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Toys R Us Closings May Prove Fortunate to Most Landlords

No One Likes Losing an Anchor Tenant but Toys R Us Closures Likely to Produce More Upside than Down
January 30, 2018
The Plant San Jose

The announcement from Toys R Us last week that it will initially be closing up to 182 stores by April could end up being a positive for many of the landlords impacted.

A significant, if not majority, of the properties are located in strong retail trade areas with attractive shopping demographics. In addition, retail properties near or in the shopping centers with stores slated for closure that are financed by publicly held loans in commercial mortgage backed securities (CMBS) have been reporting strong financial results.

As part of its September 2017 Chapter 11 bankruptcy reorganization filings, Toys ‘R Us announced last week it planned to close 182 stores, approximately one-fifth of all of its U.S. stores. While mass store closure announcements generally create angst among CMBS investors, upon further analysis the closures may actually produce more upside than down, according to John Vecchione, director of CoStar Risk Analytics.

Vecchione found that, while the total CMBS loan exposure to Toys R Us is $20 billion, the recent closure announcements will impact only about $2 billion in CMBS loans. When CoStar’s Location Quality Score is applied to this collateral, it revealed that locations backed by just $400 million of the CMBS loans was located in poor trade areas with a higher risk of replacing Toys R Us with a lesser tenant, or not being able to fill the space at all.

CoStar's proprietary Location Quality Score (LQS) uses multiple variables, including trade area incomes, retail density and market competition to evaluate the productivity of more than 1.5 million retail properties in the CoStar database.

The CoStar LQS can provide insight as to whether the store closure is warranted by a location in a poor trade area, or whether it is in a trade area likely to support a different retail user.

Toys R Us and Babies R Us have an average LQS of 70 (out of 100), which is in line with the score for the average U.S. mall. By way of comparison, one of Toys R Us’ main competitors, Walmart, has a store portfolio where the average LQS is closer to 58.

"In determining the full CMBS loan exposure to Toys R Us, we expanded our research beyond the top five tenants provided in standard CMBS reporting. Utilizing CoStar’s tenant research, we were able to compile a far more comprehensive list of CMBS loans either directly or indirectly exposed to Toys R Us," Vecchione said. "In the end we were surprised that the majority of CMBS loans exposed to Toys R Us could potentially benefit from the closings."

One such property is The Plant, a 485,895-square-foot shopping center in San Jose. Toys R Us/Babies R Us is the second largest tenant occupying 64,850 square feet under a lease with a January 2023 lease expiration.

The center has been posting strong financial results at 93% occupancy and net operating income through the first nine months of 2017 of $9.98 million - enough NOI to cover its total debt repayment amounts more than two times, according to the latest bondholders' report from last month.

At Pipeline Village East and West in Hurst, TX, Toys R Us operates both a Toys R Us and Babies R Us store occupying 60% of the 132,529 rentable square feet. Toys R Us is closing the 30,790-square-foot Babies R Us but keeping open its 49,210-square-foot Toys R Us, which it reported is profitable and in fact in the top 25% of its stores in the region, according to the latest bondholders' report from last month.

Babies R Us, in fact, make up more than half of the stores Toys R Us announced it is closing, a disproportionate share since the brand accounts for just about one-fourth of its U.S. store portfolio.

CoStar Risk Analytics shows the Pipeline Village property will probably find a tenant but at a lower rent.

Toys R Us is working with A&G Realty Partners to review its leases and has until mid-April to continue its review of its portfolio of more than 790 U.S. stores. It has asked some landlords for a three-week extension to make a determination.

Emilio Amendola, co-president of A&G Realty Partners did not get into specifics but told CoStar that interest in Toys R Us properties "has been very strong."

Other retail analysts agree that the majority of locations being closed may offer upside to their landlords.

"The good news here is that nearly all of the properties are Class A or B locations -- both the shopping center and urban locales -- and solid real estate," said Garrick Brown, vice president - retail intelligence for Cushman & Wakefield. "Toys R Us has, both in the stores they are keeping open and the ones earmarked for closure, a great real estate portfolio."

"The sizes of these stores vary but generally they are 40,000 square feet or less, which means that re-tenanting these spaces will be much easier than if the footprints were larger or if they were not within prime locations already."

Brown said he sees the potential tenant pool for this size box is fairly strong with these sites likely going to grocery, off-price apparel or other mid to junior box users.

That said, Brown added, he would not be surprised if Toys R Us continues to close some locations as leases expire and increasingly see them combining standalone Toys R Us and Babies R Us stores under one roof. As part of its closure announcement, Toys R Us said that will be the case in six of its planned store closures.

Editor's Note: To find which properties have the most upside or to learn more about CoStar Risk Analytics, contact John Vecchione, Director.

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