Foreclosure - the Result of Changing Retail

Image from the wall street journal

Image from the wall street journal

Mall owners are increasingly handing over the keys of their struggling properties, posing big problems for creditors. From January to November 2016, 314 retail-secured loans (totaling $3.5 billion) were liquidated, an 11% increase from the same period in 2015. As tightening balance sheets and competition from online retailers squeeze traditional retailers out of their space, mall landlords are finding it more advantageous to walk away rather than attempt to restructure debt on failing properties. In turn, the lenders have no choice but to sell these distressed properties, sometimes for pennies on the dollar, which resulted in losses in excess of $1.6 billion in 2016. Even retail giant and largest REIT Simon Property Group, which tends to invest exclusively in luxury and Class A shopping malls, saw failure. In early 2015, they defaulted on a loan secured by Greendale Mall in Worcester, Massachusetts. 

Despite a strengthening economy in 2016, delinquency rates for loans backing retail properties rose. The struggles of traditional retailers can be explained, in part, by changes in our preferences. Take, for example, The Wausau Center in Wausau, Wisconsin. When it opened in 1983, it was a bustling 424,000 square-foot regional center with three anchor tenants: J.C. Penney, Sears, and Younkers. Of those three, only Younkers remains today. Seeking time efficiency and more “bang-for-your-buck”, Americans’ consumption patterns have moved away from the business models of J.C. Penney and Sears and gravitated towards alternatives. CBL & Associates Properties, the owner of The Wausau Center, says that they spent significant time and resources over a 2-year period to revitalize the mall, but delays, city approval, and other red tape hindered their progress. As a result, CBL turned the keys in to their lender and walked away. 

According to Steven Marks, head of Fitch Ratings’ REIT Group, a default like this does not negatively impact a company’s credit rating. In fact, it could improve their credit rating, because it implicates a firm’s financial discipline to not allocate capital towards failing investments. Big mall landlords, like public REITs, say defaults are a justifiable response to shareholders’ demands to shore up balance sheets. Due to the limited liability of associated special purpose entities, creditors make claims only on the collateral backing the loan, not on the borrower itself. From there, REITs move on with potentially no additional hit to their balance sheets or credit ratings. Retail is changing. Until retailers like Sears (closing 150 stores in 2017) and Macy’s (closing 100 stores in 2017) learn to adapt, creditors nationwide will continue to see significant losses. 

Click here for the full article from the Wall Street Journal. Click here for more Front Street news.

Written by Front Street Intern Kenny Cutler.