Archaic Mall Model
The mall of the past was dominated by large department stores, known as “anchor tenants”, located at the ends/corners of the mall. These anchor tenants would drive most of the foot traffic given they would be a destination for shoppers looking for a variety of goods in one place.
Tenants located in between the anchors, referred to as “in-line tenants,” would benefit from the foot traffic generated by the large department stores. As a result, the anchor tenants would typically take up around 1/3 of the total mall space (net rentable square footage) but pay a reduced fraction of the overall rent. The bulk of the rent was paid by the in-line tenants benefiting from the presence of the anchors.
Covid Disruption
After the onset of Covid-19, large department stores faltered with consumers hesitating to leave their homes to buy non-essential goods in lieu of shopping online. As a result, department chains such as Sears, Bon Ton, and JC Penny filed for bankruptcy with others vacating some of their locations. When malls started losing anchors, their entire business models went into jeopardy (especially if they were unable to replace these tenants).
Given malls are a large property with a very specific use, a failed business model would plummet its valuation. Consequently, failed malls had some of the largest loan losses in commercial real estate during covid. Some malls had losses exceeding 100% severity meaning the mall itself had effectively no recovery value.
Change in Approach
The floundering of malls forced landlords to rethink their approach with business models becoming archaic. This is how landlords are repositioning:
Targeting new tenants
Prioritizing businesses that have robust omnichannel strategies (will break this down later).
Replacing mid-priced department stores with big-box and sporting goods stores.
Turning malls into more of a destination by adding entertainment and high-volume restaurants as well as creating more open spaces for consumers to utilize.
Accommodating new uses of the space through redevelopment
Incorporating medical office spaces and apartments.
Partially or fully converting malls into distribution centers where spaces are used as shipping and delivery hubs for large scale retailers.
How Tenants Must Adjust
With the recent jolt in ecommerce, the traditional value of in-store retail shopping has declined. However, the expansion of ecommerce won’t necessarily cannibalize brick and mortar retail if tenants adjust properly. There will always be a need for in person retail and through the implementation of omnichannel platforms, retailers can capitalize on the boom in e-commerce.
An omnichannel approach creates synergies between online and in-person shopping, essentially turning brick and mortar locations into quasi-distribution centers. In other words, giving consumers the ability to pick up or return goods they purchased online at the nearby store front. Implementing in store return capabilities can mitigate liability for retailers (fraud and damage), is more convenient for consumers, and generates additional foot traffic (17% of total US retail sales were returned in 2021). In fact, approximately 2/3 of customers used a physical store before and after an online transaction (AT Kearny).
For tenants to effectively utilize a direct-to-consumer (D2C) platform, they must have delivery infrastructure in place or enough capital to streamline it. In addition, the location of brick-and-mortar stores is important. There is much value being situated in regions with high population density and large consumer bases, known as Class A markets. Retailers in Class A markets utilizing omnichannel platforms have thrived and should continue to do so.
Delayed Implementation
While overall retail sales are projected to grow 6-8% YoY (NRF), the current macro environment is likely to create challenges for the entire retail sector, especially malls with non-essential stores. More specifically, rising gas prices, dwindling household savings, supply chain disruptions in manufacturing, and rising interest rates are likely to take a massive toll. In the face of a recession, consumer confidence and spending typically falters which is likely to occur given that almost 75% of consumers say that they are adjusting their spending habits (Colliers). Furthermore, the increase in construction costs due to rising energy and material prices are likely to stall the bulk of mall redevelopment efforts.
An Optimistic Future
Despite the boom of e-commerce and wavering success of department stores, I believe there will always be a need for in-person retail and malls. The definition of a mall is likely to further change – shifting away from department store anchors and towards mixed use, destination centers. The current recession with rising rates and construction costs is an obstacle and may hinder wide scale implementation of the futuristic mall model. However, hesitancy from landlords paired with declines in consumer spending should prompt a further repricing of mall assets.
Eventually, the purchase prices of malls should drop low enough to make conversion projects more feasible. It is unclear when said repricing will occur, and things may get worse before better, but eventually I believe malls will recover and once again be a strong part of the US economy.