Now that General Growth Properties Inc. has filed for Chapter 11 bankruptcy protection, the question is whether more recession-hit developers might follow.
Plummeting consumer spending has hit the profitability of many retailers. Circuit City, Linens-N-Things, Steve & Barry’s, The Sharper Image, Fortunoff and Mervyns filed for Chapter 11 protection and ultimately liquidated, shuttering hundreds of locations. Macy’s Inc., Foot Locker Inc., AnnTaylor Stores Corp. and Zale Corp. closed underperforming units that totaled into the hundreds. Meanwhile, Wal-Mart Stores Inc., Target Corp. and Gap Inc. have cut back or postponed planned expansion.
The result is that mall vacancy rates rose to 9.5 percent in the first quarter from the 8.9 percent registered for all of 2008, marking the largest single-quarter jump since 1999, according to Reis Inc., a real estate information company. With few, if any, new retail concepts in sight, shopping centers are loath to see retailers fail. That’s creating immense financial pressure on real estate investment trusts as centers lose tenants while those retailers remaining aggressively push for rent reductions.
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Malls that wouldn’t have considered lowering rents 10 years ago are now struggling to keep their centers fully tenanted. The loss of rental income is taking a toll on the revenues of several REITs. General Growth Properties, the second-largest mall operator in the U.S., had been teetering on the verge of bankruptcy for months (for more on the filing, see sidebar). Simon Property Group on March 11 defaulted on payment of the principal of a loan for the Mall at the Source in Westbury, N.Y. Simon owns 25 percent of the property. Mills Corp. came close to seeking bankruptcy protection in 2007, when it almost defaulted on obligations on a $1.1 billion loan. Mills was bought out by Simon Property Group and Farallon Capital Management later that year. The Macerich Co. last month agreed to several refinancings on debt totaling $446 million.
There are some who believe the predominance of property owners has come to an end. “The balance of power has actually shifted from landlords to tenants as a direct result of the business climate,” said Naveen Jaggi, senior managing director of retail services at CBRE in Houston.
“Where we have a tenant that we believe is in extreme financial distress, we’re trying to work with them to come up with a mutually acceptable basis for maintaining their occupancy in the portfolio,” David Simon, Simon Property Group’s chief executive officer, admitted during the REIT’s year-end conference call on Jan. 30, 2009.
But the chief executive of a REIT who requested anonymity said the pressure is less on strong malls. “There is an increasing bifurcation of the good and not so good properties,” he said. “In challenged properties, where leases are coming up for renewal, landlords are dealing. In good properties, when leases are coming up, they’re sticking with the rents they want. The rents are holding steady. In a good mall, even if sales are down, rents will reflect future opportunities, not the business of the moment.”
Andy Grasier, co-president of DJM Retail, which provides lease-mitigation services to retailers, said mall owners are much more open to making deals, however. “Just a year ago, landlords weren’t being very responsive to rent reductions,” said Grasier. “Now it’s a different game entirely.”
DJM is working with Pier 1 Imports, which has said it will terminate the leases of up to 125 stores if rent reductions aren’t achieved. CVS, Modell’s and Urban Outfitters are also said to be among the chains requesting rent reductions, which typically range from 5 percent to 25 percent, according to Grasier. A poorly performing big-box retailer seeking rent relief could receive as much as a 50 percent reduction if the store was considered important to the center.
“Landlords are concerned about any financing or co-tenancy issues that would arise if a certain retailer went away,” Grasier said. “They also look for evidence that companies are being proactive in cutting costs and improving their business. Are they reducing sku’s and reducing inventory and the cost of capital associated with that? They want to understand the entire picture.”
After Charming Shoppes Inc.’s same-store sales dropped 15 percent and total sales declined 14 percent in the fourth quarter, the retailer said it would close 100 underperforming stores unless landlords provided rent relief. “We want to give our landlords the chance to keep those stores open by making them cash-flow positive with their cooperation,” said Alan Rosskamm, chairman and interim chief executive officer, during a conference call.
“We’re taking the lid off and looking at everything, including underperforming stores and stores with leases coming up for renewal,” said Gayle Coolick, vice president of investor relations. “The message we’re giving our landlords is that we don’t take this lightly. We’ve cut internally very deeply.”
“Everybody in the business — the landlords, retailers and customers — is out to save money right now,” said Edward Glickman, president and chief operating officer of Pennsylvania Real Estate Investment Trust. “Recently, we’ve received more requests [for rent relief] than in the past. Not every retailer is in trouble. Many are asking for rent relief.”
PREIT is taking a conservative position on rent relief. “We have leases in place,” Glickman said. “The landlord can’t absorb reduced rent. We’re doing whatever we can to keep costs down. When there’s vacant space, we pick up the cost of that. Clearly, there are situations where merchants are in trouble, and we try to do what we can. When the retailers were doing well and in some cases making a lot of money, they didn’t say, ‘We’re going to pay you 20 percent more rent because business is good.’”
Charming Shoppes and other chains are taking advantage of co-tenancy clauses, which make leases contingent on certain retailers operating in a mall. When a key retailer closes, remedies the remaining tenant may seek from a landlord can include terminating the lease, not paying rent for a period of time, paying reduced rent or giving the landlord a percentage of sales in lieu of rent.
Co-tenancy clauses can cumulatively have a devastating effect on a mall. The more vacancies there are, the more co-tenancy clauses are potentially activated.
The remedies provided by a co-tenancy clause can steadily decrease a center’s cash flow, which effects the mall’s ability to maintain the property. A rundown center can turn off prospective tenants and shoppers. In the worst-case scenario, the downward spiral continues until the landlord is unable to make debt service payments, perhaps triggering a bankruptcy filing.
“You need an anchor to draw customers,” said Coolick. “If an anchor isn’t operating any longer, it changes the complexion of the center. We always have an eye out for co-tenancy. Charming has seen a higher number of co-tenancy issues in the past year. Our stores are usually in malls with anchors like Wal-Mart, Kmart Holding Corp., which has closed stores, and Circuit City or another big-box retailer.”
REITS and mall developers once believed that if they built it, the stores would come. Now, developers want tenants to sign leases before a single shovel goes into the ground. When one or more committed retailers pulls out of a project, it can set a mass exodus in motion, jeopardizing the viability of the mall.
And even before malls are now being built, prospective tenants want to know who else is going to be there.
“Our client wasn’t going to do deals at the Palazzo [in Las Vegas] unless the landlord delivered eight to 10 of the 15 tenants specified in the co-tenancy clause,” said Jeffrey C. Paisner, a broker at Ripco Real Estate. “With Christian Louboutin and Diane von Furstenberg, we named specific tenants. The Palazzo asked if they could replace one tenant with another tenant, and we said, yes, as long as it was a retailer of similar caliber.”
Retailers cutting back on expansion have pulled out of new centers under development, making other signed tenants nervous. All of this makes lenders even more wary. Not surprisingly, financing for new shopping centers has dried up and many projects in the works have been scuttled or put on hold. “The bigger challenge is how many projects that were earmarked to open in 2009 and 2010 have been delayed due to the general retail environment,” Jaggi of CBRE said.
Palisene, a Macerich project in North Phoenix, could arguably have been further along had economic conditions been better. “It is a market-driven project that focuses on the affluent trade area of Northeast Phoenix,” said Scott Nelson, vice president of development for Macerich. “It’s a flag we’ve planted, and we control the land. Tenants are saying, ‘In these times right now, we’re going to the existing assets. We know you have the opportunity to accommodate us at the right time and right place.’ We’ll do it when we think the time is right. It is on hold.”
On Las Vegas’ West side, Tivoli Village, a 700,000-square-foot mixed-use project under construction was slated to open in fall 2009 but has been pushed back to 2010. At High Street on Westeimier in Houston, for example, “Construction has completely stopped due to the lending environment and the retail environment,” Jaggi said. The project was to have 300,000 square feet of retail space, 300 residential units, two hotels and office space with a planned opening in fall 2010.
There have been reports that retailers are retracting leases for Xanadu, an ambitious shopping-cum-entertainment complex in the New Jersey Meadowlands.
Xanadu calls for a 300-foot-high Ferris wheel, 5,000-foot-long roller coaster and 140-foot-high indoor ski slope, as well as retail districts dedicated to teens, home and fashion. Sources said co-tenancy issues may have arisen. Xanadu officials could not be reached for comment.
“Tenants make their decision to go into a mall because there will be a group of tenants that will hopefully make it successful,” said Mark Gilbert, executive vice president of Cushman & Wakefield’s investment sales group in Miami, noting that the clause is written into leases “to protect the downside for the tenant. There is no upside for the landlord. Landlords would always prefer not to have it.”