tier mall assets,” Ro said. “Despite these pricing challenges, steady demand for these assets has emerged. With large institutional owners unwilling to hold and stabilize these properties; smaller, more nimble investment shops continue to show interest in acquiring assets at discounted values to justify the risk of acquisition and redevelopment.”

Vintage has immediate plans for significant capital investments to bring in new tenants and restaurants and upgrade the common areas in Southlake Mall, said Fred Sands, chairman of Vintage.

Vintage will redevelop the adjacent 160,000-square-foot building vacated by JCPenney in 2011 which it is under contract to purchase. This building, visible from I-75, opens directly into the mall’s center court.

“We plan to completely transform this space and bring in tenants currently missing from the mall’s ideal merchandising mix such as fashion retailers and popular restaurants,” Sands said.

Foreclosed regional malls such as Southlake Mall typically endure a several-year period of capital constraint leading up to and during the foreclosure process, Sands pointed out. Vintage sees an opportunity to make significant physical renovations and operational improvements at Southlake Mall that will dramatically improve the customer shopping experience, increase foot-traffic and tenant sales and ultimately create jobs for the surrounding community.

Sands indicated that the goal for Vintage Real Estate is to acquire three or four malls or shopping centers per year. He stated, “We have a great broker network and we make sure to support them on any off-market opportunities. After all, those are the people that are going to bring us the deals.”

Buyers See Bright Futures

REITs spinning off or selling non-core assets in secondary markets is nothing new, it’s the pace of change that is accelerating, Kris Cooper, managing director of JLL’s retail investment sales group told CoStar News.

"The major factor driving the sales of non-core retail assets is simple, the centers just don’t fit into REITs (investment) strategy today like they did 10 years ago," Cooper said. "It’s no secret REITs continue to target gateway markets for their acquisitions. But, that doesn’t mean that these centers in secondary markets aren’t performing or won’t have eager buyers."

"We’re seeing assets come to market that have strong cash-on-cash returns, and are a top-producing center in their region and there are plenty of buyers out there for these assets and debt is readily available, allowing these centers to be acquired with leverage. We expect private equity to be the primary buyers of these centers," Cooper said.

"The future is bright for these centers, he added. “A local or regional buyer can do a great job leasing up the vacant space because they are flexible when it comes to tenant requirements. They’re known for thinking creatively, and have the ability to uncover different and non-traditional uses for the space."

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