Wall Street Journal
By Kris Hudson
When the economic downturn began toppling national retailers, owners of retail property braced themselves for the long-term impact. Now, more than two years after the closings, a picture of that impact is emerging—and it isn't pretty.
A survey by Colliers International, canvassing 233 of the 1,259 stores closed by the prominent failures of four national big-box retailers in 2008 and 2009, found that 51% of those 233 sites remained vacant as of this month. The rest were leased for rents that averaged 17.9% less than those paid by the previous retail tenants.
The findings by the survey, to be released this week, don't bode well for a shopping-center industry facing another wave of retailers closing or shrinking stores. Recent bankruptcy filings by Borders Group Inc. and Blockbuster, for instance, added more closings to those in the survey by Circuit City Stores Inc., Linens 'n Things Inc., Mervyn's LLC and Gottschalks Inc.
Even retail landlords that are seeing signs of recovery are having to lower rents. For example, in the top 80 U.S. markets, the vacancy rate at big-box centers—typically called power centers—declined to 7% in the first quarter from a high of 7.5% a year earlier, according to real-estate research company Reis Inc. But the average rent in those centers declined in all but one of the past 11 quarters, according to Reis. It now stands at $24.84 a year compared with $26.53 in the second quarter of 2008.
Power centers typically are open-air complexes dominated by big-box retailers, such as Best Buy Co., PetSmart Inc. and Target Corp., as well as others that are closing or shrinking stores, like Borders, Barnes & Noble and Office Depot Inc.
Sacrificing lease rates to maintain occupancy can keep a center's remaining stores from bolting. But it also saps a property's cash flow and, subsequently, its value. That can make it harder for the property to cover the expense of its mortgage or refinance it. According to credit-rating company Fitch Inc., 6.9% of securitized mortgages tied to retail properties—more than $8.3 billion of loans—are delinquent by more than 60 days, up from 5.5% a year ago.
Looking on the bright side, Colliers noted that the still-vacant spaces face little competition from newly built centers since retail construction has slowed to a crawl.
"As the universe of retailers starts to pick up on expansion plans, then the remaining [sites] will be a focus," says Mark Keschl, Colliers' national director of retail.
But new tenants probably won't pay the high lease rates that Circuit City and Linens were known for, landlords say. Retailers that have moved into stores vacated by the four defunct retailers include TJX Cos.' T.J. Maxx and Marshalls, Forever 21 Inc. and Kohl's Corp.
Colliers even brokered the sale of a former Circuit City site in Houston to a gun-range operator last year.
Half of the 43 stores opened last year by Hhgregg Inc., the Indianapolis-based seller of electronics and appliances, are in former Circuit City locations.
"How good were these rates? Our understanding is that they were phenomenal," says Brad Thomas, an analyst with KeyBanc Capital Markets. "In some of the markets Hhgregg went into, they got [leases] in the midteens [per square foot] in 2009 when we were seeing rents of $22 to $23 a square foot for those same locations in 2006."
Even the strongest landlords with high-quality properties can't avoid taking at least a minor hit to their lease rates. Developers Diversified Realty Corp., which owns or manages 570 shopping centers globally, was among the largest landlords for Circuit City and Linens. When those chains closed, they left DDR with 2.8 million square feet of vacant space.
Since then, DDR has filled roughly 90% of that space, President and Chief Executive Daniel Hurwitz said in an interview this week. Last year, it did so at discounts of 25% to almost 30% from the rates the departing retailers paid. This year, that gap has narrowed to discounts in the mid teen percentages.
For example, DDR said it landed Bed Bath & Beyond Inc. last year to occupy a former, 35,000-square-foot Linens store near Minneapolis at a lease discount of 10% to 11%. Last month, DDR signed Best Buy to move into a former, 38,000-square-foot Circuit City store near Salt Lake City at a similar discount.
DDR has fared better than many peers, Mr. Hurwitz said, because retailers increasingly favor larger, more stable landlords with better located and maintained centers like DDR has.
"Good real estate, good tenancy and quality management will stay leased," Mr. Hurwitz said. "Distressed real estate will go deeper into distress."
