Diversification key for mall developers as retail landscape evolves
With traditional anchors beset by mounting competition from big-box outlets, off-price and e-commerce, it's time to rethink the very definition of a mall — or else.
Editor's Note: The following is a guest post from Kenneth A. Rosen (partner and chair, bankruptcy, financial reorganization and creditors’ rights) and Eric S. Chafetz (counsel) of business law firm Lowenstein Sandler LLP.
The difficulties facing traditional retailers are many — and they’re changing the very nature of American shopping malls.
Traditional anchors like Sears/Kmart and Macy’s are beset by competition from all sides, from freestanding big-box outlets (think Home Depot and Bed Bath & Beyond), to stores attracting fashion-forward yet price-conscious consumers (Target and Kohl’s) to mounting online competition from Amazon and others.
This is leading to the loss of mall tenants, especially anchor tenants, which are major drivers of all-important foot traffic. As a result, American malls stand at a crossroads, with some simply being demolished while others are in various stages of reinvention.
Mall owners are (or should be) rethinking the very definition of a mall. New tenants such as high-end restaurants, amusement parks, spas, health clubs, online pickup locations at traditional retailers and upscale movie theaters increasingly are essential components. Whole Foods, the high-end supermarket, recently became a tenant in a Los Angeles mall, and urgent care medical locations and other healthcare providers — which can benefit from low rents while providing medical service closer to people who don’t live near centralized medical campuses — have also taken root in some shopping centers.
Reshaping malls into mixed-used developments might run counter to a business model that worked for decades, where mall owners and developers could simply be mall owners and developers. However, these entities must realize that the need for new thinking and investment in new types of amenities and features is greater than ever to drive foot traffic.
Traffic patterns, tenant mix, parking and street exposure are important, and the demands of the new types of tenants noted above will likely differ from the demands of traditional mall tenants. Technology is also key, with some mall owners now allowing customers to text them questions and get real-time answers. Other malls have implemented mobile apps to provide turn-by-turn navigation from store-to-store in a mall and directions to their parked cars. And some retailers now send customers personalized promotions, use body scanners for sizing, and even are incorporating virtual reality technology into the shopping experience.
It’s lot to consider. But it’s the kind of thing all mall owners and developers need to be thinking about to remain relevant.
In finance, diversification reduces risk so a bad investment will have a lesser effect on an overall portfolio. This is no different for mall developers and owners. At this stage, they should feel compelled diversify, which can, in turn, reduce the potential risk of investment in REITs, which are focused on retail.
Mall owners and developers also should know how a tenant’s bankruptcy can affect their properties.
A debtor in Chapter 11 generally can sell and transfer leases despite provisions in the leases to the contrary. However, the Bankruptcy Code has provisions regarding tenant mix that do not allow a debtor to sell a lease to a prospective tenant that would cause harm to the shopping center or to surrounding tenants. The Bankruptcy Code does not, though, prevent the sale of a lease to a competing mall owner.
Consider a successful shopping center developer, in this case seeking opportunities for growth. The developer might look to acquire store leases at malls owned by competitors where an anchor has closed and redevelop the space into a cluster of smaller stores or into a mixed-use property (restaurants, movie theaters, urgent care centers, spas, etc.).
Why would the developer do this? And, why would a mall owner that suffered the loss of an anchor permit it? The struggling mall owner may welcome the competitor’s investment, which may facilitate additional investment by the owner. And the developer that rehabs the empty and substantial anchor space becomes a de facto partner — which could be a good thing for a property owner.
Even if the acquisition of an anchor lease by a competing mall owner is unwelcomed, the mall owner may be unable to prevent acquisition of the lease under the Bankruptcy Code. In the example above, the developer would only have to comply with the tenant-mix provisions of bankruptcy law. The mall owner confronted with competitors seeking to acquire a lease may find itself in a bidding war with a well-heeled suitor in a market in which retail leases might not otherwise achieve as high a price.
Acquiring anchor tenant leases in a competitor’s mall also may give the acquirer leverage if it desires to acquire the distressed mall — perhaps for redevelopment.
The transformation of malls will continue, and usher in changes that would have been unfathomable a decade ago. Last year, two mall owners — Simon Properties and General Growth Partners — teamed up with Authentic Brands and a few inventory liquidators to purchase hundreds of Aeropostale stores out of bankruptcy. The justification from the mall owners was that they were not merely trying to save a tenant, but based on the bargain basement price that they paid, believed they could make a profit. As 2017 unfolds with the expectation of additional retail Chapter 11s and store closures, mall developers and owners also may look at their competitors with an eye toward new opportunities.