Another Shakeout Is Coming for Shopping Malls

Malls came out of the worst of the pandemic with the upper hand. Shoppers eager to get back into stores helped fill vacant space and operators were able to wrestle rents higher. But the calm has shattered quickly for the long-beleaguered sector as a crucial funding market seized up and the collapse of a string of regional banks compounds the pain.

All that amounts to another moment of reckoning for malls, particularly mid-tier names that failed to use the brief post-lockdown window to upgrade their mix of tenants, lock in loan extensions and lower borrowing costs. As painful as it might be, one more washout is just what the sector needs to finally put it on a sustainable path.

Even before Silicon Valley Bank’s collapse raised the odds of a recession, malls were facing a challenging year with consumer spending slowing, borrowing costs spiking ever higher and big box stores like Bed Bath & Beyond hanging on by a thread. Interest rate volatility and economic uncertainty has constrained the market for commercial mortgage backed securities, prompting banks to become a more active source of funding for the retail property sector, Abby Corbett, the head of investor insights at Cushman & Wakefield Plc. told me. The recent string of failures among regional lenders now further threatens liquidity.

Like other commercial real estate, malls are built on debt. Owners typically provide some equity and depend on bank loans and CMBS lenders for the rest. This mix not only helps them generate better returns, but also fund capital improvements like outside lawn areas and food courts. Debt is literally the lifeblood of malls, says Chad Littell, who leads U.S. capital markets analytics at CoStar Group. Recently, much of the concern swirling around commercial property has focused on the office space. Hedge funds like Polpo Capital Management and Marathon Asset Management are betting that a fall in demand for less-desirable workplaces will make swathes of office property obsolete and put loans linked to them at risk of delinquency.

But Fitch Ratings estimated in November that the highest rates of CMBS loan delinquencies will be in retail; climbing to as much as 11.3% by the end of this year from 5.7% in October. The bulk of maturing class B and C mall loans will likely default as access to capital gets harder, it said — and that was before banking troubles sent a shudder through markets. Regional and local lenders represented about 46% of financing for retail real estate in 2022, according to a report from MSCI Real Assets.

It’s not all doom and gloom though. Some mall owners saw the writing on the wall early and used the short window of easier lending conditions and high shopping demand to refinance under more favorable rates and extend their payment deadlines.

For instance, the Macerich Co. scrambled to close refinancing deals on several of its maturing loans before the economic headwinds ramped up this year. Like other malls, Macerich has seen occupancy rates recover after being crushed by the pandemic. The company last year managed to extend loans or refinance with fixed rates or rate caps for several of its most important properties. It negotiated a three-year extension on a $300 million loan on its prized Santa Monica Place in California, giving it time to fill in empty anchor stores with experiential art exhibition company Arte Museum and the popular Taiwanese dumpling chain Din Tai Fung.

Simon Property Group Inc. is among those that focused on high-quality properties well before the pandemic shook the industry. Its dominant position in productive, class A malls “runs counter to the view in some circles that malls are dinosaurs destined for extinction,” Bloomberg Intelligence analyst David Havens wrote last month. “That may be valid for vulnerable class B and C malls losing tenants and anchor department stores.”

No doubt there are many mall operators less prepared for the rough economic waters ahead. Take CBL & Associates Properties, which represents some of the challenges facing mid-tier malls. It was slow to pivot to a growing economic divide between wealthy and middle, and low-income shoppers even as peers like Macerich picked a lane. As mid-market retailers floundered, the company hung on to tenants including Victoria’s Secret & Co. and Gap Inc. The pandemic threw the company into bankruptcy and while it emerged with a cleaner balance sheet, it continues to struggle. By the end of 2022, it lost three of its malls to receivership and foreclosure.