It's not Armageddon for all malls, some are turning store closures into higher rents

Key Points

• For the country's top mall owners, store closures provide an opportunity to make over their best properties.

• Often, landlords are able to rake in higher rents when they replace a department store with a new tenant.

• This trend is benefiting major REITs like Seritage Growth Properties and GGP.

Malls haven't hit doomsday just yet
Malls haven't hit doomsday just yet

When Greg Maloney started building malls in the early 1980s, there was only one way to get the project off the ground: sign on a department store.

But it came at a cost. To lure in these so-called anchor shops — the main driver of foot traffic — landlords often had to sell them the land they'd occupy, or lease the space at $1 per square foot.

"Without a department store, ... there would not have been a shopping center to be built," Maloney, now CEO of JLL's Americas Retail business, told CNBC. "We were the ones who were giving sweetheart deals."

Those types of deals are becoming a thing of the past. As major retail chains look for ways to shore up their profitability, they're closing down extraneous stores built during years of overexpansion. According to a new report by JLL, provided exclusively to CNBC, closures from major chains like Macy's and J.C. Penney are pouring up to 37 million square feet of space back into the market.

While the retail industry's contraction will no doubt lead to real estate consolidation, it also provides higher-end malls an opportunity to buy back desirable space that they can modernize for more attractive tenants. Often, those transactions can be quite lucrative for the landlord.

Take Seritage Growth Properties. The real estate investment trust that was spun off from Sears in 2015 has been leasing space to a bevy of new tenants. They include restaurants like Outback Steakhouse, grocers like The Fresh Market and entertainment options like Dave & Buster's.

On average, Seritage has re-leased space at 4.4 times the previous rental rate, according to JLL's report. Whereas Sears pays an average $4.40 per square foot across its fleet, third-party tenants pay $12.74, JLL said. Tenants that have signed on but not yet occupied former Sears' space are paying an average $18.55, JLL said.

That redevelopment stands in stark contrast to the dilapidated malls scattered across the U.S., which only tell half the story.

"With everything that is said out there you'd think that it's Armageddon and retail's going to be gone next week," Maloney said.

JLL analyzed 40 Seritage properties that have been released. The REIT is in various stages of redeveloping the space it acquired when it purchased 266 Sears sites in 2015.

Seritage is far from the only property owner reinventing vacant space. Fellow mall owners Simon Property Group, CBL & Associates and GGP are finding creative ways to reimagine their shopping centers to compete against the likes of Amazon.

They include GGP's Oakbrook Center, 30 minutes outside of Chicago. After GGP exited bankruptcy in 2010, the then half-century-old mall became a priority for the recapitalized firm. Located in an affluent area near Naperville, Illinois, with no competing retail centers nearby, "the property was ripe for reinvestment," Kevin Berry, senior vice president of investor and public relations, told CNBC.

Changes included upgrading the flooring and landscaping in the common area; breaking a 150,000-square-foot Bloomingdale's Home into smaller spaces for The Container Store, Pirch, Tommy Bahama and Hugo Boss; and converting the lower level of a Neiman Marcus into two restaurants.

Since 2011, GGP has redeveloped 82 vacant department stores. They've been transformed into everything from a trampoline park to a Forever 21 to a 24 Hour Fitness. While those projects cost a combined $1.4 billion, they've generated an 11 percent annual return.

"The new life of these things just really runs the gamut," Berry said.

Of course, not every retail center will have such a happy ending. Malls that have been outshined by stronger neighboring properties are less likely to merit the capital required for reinvention. And that's if their owner has the money in the first place. Given that many of those struggling centers are operated by smaller, privately owned companies, they often don't have the capital necessary for a head-to-toe makeover.

As a result, Green Street Advisors' 2017 Mall Outlook estimates there are more 300 malls in the U.S. considered "C" quality. Those lower-tier malls are the most at risk of closing over the next several years, the report said.

Despite the gloom those malls and a massive wave of store closures have cast on the mall industry, Maloney remains an optimist.

"This is the best time to be in our business," he said. "This is when you get to take space and get creative and build something bigger and better than what was there before."

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