Trepp LLC

10/28/2020 | News release | Distributed by Public on 10/28/2020 09:46

As Retail Struggles, What Happens to Empty Big-Box Spaces in Malls?

The evolution of the retail commercial property sector has been a topic of interest for quite some time. Due to a shift in consumer preference from brick-and-mortar stores towards online shopping, the retail industry had been experiencing financial stress in recent years. But, with COVID-19 and the resulting shutdowns, the pace of the so-called 'retail apocalypse' has exponentially increased.

As more retailers close up shop in malls, what happens to their empty big-box spaces?

Before the pandemic, some retailers including Sears, Pier 1 Imports, and Toys R Us filed for bankruptcy while others such as Macy's, Forever 21, GAP, and Bed, Bath and Beyond had announced store closures. However, with the impact from the pandemic, the prior slow decline of these retailers suddenly shifted gears. Since March, JCPenney, Neiman Marcus, Ascena Retail Group, Men's Wearhouse, Lord & Taylor, and Brooks Brothers filed for bankruptcy and many others have announced permanent store closures. The latest being GAP, which announced that it would be closing more than 200 stores over the next four years and sharply reducing its mall footprint.

In addition, mall real estate investment trust (REIT) CBL & Associates is expected to file for bankruptcy soon after it missed bond payments earlier this year. At the same time, RetailDive reported that mall owner and operator PREIT received notice of 'alleged events of default' from Wells Fargo on a term loan, according to a securities filing last week.

The distress is also visible in Trepp data. It reveals that the retail CMBS delinquency rate shot up to 18% in June, from below 4% in March. The rate came in at about 15% in September which reflects almost $18 billion worth of loans that are more than 30 days behind payment.

The Conversion of Big-Box Retail

In the current scenario where retailers are looking at closing their high-rent, low-revenue stores, a large number of big-box spaces are now becoming available in malls across America. This has resulted in property owners scratching their heads on how to breathe life back into these spaces. The most obvious solution is re-purposing these spaces into some other type of commercial property which continues to provide good return. The billion-dollar question here is, what?

Many options have been discussed in the commercial real estate industry. Warehouse/Distribution centers, Self-storage, Industrial, Residential Complexes, and Mixed-use with office and retail have emerged as strong contenders. However, a new report from Barclays points out that some of these alternatives could result in massive write-offs in property values.

'Turning a shuttered mall into an e-commerce warehouse or a residential complex could reduce the value of the property anywhere from 60% to 90%', says Ryan Preclaw, a research analyst at Barclays, as reported by CNBC.

He goes on to say that the land that malls sit on may offer better recovery values if it is used for a mixed-use development. Although historically, that has only happened for about 15% of former malls. Considering a long downtime and high cost involved in such a re-purposing of the space, many developers may have shied away from this strategy.

The Switch from Retail to Industrial

In recent months, to maximize asset value (which is most likely much less than its former use), several property owners have either taken or are considering the step to convert these big box retail spaces into industrial warehouses. Back in July, Trepp noted that widespreadrestrictions provided a boost to the industrial sector due to the increasing reliance on online shopping for essentials as a result of the outbreak.

In a recent article, JLL notes that a boom in online shopping has resulted in an increased demand for logistics space. Since most malls are located near densely populated areas with high foot traffic and proximity to large logistics hubs, developers are converting the empty retail spaces into warehouses. The article points to some examples in the U.S.: Randall Park and Euclid Square Malls in Ohio, which have been converted into fulfillment facilities by Seefried Industrial Properties, resulting in a 20% increase in lettable area across the assets.

In July 2020, CBRE published a report stating that across 59 projects that have begun or completed since 2017, about 14 million square feet of former retail space has been converted into 15.2 million square feet of industrial space, most of it for e-commerce distribution.

What About 'Recession-Resistant' Self-Storage to Replace Retail?

Another property type that is also seeing a boom in the retail re-invention area is the self-storage sector. With proximity to population centers, low construction costs, and good access and visibility, many investors and developers are considering converting big retail parcels into a self-storage operation or split it up into smaller retail spaces and a self-storage operation. Bearing in mind that the sector has seen little impact due to the pandemic, the retail-to-self-storage conversion may result in transforming the formerly pandemic-battered retail space to a 'recession-resistant' space.

Of course, there may be many other alternatives that may be utilized by developers. But, like the two options discussed above, the answer will be the option that will provide the highest return.

Questions or comments? Contact Trepp at 212-754-1010 or [email protected].