Changes in demographics, urbanization, and the rapid increase of e-commerce have been impacting the fundamentals of the retail commercial property sector over the last couple of years, particularly for the traditional malls. And the rapid development of this sector since the 1960s has resulted in too many structures for the current level of shopper demand, lowering their productivity and profitability. As online sales have taken a greater share, decreasing foot traffic has resulted in mall department store (“the anchors”) sales to trend lower since 2001. This can be seen in the charts below.
In the current environment, mall anchor tenants such as Sears, JC Penney’s, and Macy’s continue to announce store closures, and many investors question their long term viability. These department stores were expected to draw volume customers who would then typically support sales for the smaller inline mall tenants, typically store sizes of 10,000 square-feet or less. The closure of an anchor department store can cause a domino effect of other mall tenants also departing, ultimately resulting in a specific mall structure becoming obsolete.
However, it is important to distinguish between better-performing assets with increasing sales (class A malls) versus average properties with stagnant sales figures (class B malls). The class A malls are typically located in areas with a limited number of potential large land sites near population centers. The below chart indicates the divergent paths for the two mall types using sales-per-square foot figures post the financial crisis.
All is not dire for class B malls, as landlords are becoming more creative in drawing foot traffic by inserting entertainment venues or using non-traditional anchors, such as gyms, to backfill vacant space. Several of the larger retail REITs, like Simon Property Group, have demonstrated their commitment to “second tier” malls by investing in costly renovations, or injecting equity to roll debt encumbered by these assets. Like all commercial real estate, the survival and perhaps revival of B malls will ultimately depend on location, competition, and how shopping trends evolve going forward.
For investors in CMBS, an asset class with approximately 30% of the underlying securitized loans backed by retail assets, projecting outcomes for these malls is a complicated yet crucial task. Indeed, the consequences of having exposure to a deteriorating retail property can be extreme, with average loss severity of a defaulted retail asset being 46% and certain malls experiencing 100% losses. Ultimately, how a CMBS portfolio is affected by the changing retail environment will depend on granular loan-level analysis that takes into account a combination of econometric and idiosyncratic factors.