October 15, 2018

Bankruptcy Announcement:

  • Sears Holdings Corp. announced Monday morning it has sought Chapter 11 bankruptcy protection in the U.S. Bankruptcy Court in the Southern District of New York. The retailer plans to close another 142 stores, leaving it with approximately 580, according to locational data provider AggData.
  • Additionally, Sears disclosed that it is negotiating with chairman and majority shareholder Edward Lampert’s ESL Investments to purchase “a large portion” of its store base, though that bid likely would then go through an auction process to determine if higher bids would materialize.
  • Mall owners have anticipated Sears’ potential closure for several years and have made contingency plans that could mitigate the increased supply of available space. 
  • For mall or strip center owners facing the imminent shuttering of a Sears or Kmart, recovery will be a protracted process. It often takes 18 to 36 months to backfill a typical department store, but the complexity of this bankruptcy filing will make this less than typical.
  • Sears’ filing will be one of the most complex retail bankruptcies to date, making its timelines especially hard to predict.

Overview of Sears Real Estate:

  • The bankruptcy affects approximately 380 Sears stores and 342 Kmart locations (prior to closings) across the U.S., Puerto Rico, and Virgin Islands, totaling an estimated 100 million sq. ft. of owned and leased real estate.
  • Though most Kmart stores are in strip centers or stand-alone locations, the vast majority of Sears stores (>87% of boxes) are in regional malls.
  • The current portfolio of Sears stores is heavily concentrated in mall properties that are Class B and below. It is estimated that less than 30% of Sears stores are in Class A malls (>$450 psf) with just over 50% of locations in Class B properties ($300-$449 psf) and around 20% in Class C malls and below (<$300 psf).1 

Implications for the Marketplace:

  • Many mall owners, long expecting Sears’ bankruptcy announcement, have detailed contingency plans in anticipation of store closures. Nevertheless, many of these plans cannot be instituted until often-protracted bankruptcy proceedings unfold. Other considerations for the retail real estate industry include:
    Backfilling department stores takes time

Backfilling department stores takes time:

  • Backfilling department stores takes an average of 18 to 36 months, and the ease and speed of re-tenanting or redeveloping those stores will vary significantly by location, property, ownership, capital availability, regional or national economic fundamentals and numerous other factors.
  • Stores in major markets and in prime locations will be easier to repurpose than those in secondary and tertiary markets where consumer demand is weaker or has declined in recent years. Generally, Kmart stores are in less-prime locations than Sears stores, so it likely will take longer to secure tenants and redevelopment plans for those sites.

There is no one-size-fits-all solution:

  • There is no single, scalable reuse option for the affected properties. Redevelopment or re-tenanting options will vary widely, depending on trade area, capital availability and landlord strategy, among other factors.

For many owners, the announcement and final resolution could be a positive outcome:

  • For many of Sears’ leased locations, rent was set at well below market rate and closures present opportunities to re-tenant with higher-paying retailers that drive more traffic. 
  • In other cases, owners are expected to pursue other alternative uses that would also drive more traffic to the property and its co-tenants, such as hotels, apartments, restaurants, entertainment and offices. 

Market shock dulled by years of preparation:

  • Much of the Sears portfolio has been underperforming for years and posting steady declines in both traffic and sales, driving many owners and occupiers to prepare for closure and reducing the impact that such a vacancy may have on the property’s NOI. 
  • Most existing retailers in Sears-occupied malls likely will not see a significant negative impact on store traffic or sales following a closure. Sears’ steady performance declines in many malls means it has long ceased to be a key traffic driver, so closure will have minimal impact on co-tenants’ performance.
  • While a major mall anchor or department store closure can often trigger kick-out clauses for in-line retailers—the right to early lease termination—this is less likely to happen with Sears’ closures. Many mall owners already have re-negotiated such kick-out clauses as they pertain to Sears store closures, effectively minimizing the domino effect such a vacancy will have on their properties.

Other retailers eye an opportunity:

  • Many non-traditional mall tenants have long targeted Sears locations as a potential opportunity. Expanding big-box and junior-box retailers traditionally focused on power centers may seek out Sears locations with complementary merchandise mixes in appropriate trade areas.
  • Alternative, non-traditional mall tenants in categories with rising demand for retail locations—such as grocery, health care and education—likely will consider existing Sears stores as potential expansion opportunities.

What’s next?

  • The bankruptcy process can be lengthy, especially if the bankrupt entity includes a complicated ownership or debt structure. It isn’t feasible at this point to reliably forecast if Sears will liquidate or survive in some form, nor who might end up owning the majority of a surviving entity.
  • A filing in Sears’ bankruptcy case on Monday identifies the 142 stores to be closed (docket entry 23). Sears announced that other stores remain open for the holiday season.
  • Chairman Edward Lampert’s ESL is assembling a bid to purchase “a large portion” of Sears’ store base. However, that bid will most likely be subject to a competitive auction process in the bankruptcy court to determine if the market will yield a higher value.

1 Source: CBRE Research and Green Street Advisors, October 2018.
 
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