The retail real estate sector could be on the verge of a major upheaval, beyond the near steady stream of headlines about brick-and-mortar store closures and bankruptcies in recent weeks.
Many experts now believe the troubles will move upstream to landlords and property managers of American malls and shopping centers.
Steve Wybo, a senior managing partner in Birmingham at turnaround firm Conway MacKenzie Inc., said he can easily envision a dire scenario ahead for property owners and the large financial institutions that service the debt on commercial mortgage backed securities (CMBS). Many developers have used CMBS to finance their retail real estate deals for more than a decade.
“A commercial property is only as good as its tenants,” Wybo said. “If J.C. Penney (hypothetically) goes out of business or files for bankruptcy and rejects all their leases, you’ve suddenly lost millions and millions of square footage of rental income, which effectively is the net operating income calculated in these debt service coverage ratios.”
Because of heightened competition from online outlets like Amazon, retail stores have experienced a seismic shift for years, but the pace of change has ramped up in recent months. Financial services firm Credit Suisse reports that 2,880 stores closed in 2017 through April 6, up from 1,153 in the same period a year ago, according to multiple reports. If that pace continues, Credit Suisse analysts project store closings could surpass 8,640 this year. That’s well ahead of the depths of the Great Recession in 2008, the worst year on record when around 6,200 stores closed, Bloomberg reported last month.
So far this year, more than a dozen retailers have filed for bankruptcy — more than all of last year, according to Business Insider. They include Payless Inc., Gordmans Stores Inc., Gander Mountain Co. Inc., The Wet Seal LLC, Limited Stores Co. LLC, and RadioShack.
In West Michigan, legacy retailers J.C. Penney, Sears, K-Mart and Macy’s have all announced store closures, while Grand Rapids-based Family Christian Stores shut down its operations just two years after emerging from bankruptcy.
Additionally, the parent company of MC Sports filed for Chapter 11 bankruptcy and is in the process of liquidating all of its 68 stores across the Midwest.
Once those stores begin to close as inventory is liquidated, the landlords of the empty big-box stores will need to get creative with backfilling the space to cover their payments, Wybo said.
“When you lose tenants, your income goes down and your debt service is the same,” he said. “We’re seeing that right now.”
CAUSE FOR CONCERN?
While Wybo continues to monitor the ability of large commercial property owners to make debt payments amid a string of retail closures, recent reports show there’s minimal reason for concern, at least currently.
In an April report, Trepp LLC, a New York City-based data and analytics firm that monitors the CMBS industry, noted that 86 percent of the maturing debt last month was paid in full, either at its maturity date or before.
“Though there was plenty of madness in March, the final result of maturing CMBS performance was a positive one,” according to the Trepp report.
The impact of any hiccup with CMBS could have a muted effect on West Michigan. In part, that’s because most long-standing CMBS debt is concentrated in major coastal metropolitan areas, as well as in booming Sun Belt regions like Dallas, Houston and Phoenix.
By and large, commercial real estate brokers say they still consider West Michigan to be an attractive and relatively safe market for investment, even while noting they’re closely monitoring concerns of a CMBS bubble.
“Nationally, it’s a huge deal,” said Michael Visser, a senior associate focused on the investment market in the Grand Rapids office of Colliers International Inc., a commercial real estate brokerage firm.
Visser added that tens of billions of dollars of CMBS debt will come due on commercial real estate developments all over the country in the coming years.
“We’re isolated in West Michigan,” Visser said. “But when you look at the markets that were hot in 2004 through 2008, who were putting debt on and structuring their equity — or lack thereof — it’s an issue.”
LOCATION, LOCATION, LOCATION
To Visser’s point, the Grand Rapids market in many ways continues to buck the conventional wisdom when it comes to the strength of retail.
For instance, Pennsylvania Real Estate Investment Trust (PREIT) announced earlier this year that it would buy back the lease of a 316,000-square-foot Sears department store in Woodland Mall in Grand Rapids.
The move allows the Philadelphia-based owner of the 1.17 million-square-foot Grand Rapids mall to move forward with redeveloping an entire aging wing of the facility.
High-end department store Von Maur will take at least part of the space once the redevelopment is completed, as MiBiz reported in January. An expanded Apple Inc. retail store also recently opened in Woodland Mall. A handful of other high-end retailers have been “proposed” for both the interior and exterior portions of the facility, although the company has yet to confirm the other leases.
All told, PREIT executives have said they plan to invest around $100 million into the facility in the coming years.
Joe Coradino, PREIT CEO told MiBiz in an email that modern consumers increasingly want options such as gyms, grocery stores and entertainment concepts as part of their broad shopping experience.
Commercial real estate sources contend that Woodland Mall’s location along one of the busiest retail corridors in the region will continue to make it popular with a variety of shoppers.
“In my opinion, it’s dynamite location,” Jeff Hainer, a senior research analyst with Colliers International in Grand Rapids, said of the mall’s success. “It’s just (being) on the corner of Main and Main that’s helped sustain it. It’s on the way to anything.”
Commercial real estate sources say the malls that can cater to high-end shoppers and offer an “experience” rather than just a place to shop have the best chances of survival. Even so, some experts say the ongoing struggles of legacy mall anchors such as Sears and Macy’s will prove detrimental to mall owners for years to come.
“You’ve got some niche type players that will survive (as) brick and mortar (stores) — obviously grocery stores,” said Wybo of Conway MacKenzie. “Maybe you put in a Whole Foods or a Trader Joe’s that could occupy that space. But it takes a lot of fast-casual restaurants to fill up a big retailer. And it takes a lot of niche retailers to fill those big box platforms.”
A PLACE TO INVEST
Even with the doom and gloom surrounding brick-and-mortar retail as more consumers shift their buying habits to e-commerce platforms, multiple real estate experts say the market is merely going through a correction period and that overall financial hardship will be limited.
“People didn’t anticipate this would be an issue when they put out … a 10-year mortgage,” said Nyal Deems, a partner focused on real estate transaction law in the Grand Rapids office of Varnum LLP.
“But now times have changed over the 10 years and the internet became a much bigger factor than we anticipated,” Deems said. “It’s there to be dealt with. It’s an adjustment that will burn some people and some others will find ways to get through it. I don’t think it’s a big bubble. I think it’s an issue and the people holding those securities should start looking hard at what they can do.”
Other industry watchers share his belief that the retail sector is going through a market correction, but it’s the extent of that shift that’s up for debate.
“I just don’t see the retail storefront space in malls, especially in enclosed structures, ever being what it once was,” Wybo said.
Nonetheless, he concedes that even if a retail bubble were to burst, it would be nowhere near as devastating to the economy as the Great Recession.
“I don’t think it will be the same as the residential mortgage bubble by any stretch because those directly impacted you and I when our houses went from $300,000 to $150,000,” he said, adding that the housing bubble brought about a massive downward spending trend by Americans and sent ripples throughout the economy.
Instead, he expects ordinary Americans will only further continue to spend money on e-commerce retailers.
“I think people will still spend money,” Wybo said. “Disposable incomes are up, the market is at an all-time high. The income is there (even though) it’s not great by any stretch. People will still spend money on Amazon and everywhere else when they can still get these same products at a cheaper price or a more convenient way.”