American Consequences - December 2017


This last reason for shorting is certainly our most controversial. Most market pundits think the picture is rosy for malls. But looking at the data, we see big problems ahead. Sales at North American department stores dropped from $200 per square foot in 2006 to $165 per square foot in 2015... Yet despite being in a tenuous transition period, mall property values have soared. According to Green Street Advisors, mall values declined around 35% during the credit crisis. But they have since ballooned and are now 44% higher than the pre- crisis 2007 peak. Meanwhile, an analysis of capitalization rates, or “cap rates,” demonstrates just how frothy the mall market has become. A “cap rate” is essentially the rate of return for real estate based on the income a property is expected to generate. The higher the cap rate, the better the potential return for the investor (disregarding price appreciation/depreciation). Today, cap rates are at extreme lows. In fact, cap rates are near levels seen right before the last credit crisis. Of course, as often happens, conventional wisdom ignores the writing on the wall. “Mall bulls” say that things will be just fine... that the demise of the American mall is greatly overstated. After all, occupancy rates are still north of 95%. But with their largest tenants on the ropes... record redevelopment expenditures on the horizon... and a potential credit crisis looming... it seems like an odd time for mall property values to be pushing record highs. When you add it all up, mall owners are a great target for the short portion of your portfolio.

One thing that you’ll often notice in these redevelopment efforts is that, in an unexpected twist, America’s shoppers nowwant their malls to be full of outdoor space... Here in suburban Baltimore, when a huge L.L. Bean store closed its doors, the Mall in Columbia underwent a $23 million outdoor renovation. The mall’s operator razed the L.L. Bean building and another interior inline space to create the open- air Plaza at the Mall in Columbia. The new space includes two upscale restaurants, the high-end fashion store Anthropologie, and a shop selling expensive vinegar and olive oils, among other retailers. The conversion has been a rousing, if expensive, success. But so far, the store closures have been proceeding at a leisurely pace. For example, GGP – which owns the Mall in Columbia – has only dealt with 83 department-store vacancies since 2011. That’s really only 15-20 per year. If the Macy’s announcement that it would close 15% of its locations is any indication of what’s to come from other big-box retailers, the pace of store closures will double or even triple in the next couple of years. And you can only fill so many square feet with movie theaters and olive oil shops... The huge problem mall owners face is that redevelopment efforts are expensive – costing tens of millions of dollars. If the pace of store closures accelerates at the same time the credit cycle tightens, mall operators are going to see many of their properties go bust.

46 | December 2017

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