With 100,000 stores set to close by 2025, mall owners face this legal hurdle next

Key Points
  • UBS is expecting 100,000 stores to permanently shut between now and the end of 2025. 
  • Mall and shopping center owners are likely going to be hearing from tenants that are pulling out of leases with co-tenancy clauses, as department stores and other anchor tenants shut for good. 
  • This could deal another blow to the retail real estate industry. 
A visitor looks down an empty hallway at The Fashion Mall at Keystone, Wednesday, March 18, 2020, in Indianapolis. Simon Property Group, the largest owner of shopping malls in the nation, is closing all of its malls and retail properties because of the coronavirus outbreak.
Darron Cummings | AP

Mall and shopping center owners around the country are getting ready to come face to face with a major legal hurdle: Co-tenancy clauses. 

The coronavirus pandemic will accelerate the rate of permanent retail store closures, as sales shrink close to nothing with many shops temporarily shut to try to halt the spread of Covid-19. Liquidity also is drying up and finances are being squeezed. UBS is expecting there will be 100,000 stores permanently shut between now and the end of 2025.

Meantime, online sales as a percentage of total retail sales in the U.S. are expected to grow to 25% from 15% over that same timeframe, UBS analyst Michael Lasser said. 

With another wave of department store closures inevitably looming, and some chains potentially filing for bankruptcy, landlords' phones will likely be ringing — with retailers on the other line demanding rent reductions or outright saying, "I'm leaving your mall." 

Here's how co-tenancy clauses work, on a basic level: They are typically built into the leases of the specialty tenants, like a Gap or an AT&T store, in the middle of a mall, or the shops situated along a grocery-anchored shopping centers, like a Big Lots or a TJ Maxx

The clauses will say something along the lines of: If less than 80% of space is occupied at this property at any given time, or if a major, anchor tenant like a department store or a grocery store goes dark here, the tenant is allowed a break in rent. Or the tenant is given the ability to terminate a lease early. The clauses are meant to protect tenants when circumstances happen that are outside of their control. 

Tom Mullaney, head of restructuring services at commercial real estate services firm JLL, said all of his retail clients are watching their co-tenancy clauses "like hawks." 

"As majors close and do not reopen, my clients are pulling out their leases," Mullaney said. "The whole purpose of a mall is to generate large amounts of foot traffic." If you lose an anchor or two, the purpose is lost, he said, and retailers will have an opportunity to speak up. 

A wave of retailers demanding rent reductions, or leaving malls and shopping centers entirely, would deal another blow to an industry that has already been struggling to fill excess space.

Store closures are nothing new. A record was announced in 2019. But the rate of closures is only going to accelerate due to the Covid-19 crisis. This could put some malls entirely out of business. Already, some retail landlords, including mall owners, are defaulting on their mortgage payments to lenders, CNBC reported

Many analysts say America is still over-retailed. Currently, there are nine malls per 1 million households in the U.S., according to an analysis by UBS. That is up from eight malls per million in 1980, when retailers didn't even have websites, the firm said. Ironically, the number has grown as e-commerce has proliferated. 

"This is where you'll really see malls start to suffer," said Daniel Herrold, a broker for Stan Johnson Company. 

America will emerge from coronavirus pandemic with fewer department stores