By American Consequences Editorial Staff
The downtown department store was the retail king for about 60 years. The suburban malls that replaced it have enjoyed a reign nearly that long, and many are now long in the tooth.
Many department stores successfully rode that wave of change, enjoying a symbiotic relationship with the malls. They became the malls’ anchor tenants, helping them lure billions of shoppers each year.
But that’s changing…
American shoppers never stop evolving. There are outlet malls now – outdoor clusters of manufacturer-branded stores. And of course, Internet shopping has changed everything. You can now buy anything you want without leaving the couch. Indeed, U.S. Internet sales have grown 18% per year from a mere $27 billion in 2000 to $400 billion-plus this year.
And this holiday season, the massive shift from brick-and-mortar stores to online retailers continues…
More Americans shopped online than in physical stores on Black Friday and over the Thanksgiving holiday weekend.
To thrive in this new retail world, mall operators will need to be nimble and spend considerable cash to stay out in front of the changing environment.
And about a year ago, the analysts at Stansberry’s Investment Advisory recommended “shorting” the worst mall operator of the bunch. Below, we’ve featured an edited excerpt from what they wrote, originally published in September 2016. Did you read it?…
Store Closures Are Just Getting Started
Thousands of malls were built in the 1960s and 1970s, and while the architecture could differ from city to city, the format was basically the same… The original suburban mall was designed to showcase department-store tenants.
When Younkers, Hutzler’s, and Miller & Rhoads opened mall locations, they became the property’s prized possessions. You couldn’t operate a successful mall without large department stores “anchoring” each end. People came to the malls for the anchor stores, and the traffic these stores generated sustained the other smaller retailers, known as “inline” tenants.
That model has now flipped…
The inline retail stores generate the traffic. The department stores are increasingly a place for busy shoppers to cut through on the way to the parking lot.
Furthermore, the Internet helps shoppers find exactly what they want before they go to the mall. They no longer need to browse in large department stores and get the help of department-store employees to make decisions.
Large department stores like Sears and JC Penney have been shutting down their weaker stores for years. That’s not news. But until recently, store closings have plodded along at a moderate pace, and mall operators have been able to replace their lost anchor tenants with smaller retailers and innovative reconfigurations (more on that in a moment).
Mall ‘Survivors’ Face a Huge Capital Burden
The traditional enclosed-mall design is dead. Not that everyone knows it yet.
At a time when many brick-and-mortar retailers are either closing stores or going out of business, debt-ridden mall operator GGP (GGP) is building a new mall…
The company expects the $525 million mall in Norwalk, Connecticut to open in 2019, with Nordstrom and Bloomingdale’s as its anchors. The move shows that GGP is behind the times. Only six large malls were built in the decade ending 2015… compared with 54 in the previous decade.
This might just be the last mall ever built.
These days, developers are generally only interested in building places like The Grove in Los Angeles, a 575,000-square-foot outdoor marketplace dotted with art-deco style architecture and a lot of open spaces.
For “traditional” malls to survive, they need to commit to massive capital investments to transform the vacant space left by the disappearing store anchors. When an anchor store leaves, something else has to replace it.
And we must admit, the mall operators – particularly Simon Property Group (SPG) – have done better than we expected filling these retail holes. These redevelopments have included health clubs, call centers, movie theaters, restaurants, and even subdivided inline space. They’ve handled these closures well, at least so far.
One thing that you’ll often notice in these redevelopment efforts is that, in an unexpected twist, America’s shoppers now want 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.
The Mall Market Is Overheated
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.
How’d It Turn Out?
Despite a raging bull market that has pushed most stocks in the U.S. to record highs, malls have suffered… And the “mall owner in the worst position” – GGP – that the analysts targeted for shorting dropped more than 30% before a competitor announced a bid to acquire it.
Both mall operators are saddled with billions in debt. And that’s before the transaction.
Too often when executives don’t know how to compete in a changing market, they believe getting bigger is better. The outlook is grim for this combined company once it completes the merger.
In the meantime, the Investment Advisory analysts locked in 20% gains on this short position for their paid subscribers.
It’s critical to maintain short exposure in your portfolio as a form of “insurance.” Shorting stocks (especially in a bull market) is inherently difficult. But a few smart short sales can serve as an effective hedge should the overall market turn south.