Sears (SHLD) announced that they are closing another 46 stores by the end of the year. In the previous round of closings, Washington Prime Group (WPG) had six malls that were impacted. In an article, I observed that WPG might redevelop as many as four of them, only one of which is tier 1.
Sears closings are a double-edged sword for mall REITs. The bullish thesis relies on the idea that redeveloping Sears stores will improve returns not only for the store itself but also for the entire mall.
Once an anchor that attracted tens of thousands of customers, malls bid aggressively to get the local Sears to their location. Offering long-term contracts and low rents, mall owners believed the concessions would be made up by the in-line tenants who would pay a premium to be close to a Sears.
The popularity of Sears has clearly waned, and with it, the large amounts of traffic it once attracted has evaporated. Sears has gone from being a benefit to a liability. Almost anything, possibly even demolishing the whole space, is better than having the ghost town that many Sears stores have become.
On the other hand, redevelopment takes a lot of resources. It takes money and time, not only for the landlord but also potential replacement tenants are going to want to expand at a pace that their business is able to handle. It is important for mall REITs that the stores close at a pace they can manage in order to minimize the impact of any co-tenancy clauses and also to prevent the current consumers from deciding “this mall is dead” and shopping elsewhere.
Everyone knows that SHLD could head for bankruptcy tomorrow. While I believe that WPG would survive and eventually manage to redevelop most of their properties, it would not be ideal. The large number of properties they would have to redevelop would flood the leasing market, forcing them to offer more concessions and pay the costs of longer vacancies.
How Much Time
In reference to the 28 department stores that WPG has identified will need to be replaced, Mark Yale said:
We are estimating our share of additional capital investment to be approximately $300 million to $350 million to transition this real estate. Discount does exclude the 13 boxes owned by non-retailers, including Seritage. With a three to five-year investment time horizon, we’re comfortable that we’ll have the necessary capital to address these opportunities.
That means that WPG’s plan is to redevelop at a pace of 6-10 stores per year. That pace is consistent with their current pipeline of redevelopments at 8 significant projects. The majority of the stores on the list are Sears, but there are others as well. So the ideal rate of closures for WPG owned Sears stores would be 4-5/year.
Most of these projects will be completed by the end of 2018 or the beginning of 2019, clearing the slate for another round.
New Closings
On the latest list of closings, only two are in WPG owned malls. The two malls are Dayton Mall in Dayton, Ohio, and Mesa Mall in Grand Junction, Colorado. Both are listed as tier 1 malls and will be redeveloped.
The Dayton Mall is an ideal situation for WPG.
Located near the junction of two major freeways on the south side of Dayton, it is easily accessible from two exits. The area is very active with many restaurants, chain stores, local stores, hotels, and office buildings.
The mall has been healthy; in the 10-K, occupancy was reported at 96.7%. This year, the Elder-Beerman store located on the west end of the mall is closing by the end of August due to the Bon-Ton (BONT) bankruptcy. So the mall has two anchors closing at the same time.
The great news for WPG is that the Sears is owned by Seritage (SRG), which has the support of Warren Buffett as one of their largest shareholders. The Sears store will be redeveloped and WPG will not have to spend a penny on it.
The Sears space accounts for over 15 acres and includes a Sears Auto Center which was already recaptured by SRG and is in the process of being redeveloped into an Outback Steakhouse.
The Dayton Business Journal reports:
While the township was unable to comment “regarding specific plans for the site beyond the current redevelopment of the former Sears Auto Center facility,” officials said the decision to close the store was “not unexpected,” and plans for transitioning the site have already been in the works.
“The decision by Sears removes a level of uncertainty regarding the status of the store and will allow planning for the future of the site and its place within Miami Crossing to be accelerated,” the statement said.
This suggests that the store will be redeveloped sooner rather than later. WPG can sit back and reap the benefits with their in-line space and as a selling point for negotiating a lease for the soon to be vacant BONT space.
Mesa Mall
Followers of WPG are likely familiar with the Mesa Mall. WPG threatened to hand the keys back to the lender which led to a renegotiation of the mortgage and a discounted payoff in 2017.
Now unencumbered, the Mesa Mall is likely to become a significant redevelopment project for WPG. Sports Authority closed their store in 2016 and it remains vacant. Additionally, there is a Herberger’s, another BONT brand, that is closing at the end of August. The Sears store is owned by WPG and will be closing in November.
The 10-K reported 93.2% occupancy, suggesting that the majority of in-line space is leased, and the mall was upgraded to tier 1 for 2018. After Sears closes, the mall will be anchored by Cabela’s, J.C. Penney (NYSE:JCP) and Target (NYSE:TGT). WPG does not own the space for those anchors.
Where the Dayton Mall represents an opportunity for WPG to benefit from the secondary impacts of SRG’s spending, the Mesa Mall is going to be all WPG. They will bear the brunt of the costs, but will also gain directly from increased rents of the anchor space.
With the mall being unencumbered, WPG has a lot of options that they are no doubt already exploring. They could sell the anchor space outright or as a JV, they could seek a new mortgage on the entire mall, or they could redevelop with cash to leave the mall unencumbered, leaving open the possibility of selling or mortgaging the mall after new anchors have improved its value.
Being an unencumbered tier 1 mall with three empty anchors, Mesa Mall has almost certainly jumped to the top of WPG’s priority list.
Conclusion
The latest announcement of store closing is a positive for WPG. Both of the impacted malls are ones that WPG has been planning on redeveloping. The Dayton Mall comes with the extra bonus that the substantial portion of redevelopment funds will be spent by SRG. WPG only needs to worry about the much smaller BONT store.
The Mesa Mall will be a major project for WPG. With three empty anchors, WPG will be looking to redevelop sooner rather than later. The key will be the ability of the leasing team to execute and fill the spaces. From a financing perspective, the unencumbered property provides WPG with several options.
Overall, the pace of store closings is one that WPG should be able to manage. If SHLD continues the current pace, it will help WPG and other mall REITs redevelop at a steady pace and reduce the impact of the eventual SHLD bankruptcy.
Disclosure: I am/we are long WPG.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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