The ICSC Blog

Dept. Stores Dole Out Excess Space to Other Retailers….

 

By Joel Groover

Department stores have figured out a way to deal with all that excess space resulting from the collapse of consumer spending: They’re doling it out to expanding chains. These store-within-a-store subleases tend to be all upside, no downside for the anchors and the new lessees alike, observers say. For landlords, not so much.

“It can be a net negative for the landlord, because, effectively, his own tenants become his competition,” said Lew Kornberg, a managing director of the retail division at Jones Lang LaSalle.

Sublease deals date to the earliest history of the department store, of course. But they are on the upswing today, thanks to a raft of trends in their favor, some say. Economically pressed retailers everywhere have pushed for rent relief, slashed payrolls, cut inventories and otherwise tightened operations. In the light of such heightened efficiencies, outsized stores began to look like a serious drag on productivity, says Ivan L. Friedman, president and CEO of New York City–based RCS Real Estate Advisors. “A lot of the department stores’ top lines have been shrinking,” Friedman said. “Their profits aren’t terrible, but they’re doing less business today. If you look at their comp-store sales over the past five years, it’s clear that many of them have too much space.”

Given the still-sluggish state of the economy, neither retailers nor landlords are keen on spending huge amounts of money. This has led to a focus on adaptive reuse rather than new construction, says Kornberg. “Factors like the glut of space and lack of liquidity, as well as a certain movement afoot to reduce, reuse and recycle, are driving a greater willingness on the part of retailers and landlords alike to reuse existing inventory,” Kornberg said. For department stores, selling or leasing excess space to other retailers is a logical approach to adaptive reuse, in part because the anchors’ long-term leases typically contain lower rent burdens than those of in-line tenants. In addition, the pronounced lack of co-tenancy restrictions in anchors’ leases with malls gives department stores the freedom to chase lessees as they please, Friedman says. “Whatever rent agreement the department store has with the mall, certainly it is well below what the in-line retailers are paying,” Friedman said. “So the department store can make a spread on that. It can give Forever 21 or any other retailer a lease in which the rent that is coming to [the department store from its lessee] is in excess of what the department store pays to the landlord. Doesn’t that sound simple?”

The anchors certainly have no trouble with this math. At first glance, the property listings on the Web site of SHC Realty (the real estate unit of Sears Holdings) could be mistaken for those of a national brokerage firm or shopping center landlord. A retail executive can use the site’s search engine to sift through available spaces at some 3,900 U.S. properties. These would not be shopping centers, however, but Sears and Kmart stores with excess space for sale or lease, ranging anywhere from 1,000 to 50,000 square feet.

“The third-party leasing program is something we’re doing all over the country,” said Sears Holdings Corp. representative Kim Freely. “We just announced a deal with Whole Foods, in Greensboro, North Carolina, where they will be taking 34,000 square feet in our Greensboro store. We did 12 stores with Edwin Watts Golf. It’s an effort to optimize our customer shopping experience and leverage our real estate.”

Such deals are hardly limited to underperforming stores in moribund markets. Forever 21 is slated to open a 43,000-square-foot store this spring inside the Sears at top-performing South Coast Plaza, in Costa Mesa, Calif. This store-within-a-store, called XXI Forever, will occupy parts of Sears’ upper and lower levels at the upscale mall, with dedicated entrances on both floors. Forever 21, famous for its flexibility on store formats, has struck similar deals with other department stores. CBL & Associates Properties announced in September that the two-level Belk store at Hamilton Place Mall, in Chattanooga, Tenn., would be consolidated to make way for a 60,000-square-foot Forever 21 that is due to open early this year. Belk, which just completed a $4 million renovation of its two buildings at Hamilton Place, will sublease one floor to Forever 21, says Stephen D. Lebovitz, CBL’s president and CEO.

Particularly in this economy, store-within-a-store arrangements make good sense for retailers because they allow for testing markets and expanding portfolios without the building of hundreds of stores from scratch, says Howard Davidowitz, head of New York City–based retail consultant firm Davidowitz & Associates. “This is a low-risk approach for Forever 21,” he said. “They can just feed off of the traffic of a retailer like Sears. Most American apparel chains — the Limited, Abercrombie, just go through the list — have a fixed prototype store, but Forever 21’s approach has been unique.”

For international chains, moreover, store-within-a-store arrangements are a smart way to expand into the U.S. with minimal capital costs, says Kornberg. Barcelona, Spain’s Mango, known for introducing moderately priced fashions at a blistering pace, operates some 1,300 stores across roughly 90 countries. Mango says it plans to open as many as 600 specialty stores inside JCPenney stores by the fall of 2011. As part of the deal, JCPenney has been named exclusive U.S. department store retailer for the MNG by Mango brand.

The Mango deal marks the largest rollout of any fast-fashion concept, says J.C. Penney Co., but JCPenney has conducted such experiments before. The chain introduced the Sephora-inside-JCPenney concept in 2006, and these specialty stores continue to beat expectations, says Penney Chairman and CEO Myron E. Ullman III.

Other major tenants, meanwhile, are similarly bullish about sublease deals. Wal-Mart Stores announced plans in 2009 to ramp up and diversify its in-store leasing program, which includes some 10,000 sublease tenants across its U.S. portfolio.

Naturally, landlords want their anchors to thrive, but Friedman says they are right to be circumspect about this trend. “If you wanted to take this to its ultimate conclusion, a department store could reconfigure its entire space into small stores, undercut the landlord at his own mall, and take these tenants away,” Friedman said. “I don’t know what expletives could be put in an article, but you know what the landlord is going to say.”

In theory, a tenant wanting to pressure a landlord to take back a lease could use a sublease threat as leverage, says Friedman. Landlords do have other options, however, such as gobbling up a retailer’s stock and thereby gaining shares of its profits. An October 2010 department store analysis by Citi and Fox Real Estate Advisory noted that unlocking the value of Penney’s real estate, whether through subleases or outright sales of stores or space, probably spurred Vornado Realty Trust to acquire nearly 10 percent of Penney in 2010.

Of course, landlords are often perfectly willing to take over department stores and create something new. At West County Center, in St. Louis, CBL carved a former Lord & Taylor into an outdoor plaza with restaurants and such tenants as Barnes & Noble and Forever 21. “That opened a year and a half ago,” Lebovitz said. “We have also purchased department stores back and put in movie theaters, which have been doing very well, and have put Target, Costco and health clubs into our malls.”

Though such creativity may be a forced adaptation to one of the worst economies in recent memory, it is nonetheless a positive sign, says Davidowitz. “Developers, for the first time, are looking for new venues, and that really could be a partial answer for shopping centers,” he said. “If you can get Costco — the largest wine seller in the United States, with fantastic value and an upscale demographic — that is a very sensible way to generate footsteps at a center.”

In today’s retailing, however, nothing is a lock, cautions Davidowitz. When it comes to doing deals with value-oriented chains like Forever 21, he says, landlords or, for that matter, sublease-happy anchor tenants should keep a cautionary tale in mind. “Don’t forget Steve & Barry’s — they took all of those [former Mervyns] spaces,” Davidowitz said. “They had the value proposition going for them. They bragged about how brilliant they were. And they went straight into liquidation.”

This story is from the January 2011 issue of Shopping Centers Today.

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