For years, traditional malls around the United States have been in a state of partial or full collapse thanks to “the Amazon effect”: deteriorating conditions, bankrupt or cash-bleeding tenants, with some even transforming into homeless shelters as the retail industry “evolves”.
In other words, as Bloomberg writes, “things are getting worse for malls across America.” So much worse, in fact, that their owners are simply walking away early from struggling properties, a trend that has sparked fears of material losses among mortgage bond investors.
Investors in and lenders to malls across America are bracing for the fallout from the disappearance of the brick and mortar sub-sector of the industry. With the recent bankruptcy of retail giant Sears, mall operators are continuing to see accelerating defaults in the wake of numerous other retail bankruptcies from stores like Bon-Ton, Wet Seal and RadioShack, and many others, resulting in abrupt declines in rental and lease payments.
And amid the ongoing collapse in what was once a staple source of shopping and entertainment for “middle America”, many mall owners are simply turning over the keys to lenders even before their lease is over, according to Bloomberg. That puts the loan servicing companies in a position to either try to run the properties themselves or turn around and sell them. If they can’t make the debt payments, the new owners of the commercial mortgage backed securities in turn end up facing the consequences themselves.
While much of the noise surrounding the “big mall short” which dominated the 2017 airwaves has faded, the number of mall loans issued since the financial crisis that identified as “highest risk” has almost tripled to 29 this year. And the consequences are becoming painfully visible. The Washington Prime Group REIT last month simply gave up on two malls in Kansas where the loans had either defaulted or were close to default. This month, Pennsylvania REIT announced that it left a mall in Wilkes-Barre that also had a loan ready for default. The PA REIT is considering abandoning another mall in Wisconsin for the same reason.
Ben Easterlin, head of commercial lending at Atlanta-based Angel Oak Companies, told Bloomberg that many small town malls are no longer being included in CMBS packages. “It’s easier to value a mall in L.A. than it is in Sheboygan,” he said. “We talk about these malls all day long. We have not seen any of these malls in a CMBS lately and don’t expect to, frankly.
Meanwhile, even though the delinquency rate right in the commercial mortgage backed securities market is at post-crisis lows now, the pain will likely take a couple of years to show up due to maturities that won’t occur for several years.
Adding to the pain, stores leaving these malls often cause a waterfall effect because of co-tenancy clauses that are included in many small mall leases. These clauses mean that if there aren’t enough tenants in a mall at a given time, other tenants have the option to leave. So when a “major” anchor-store company – like Sears – closes a bunch of stores, it can triggers clauses releasing other stores from their contractual leases, further hitting the mall and its creditors.
Still, not all investors see this as Armageddon.
The Galleria at Pittsburgh Mills was seen as an investment opportunity by New York-based Namdar Realty Group and Mason Asset Management, who bought the property for $11.35 million earlier this year after it was once valued at $190 million in 2006, before it was packaged into a commercial mortgage backed securities pool.
Steve Plenge, managing principal of Pacific Retail, is another optimist who sees today’s climate as opportunistic. His firm has taken over at least two malls that have been returned to lenders after defaults. He told Bloomberg: “we think this sector, the servicing business, will get bigger for us. There will be more defaults, more foreclosures.”
We agree. In fact, at the beginning of October we noted that mall vacancies had hit 7 year highs. And, according to a WSJ report, the average rent for malls in the third-quarter fell 0.3% to $43.25 a square foot. This is down from $43.36 in the second quarter and is the first time this number has fallen sequentially since 2011, according to research firm Reis, Inc.
At the same time, vacancy rates are on the ascent, rising to 9.1% in the third quarter from 8.6% in the second quarter, and the highest they’ve been since the third quarter of 2011, when these rates hit 9.4%.
Barbara Denham, senior economist with Reis, told the Journal: “The retail sector is still correcting”. And, as long as ever more people continue to migrate to online retailers (or buying less stuff in general), it will be for years.