Shopping Malls: An Endangered Species?

"Retail Heaven" was once a term applied to thriving malls and bustling shopping centers. Today, "Retail Heaven" refers to that little place in the sky where retail stores and entire …

"Retail Heaven" was once a term applied to thriving malls and bustling shopping centers. Today, "Retail Heaven" refers to that little place in the sky where retail stores and entire chains go when they cease to exist. It has become quite crowded lately.

As the rest of the economy falters, so, too, has the retail industry. But at the end of this cycle it may not be able to dust itself off and begin rebuilding, as will many other sectors, including the housing, stock and office markets. Instead, the retail industry will notice that its inventory has shrunk, as have its suppliers.

We already know that Linens N’ Things, Circuit City, Mervyn’s and Steve & Barry’s won’t survive the downturn, while other retailers like Virgin Megastore, Starbucks and Macy’s are significantly cutting back on their spatial and workforce needs. In fact, Macy’s just announced that it will cut approximately 7,000 jobs—or 4 percent of its workforce—in an effort to survive. Macy’s also reduced its quarterly dividend from 13.25 cents to five cents a share. The large problem that major retailers like Macy’s are facing is not just that in-store sales are dropping—despite significant price reductions—but that many of these companies’ vendors are also experiencing extreme difficulties. Liz Claiborne, a popular brand sold at Macy’s, is cutting 725 jobs, or 8 percent of its workforce, as it struggles to stay afloat. The company’s stock took another hit Feb. 2 when it dropped 17 cents, or 7.7 percent, to $2.03. The Dow Jones Newswire estimated that Liz Claiborne stock has plummeted nearly 90 percent since this past September.

Best Buy is another major retailer that may be vicariously affected by its vendors’ woes. Electronics giant Apple experienced a 17.4 percent drop in last December’s sales, compared to those of 2007, reports estimate. So it’s no surprise, then, that a large chain like Best Buy, which relies on popular brands like Apple to keep its sales robust, experienced a 6.5 percent decline in sales in the fourth quarter of 2008, compared to a year ago.

Aside from watching one’s stocks in various retailers plummet, there are other reasons why investors should keep their eyes on the retail landscape.

The Fall of the Mall

One of the largest reasons is that this downturn, combined with the worst holiday sales on recent record, may bring about the extinction of the traditional mall as we know it.

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According to the U.S. Census, there were 47,104 malls and shopping centers in America in 2003. Last year alone brought about the demise of 148,000 retail stores. If you do the math, that would mean that every major retail center in America lost more than three of its tenants. Though there are variables to account for, such as malls that shuttered altogether, retailers that simply relocated, new retailers that filled empty spaces and those businesses that would have failed in any market, the numbers are still scary. As frightening as this information may be, however, Robert Bach, senior vice president and chief economist at Grubb & Ellis, noted that this does not spell doom and gloom for the entire retail world—just certain factions of it.

"Regional home improvement and home furnishings stores, mid-range department stores and casual dining retailers are most at risk," he said. "[While] lower price-point retailers have done relatively better, such as McDonald’s, Wal-Mart, dollar stores and warehouse stores."

The problem for the traditional shopping mall is that it typically contains those department stores and casual dining retailers, and while many also boast a McDonald’s, few contain big-box retailers like Wal-Mart or Target, or warehouse stores like Costco or Sam’s Club. Instead, they contain mid-sized retailers and department stores… like Linens N’ Things, Steve & Barry’s, Virgin Megastore, Macy’s and the late Robinsons-May.

Struggling restaurant sales are also hurting malls. The Restaurant Performance Index (RPI), which is released by the National Restaurant Association, stated that 66 percent of restaurant operators reported a decline in their December sales. The association, which is composed of 945,000 restaurants and foodservice outlets, noted that this was the highest number on record, though the monthly performance index cited that 60 percent of operators reported sales declines in September, October and November of last year. Bach also noted that "grocery stores are taking market share from restaurants."

By all accounts, December should be a strong month for malls, as it produces the majority of holiday sales, which account for a significant portion of a retailer’s yearly revenue. This year, however, that was not the case, as the International Council of Shopping Centers (ICSC) asserted that 2008 was the weakest holiday season it had seen in nearly 40 years.

Based on the gloomy numbers it has seen, the council believed that another 150,000 stores may be closing in 2009, which will include stores from Footlocker, Bombay Company, Sharper Image and Pacific Sunwear. When the dust settles, ICSC estimates that this recession will have wiped out 15 percent of the current retail industry by 2011.

Down, but not completely out

With the tremendous amount of space that is and will continue coming back on line, retail construction will be virtually nil for the next few years. Instead, shopping center investors should focus on what repairs and improvements they can feasibly postpone for the next few years, which tenants are going under or on the brink, how much and when debt is coming due and whether refinancing may alleviate some of the burden—if it is even possibile.

REIT investors must also stay on top of their game. In December, the IRS ruled that REITs, including shopping mall maven Macerich, whose shares yield approximately 20 percent, can pay a maximum of 90 percent of their dividends in stock. This is an attractive option in a market where everyone is vying for liquidity. Bloomberg estimates that this pay-out swap could save the REIT industry up to $10 billion a year.

Despite the grim forecast for retailers and shopping malls across the country, Bach predicted that there are some product types and regions that will weather the recession better than others. "Strong malls will be fine, but older malls with deteriorating trade areas or newer centers down the road will be renovated or redeveloped for other uses," he said. "Lifestyle centers [are also] holding up better because they typically have lower common area maintenance charges than enclosed malls, and it’s a relatively new and fresh concept. But leasing and development activity at lifestyle centers also has slowed."

Retail leasing activity is not anticipated to pick up, and investors entrenched in some of these older malls or fledgling areas may want to consider reusing vacant space for other purposes. Vacated space of any size, from small boutiques to large department stores, can be converted into warehouses, offices, call centers, customer service centers or even utilized for mall administrative needs, such as security, lost and found, first aid or a leasing office.

Bach also noted that retailers are doing the best in "the swath of states stretching from Texas northward through the Dakotas and Montana because their economies are based on energy, commodities and agriculture, which, until recently, had been a bright spot."

Other optimistic markets include Seattle, the District of Columbia, Raleigh-Durham, Philadelphia and Boston, as Bach noted that "every area has been affected [by the recession], but these areas have been more resilient so far."

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