CoStar Q & A


With retailers and shopping center owners heading to Las Vegas later this month for RECon, the world’s largest retail real estate convention, we asked Mark Dufton, CEO of Gordon Brothers' real estate practice, for his take on the evolving retail real estate market. 

Gordon Brothers is among the handful of retail restructuring specialists capturing the lion's share of restructuring work involving store closings and dispositions. Dufton has more than 25 years of real estate and management experience. He is also a managing director for Dinosaur Capital Partners, a Boston-based real estate investment and development company, as well as a member of the International Council of Shopping Centers and the Turnaround Management Association. 

1. Using the iceberg metaphor; we’ve seen at least 9 major retailer bankruptcy filings this year. Please explain though how much restructuring may be going on below that surface that the market is not seeing.

Below the surface restructuring is not as prevalent as people think, as it has become very difficult to conduct out-of-court restructuring. While it used to be much more commonplace, the vast majority of retail restructuring is done through bankruptcy. It’s essentially become the contemporary standard practice and banks don’t seem to mind. What happened with The Sports Authority last year is a good example of this shift, with EMS and Gander Mountain being more recent examples from the same category.

We’re also seeing a two-level market with strong A property malls with pretty good occupancy and rent and the remainder of the market is distressed and will continue to face challenges. 

2. Even though a lot of news has been focused on major anchor tenants, inline retailers might have it worse, in that they are facing the same challenges as anchors but adding to theirs is the decreased foot traffic those anchors are bringing in. What kind of adjustments are we seeing in their real estate decisions?

This can really be viewed through two angles: new store openings and lease renewals. 

The volume of new stores has slowed dramatically and when new stores are opened, they are being scrutinized in a way we haven’t seen before. That’s because:
Deals take twice as long as they used to. If it used to take 6 months to close a deal on a new store, now it’s a yearlong process.
New store decisions used to be made by an internal real estate committee, but new store decisions may now go all the way up to the board for input. 

This level of thought and scrutiny for new stores is a good thing for the industry, as it’s important to have greater discipline when adding new locations. 

With lease renewal, there has been a greater focus on the timing of lease renewals and if that lease is at market value. Retailers are now asking what other factors are associated with the lease and whether they should renew or close – ultimately more attention is being paid to this decision. In the past, if a store’s sales were mediocre with a small rent increase, most retailers would renew. Now, retailers are looking deeper at every detail, and marginal stores will go out and look at the market and restructure the lease to make it more profitable. There is more attention to overall occupancy expense than ever before. 

Under the current retail environment, lease renewal is no longer a secondary consideration – it is now the biggest expense for retailers after their people.  

3. In our coverage, as well as national media, we tend to associate retail troubles with real estate and blame downsizing on the oversaturation of retail space. How much of the trouble in the retail industry is associated with real estate and how? And the second part of that would be what other forces are at work? Not only is where consumer are shopping changing but also what they are buying is changing. So how much of their troubles are tied to not keeping up with their customers’ needs and wants?

Real estate is the cart and slowing sales is the horse. The oversaturation in the retail industry was caused by lagging sales among retailers. This only became a real estate problem when sales could not keep up with the market and leases became unprofitable. 

The other forces at work that are affecting retailer sales and eventual real estate longevity include:
Income stagnation continues to put a damper on the mass consumer.
Growth of online retail and increasing preference for the channel over bricks and mortar.  
Millennial consumer preference to spend on experiences instead of retail goods. 
The sheer size of the retail footprint has been too large and the store count too great.

As customer needs and wants evolve, retailers have struggled to keep pace with the trends of younger generations, such as considering experiential retail to mimic the restaurant and entertainment experience.  Also, not all retailers did a good job integrating their online presence with their brick and mortar operations. We see some retailers who do this exceptionally well and others who have not kept pace. 

4. When it comes to store closings and lease cancellations, there is an apparent bifurcated impact between Class A properties and Class B and C properties. How is this showing up in efforts to find new tenants for vacated space? And how is it showing up in the renegotiation of leases?

There is a clear bifurcation between Class A properties and Class B and C. For vacated spaces, landlords have leverage over Class A properties, because everyone wants to model Class A traffic. This also means landlords have the power when renegotiating rents with Class A retailers. 

However, malls no longer publish traffic numbers (which in itself is telling) and landlords have little leverage with B and C retailers for vacated spaces and are renegotiating rents. We expect to see Class A properties continue to do well and Class B and C struggle. The divide between A and B and C will simply become greater. 

Yet, Class B and C properties will continue to be repurposed as retailers are desperate to restructure. There may be many unknowns, but retailers and landlords will choose to repurpose and restructure to improve cash flow which impacts debt restructure and has an overall cascading effect on the property. You will see more and more vacancies and lower rents with these properties. 

The future for the bottom market B and C retailers is going to look like repurposed quasi-retail, including schools, churches, call centers, gyms and medical clinics. 

All this will lead to a big shift in retailing – instead of the 1,200 malls we see in the U.S. today, we can expect that number to shrink to 800 or 900. 

5. Even as Class A properties seem to be thriving, there is also a rise of discount retailers and outlet stores. These aren’t the type of tenants associated with Class A space. What are they taking and why?

Value shopping has become prevalent at every level of the market, including luxury.  For example, we see Nordstrom Rack, Saks Off Fifth and Last Call by Neiman Marcus exceeding margins and levels never anticipated.  

While value retailers like TJX concepts have held up reasonably well, outlets and Class A properties are not performing as they once were.  The former darling of the retail industry, outlet stores and Class A are now reporting a downturn in traffic, which means it is more difficult to terminate their leases. 

Historically, outlet and high streets like Fifth Avenue in New York and Newbury Street in Boston were minimally affected by industry shifts, but now we’re seeing more softness among outlets and high streets. In both categories there are more vacancies than we have seen in years. 

6. Beyond store closing, retailers are taking strides to be more efficient overall in their current space and allocation of occupancy dollars, as well as selection of new locations. Not counting closures, where is this additional shrinkage coming from and how much shrinkage are we seeing?

Retailers are trying to be more selective in opening new stores and in determining which stores will remain open. We are seeing retailers make the choice to conserve capital when confronting lease mitigation. Instead of spending capital on the buyout, retailers will ride out for the remainder of the lease, close and maybe relocate.  

For many retailers, downsizing is an easier-said-than-done proposition. Some big box retailers don’t lend well to splitting up due to challenging configurations, cost to split and utilities and they may not get the return on investment without certain rent levels. 

Downsizing is much more challenging to execute and more likely it is easier to relocate and downsize as the lease comes up for renewal.