The gap between strong class-B malls and struggling ones is getting wider by the day. Market rents are increasing for the “only game in town” malls, according to research firm Green Street Advisors, and private equity investors such as Starwood Capital have made big investments in the space. Meanwhile, class-B malls in larger markets that are competing against other properties are losing tenants and struggling to stay afloat.
“There are some B mall assets that are doing well—they’re growing at a pretty decent clip,” says Paul Morgan, managing director and senior equity analyst at boutique investment bank MLV & Co. “But there’s also a group that is struggling. They’re in the lower half of the pack, and they’re barely hanging on.”
Replacing dark anchors
Although class-B malls are often defined by their location in secondary or tertiary markets, they are best identified by their sales per sq. ft. performance. Class-B malls generate anywhere from $300 to $500 a sq. ft. in sales. Anything less is considered a class-C mall, and anything higher belongs in the class-A category, according to Ray Cirz, chairman of Integra Realty Resources, who has valued hundreds of malls.
Cirz’s firm regularly tracks 300 malls, and he says strong class-B malls in good markets without a lot of competition are likely to hang on to their retailers. However, a class-B mall facing a lot of competition and weak occupancy is going to have a hard time keeping its tenants.
Weak performance of anchor tenants such as Sears and J.C. Penney has already challenged occupancies and rental rates at many class-B malls. However, savvy mall owners have managed to overcome these challenges.
CBL & Associates Properties Inc., for example, has managed to regain control of some of these dark boxes. At Hickory Point Mall in Forsyth, Ill., the REIT backfilled a former J.C. Penney space with a Hobby Lobby. It also opened a Ross Dress for Less in the mall and is in discussion with a number of other junior anchors.
Stephen Lebovitz, president and CEO of CBL, said Hickory Point is a prime example of the REIT’s strategy. “In that market, the mall is the location of choice not just for mall retailers, but also for the boxes,” he noted.
Stealing mall tenants
Increasingly, class-B mall owners are forced to play defense when it comes to keeping their tenants. They’re competing not just against other malls, but also open-air centers. Shopping center REITs Brixmor Property Group Inc. and Kimco Realty Corp. noted greater interest in their properties from traditional mall tenants during the companies’ third quarter 2014 earnings calls.
“We now have a dedicated focus on relocating traditional mall-based retailers off the mall and into our open-air center,” said Michael Carroll, CEO of Brixmor Property Group. “We have recently hired three leasing professionals, all from the large public mall companies, to spearhead such leasing efforts.”
Brixmor has tempted traditional mall-based retailers to relocate, as well as open additional stores outside the mall, according to Carroll. He says the movement is a result of the change of mall ownership across the nation.
“Now that the large mall companies no longer own the B and the C malls, there is really no lever for [retailers] to negotiate favorable terms on the A and B properties, because they’re not doing anybody a favor by staying in the C mall any longer,” he says. “So they’re getting squeezed as occupancies are full in the better B malls and the A malls and as their sales are not moving up as fast, as occupancy costs are, they’re looking at alternatives.”
Carroll noted that many of these retailers have contacted Brixmor directly. “It’s something that we saw over the last year… just more from reverse inquiry where we started to get some inbound calls from of the mall retailers about it,” he said.
Brixmor has already seen initial success with 10 leases executed with traditional mall retailers, including Gap, Banana Republic, American Eagle and Chicos, among others.
Paul Morgan is quick to point out that this movement is “a revolving door that goes both directions.”
“Yes, there are some smaller retailers that are leaving malls, but there are also retailers that are going the other way,” he says. “Some of these malls have the best location in town, and retailers want to be there. We’re seeing discounters come in and take larger blocks of space. It’s a gradual process of adding junior anchor tenants to replace department stores.”
There’s a limited pool of buyers for class-B properties. “More traditional institutional investors are shying away from B malls,” Cirz says. “The investors who are buying these assets are looking for ways to enhance them.”
Stable assets with little competition are attracting private equity investors, Morgan notes. Earlier this year, Starwood Capital Group acquired seven regional malls totaling more than 7 million sq. ft. from Taubman Centers.
The properties will be owned and managed as part of Starwood Retail Partners’ portfolio. This group redevelops, manages and repositions retail assets in order to enhance cash flow and create long-term value.
Researchers with Green Street Advisors say valuations for class-B assets are fairly stable. Cap rates range from 7 percent to 8 percent. In comparison, class-A malls are trading at cap rates below 5.5 percent.
CBL is actively marketing 10 malls, and Lebovitz says investors are in various stages of underwriting. But the recent news about Sears has made the process more challenging.
“In certain cases, we have delayed the marketing properties and our disposition portfolio to finalize leasing with retailers replacing vacating anchors,” he noted, before adding that the REIT continues to receive interest from potential investors.