It has been a tough decade for shopping centers.
Not only have retailers across the country had to contend with the Great Recession, they also have had to fend off growing competition from the internet and shoppers who just don’t go to brick-and-mortar stores like they used to.
And much in the same way that homeowners reeled from the subprime mortgage crisis in 2008, retailers have had their own mortgage woes. Some have been able to handle the debt. Others have not had as much luck.
“There (were), as with the subprime mortgage crisis, unrealistic expectations that things wouldn’t go down,” said Manus Clancy, a senior managing director at Trepp LLC. “It was like the dot-com bubble, driving prices higher and throwing money at stocks with no revenue.”
“When markets get euphoric, things like this happen,” he said.
In the case of the loans dubbed commercial mortgage-backed securities — or CMBS loans — the mortgages on retail properties, apartments, office buildings and other commercial properties are bundled into packages and sold to investors.
And for years commercial real estate was a hot market, in which everyone wanted to make some cash. Retailers and developers spread out, expanding their store counts.
Part of the reason CMBS loans, and real estate in general, was a hot investment 10 years ago was that there really was a high demand for space, said Ryan McCullough, analyst for commercial real estate data firm CoStar Group Inc.
“Retail was expanding because that was the business model. That’s how Wall Street rewarded retailers,” Mr. McCullough said. “Stock prices rose on physical expansion, which created the drive for retail investment, which created these channels.”
Then the bubble burst. Consumers closed their wallets. Many retailers and developers couldn’t make payments on their loans.
It took about four years after the recession hit for the delinquency rate to peak nationally, said Steve Jellinek, vice president, CMBS, at Morningstar Credit Ratings. “Payments had caught up and properties started feeling the pinch of economic stagnation and decreased consumer spending.”
In the Pittsburgh area, the commercial mortgage bust hit a high in 2012, with the default rate hitting more than 13 percent, according to data from New York City-based Trepp, a market research firm.
Deliquencies began to fall but then spiked again in 2015, with the rate wavering between 17 percent and 29 percent through January 2018.
If you take away the Mills delinquency, the Pittsburgh market is pretty healthy.
Even so, Pittsburgh wasn’t as punch drunk as other cities.
Because retail properties tied to CMBS loans represent a smaller pool of property in Pittsburgh than in bigger cities, “that can mean more volatility if a single loan goes delinquent,” explained Sean Barrie of Trepp.
One large delinquency in the region has been that on the Galleria at Pittsburgh Mills in Frazer, which was foreclosed on in 2015. The 1.1 million-square-foot mall in northern Allegheny County opened in 2005.
“If you take away the Mills delinquency, [the Pittsburgh market] is pretty healthy,” Mr. Barrie said.
Last summer, the CMBS delinquency rate for the region jumped due to another property — the Miracle Mile Shopping Center in Monroeville — becoming non-performing beyond maturity. The loan was resolved with a “very small loss,” according to Mr. Barrie.
While the delinquency rate nationally for outstanding commercial mortgage-backed securities loans (including non-retail properties) has been falling in recent months — Morningstar reported the rate fell to 2.32 percent in February from 3.04 percent a year ago — the legacy of older loans still hangs heavily.
The firm said delinquencies from deals issued before 2010 represent 87.9 percent of all delinquencies.
Pumping the brakes on construction
Nationally, the amount of retail square footage per person has been shrinking, according to CoStar.
“What we’ve seen since the recession is that there’s been some retail construction, but it’s going at a slow pace, and the population is growing at 1 percent a year,” Mr. McCullough said. The firm aggregated the largest 54 markets in the country to analyze the trend.
In the fourth quarter of 2017, there was about 51.3 square feet of retail space per person. That’s down from 53.3 square feet per person in the fourth quarter of 2009.
“We think this is a process by which retail will heal itself,” he said. “It’s Darwinism — closing out retail that isn’t competitive and channeling spending into a smaller subset.
“Now, we’re seeing retailers’ strategy is focused on profitability [rather than adding stores],” Mr. McCullough said.
As for the Pittsburgh area, specifically, vacancy rates have been steadily declining since 2010 — right now it’s about 3.5 percent — largely due to a lack of new real estate on the market, according to Ben Atwood, also an analyst at CoStar.
“There’s not an explosive level of demand there,” Mr. Atwood said, noting that rents have been fairly static since 2009, hovering around an average of $14.64 per square foot.
Although malls in rural areas, like Century III Mall in West Mifflin, are struggling — in fact the property has been slated for sheriff’s sale in June — other areas, like Bakery Square in East Liberty and Cranberry, are thriving with “high-end shops and new shopping centers, so Pittsburgh is pretty strong,” he said.
Meanwhile, other malls in wealthier areas are reinvesting in properties where an anchor tenant left.
“In the instances where we see vacancies, they’re redeveloping it into entertainment, services, apartments, hotels,” Mr. McCullough said. “That’s a space they intend to bring back.”
The owner of Ross Park Mall in the North Hills plans to revamp a space left empty by Sears starting in 2019. Simon Property Group, which also owns South Hills Village, expects the redevelopment to include a new dining hall, new stores and entertainment.
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Finding the sweet spot
For retailers, especially brick-and-mortar stores, the fight is coming from many sides — how best to invest in online shopping while finding the sweet spot for physical stores and courting shoppers who increasingly prefer to spend their dollars on gadgets and experiences, and are still looking for the best value rather than the latest fashion trends.
For retailers, some will fare better than others, depending on how they differentiate themselves from the competition, Mr. Jellinek said. Although it sounds like a simple business principle, the field has changed substantially in recent years.
“The mass amount of department stores are competing against themselves while a whole new rash of competitors have grown exponentially over the last 10 years — discounters like TJ Maxx and Ross and wholesale clubs like Costco, along with upscale department stores like Nordstrom,” Mr. Jellinek said. “And then all of those are competing against the internet.”
Meanwhile, the country just has a lot of stores. Perhaps, too many.
“We’re definitely overstored, so those that don’t engage their customers, that will be magnified across their locations,” Mr. Jellinek said.
But it’s not all dark times ahead for brick-and-mortar stores. Many stronger malls continue to thrive by changing their mix of retailers and offering different services and experiences.
“For those profitable retailers working through industry structural changes, tax reform and a solid economy will buy them time to further align their business models with the future state of the retail environment (Target, Kohl’s, and Macy’s, for example).” S&P said.
“However, 2018 will be a tough year for business models that have struggled to access capital or benefit from leveraged acquisitions (such as GNC and PetSmart).”
Pittsburgh-based health supplements retailer GNC launched a campaign, “One New GNC,” in 2016 after struggling in recent years. In December, the company said it had hired Goldman Sachs and Co. to advise it as it looks at possible changes in its current capital structure.
Meanwhile, the commercial mortgage market has begun to steady as liquidations worked their way through the system and lending terms became more conservative.
But there’s always going to be another bubble that bursts.
“These things happen all the time — dot-com, subprime, residential, commercial,” Mr. Clancy said. “And sometime again, there will be another bubble. People will chase money.”
Stephanie Ritenbaugh: firstname.lastname@example.org; 412-263-4910.