The Effects of Retail Bankruptcies on Retail Real Estate
Guest: Karly Iacono
Topics: Retail bankruptcies, Bed Bath and Beyond
Chris Ressa 0:00
This is retail retold the story of how that store ended up in your neighborhood. I’m your host, Chris ReSSA. And I invite you to join my conversation with some of the retail industry’s biggest influencers. This podcast is brought to you by DLC management. Today’s episode is brought to you by complete solutions and sourcing complete is a partner of ours at DLC, and they provide waste and sustainability solutions for our properties.
Karly Iacono 0:34
Welcome everybody to what’s in store the show where we cover hot topics at the cross section of retail and real estate. I’m Carly Iacono, Senior Vice President at CBRE and I’m joined by my co host Chris Russa the COO of DLC. Good morning, Chris, how are you today?
I’m doing great. Good morning.
Nice to see you. I hear you are back from a trip around the country looking at retail real estate. Our favorite thing to do, how was your trip?
It’s good. This is like my first day back in the office. And like 18 days I was in Denver, got a property to buy then I was in Florida vacation. And I was in Arkansas for two properties we own as well as talking meeting with retailers down there. So there’s actually more retailers in Arkansas than you would imagine. There’s a lot of real estate directors heads of real estate of retailers who work remotely have come out of the Walmart real estate program. So the head of real estate of Top Golf lives in Northwest Arkansas. David there, that’s what took place in Northwest Arkansas. Amazing. By the way. I’ve never been there. It’s like an envelope. Like, I could live there. My wife couldn’t but I could certainly live there. It’s a great place.
Tell me your favorite thing about Arkansas before we kick off today’s show. One thing top thing besides
I think, you know, the scenery, the landscape is amazing and how they’ve built up. A lot of the warmth Waltons have invested so much money into the Northwest Arkansas area, whether it’s between the arts and theater, whether it’s hiking, or just the physical architecture of the real estate that’s there. It’s it’s impressive.
I had no idea. So there you go listeners today shameless plug for Arkansas. Not sure what your sponsorship amount was for blog, but I’m sure it was a lot. No, it sounds like a good mix of a business and lifestyle. Yeah, for sure. Okay, we’re gonna jump in to today’s episode, which is on the effects of retail bankruptcies on retail real estate. So retail bankruptcies are always a huge buzz line headline because the media loves to say that everything’s falling apart. So kind of, you know, boost for attention when it comes to retail real estate. But retail bankruptcies are not always a bad thing. Of course, sometimes they are. So today, we’re gonna dig into some of the big retail bankruptcies of 2023. And what we think that means for real estate. You want to kick it off with the big one from yesterday, Chris?
Yeah. So So Bed Bath announced filing and they they’ve put on their website that they’re winding down operations. So that that’s obviously one that I think the very much anticipated the retail real estate world has been looking at this one happening for a while. And so I don’t think it’s a surprise to anybody. And I think a lot of retailers have been chomping at the bit waiting for this to happen to get access to real estate that we’ve had Tuesday morning file this year, we’ve had David’s Bridal and Party City who filed and then there was Regal, which I forget was either the end of last year or the beginning of this year. Also filed so we’ve had to pick up in retail bankruptcies but and so I think what that means for the retail real estate is interesting. And the place I’d like to start is is the Tuesday morning bankruptcy. Okay. So Tuesday morning had not a large number of stores that had like 264 stores. The thing I found interesting was how many stores sold at auction. So the leases were sold and what that means for retail real estate so Five Below Michaels arts and crafts Dollar General Me, and a couple others bought stores in bankruptcy, which some of them it, it is new to them, you know, five below hasn’t done this before. And Dollar General who is arguably our arguably the goat at opening up new stores, they are a new store machine from organic growth. And for them to go and buy some leases speaks to a lot of things. One. on the dollar generals case, it talks about how challenging it is to develop, because of construction costs interest rates. On the Five Below case, it talks about like, one, how expensive they bought the most stores, how expansive they’re trying and how much they’re trying to grow. And I also think, if you look, this was like in 19, only only only 30 of the 264 stores. So more than 10% were sold off at auction. But this was in like 19 different states. So I think what this shows is the supply is so constrained across the board in the entire marketplace, not just in any one geography, but in the entire marketplace supply is so constrained, that this is a way that an end because it’s so constrained retailers were you know, clearly nervous that someone might go in and buy these leases. So they’re in there, you know, vying for leases to buy, which I just found really interesting, especially when you think about five below who hasn’t done this. You think about Dollar General who’s you know, arguably the gold at opening new stores today. And you think about how many different states that it opened in this. This is remarkable.
I think that’s such a fascinating case study for all the reasons you just mentioned, when we often hear there’s growth in Texas, there’s growth in Florida. But to see 19 Different states get picked up across the board and the demand that’s so widespread, I really do think that tells a different story for retail. That’s not just regional population shifts and retail changing. It’s just absolute lack of availability, and a need to expand any way possible. And I also think your point that it was not just one retailer backfilling but there was competition to backfill the spaces. I think that paints a very different picture than the headlines of, you know, retailers is dying. There’s all these bankruptcies, where do we go from here? It’s no, there was a few select bankruptcies. And now there’s competition to backfill those spaces. What completely opposite storyline? Then we’re reading in the news.
Yeah, there was one market in Oklahoma, where if you look it up, I think Dollar General and Five Below were both they were, they were bidding up the lease. And I think was the only one they competed against each other. I’m going just some, you know, market in Oklahoma, they can’t find any space, this is the best. Now, you could, I’m sure there’s much more that goes into that, right, maybe it was the best piece of real estate in the market. And so retailers sometimes say if I can’t have that, then I’m gonna wait on that market. And so I can get into that property. So maybe it was just a dominant piece of real estate. And that’s where they wanted to be. And this was their golden opportunity. So they were, they were making a yeoman’s effort.
Have you seen subdivision of any of these spaces? You know, I tend to think of Dollar General a little bit smaller than Tuesday morning, how have you seen them take over?
So that’s something that’s what’s amazing. I think there’s some, there’s like a, I don’t think so I think we’ll see what they do with them, I think, but some of the spaces are a little bigger. And I think Dollar General might be using the Pop Shop concept in those. But you know, I there was a 15,000 square foot space that was purchased. And here’s the other thing, the option for the retailer, to take the chance on, letting that lease go back to the landlord and then making a direct deal with the landlord. Which could be sometimes it’s beneficial, sometimes isn’t typically the beneficial side. The The opportunity is that the landlord will invest some money to get that tenant whether that’s in landlord work and try to make it that that source prototype. The risk is that the rent could be more than the use with that tenant.
Now when they’re taking over these new sites, if it’s not going back to the landlord, is this a sublease clause in the lease? Have you assignment provision. Yeah. Okay, so they can directly assign it. But if the lease didn’t have the assignment or it had to be approved by the landlord, then that may not be quite the same,
I think. I think my experience is in bankruptcy court, a lot of that gets thrown away in the bankruptcy court, you know, dictates a lot, because they’re trying, you know, a lot of the rules of engagement that happen outside of bankruptcy court are different than in bankruptcy court. So, you know, I think there’s exceptions that get made depending on what the bankruptcy court decides to do. But the part where I was going, and I think it’s fascinating is, these retailers are going to invest money in the stores, they’re going to have to deploy capital, especially if they want to turn it into their store prototype, there’s a significant investment could be seven figures to get the stores that way. And that’s the level of investment going into retail. And I think when you think about the retailers who are buying leases, there, they’re today’s like dominant first class retailers. And I think that that’s going to be better for consumers, because they’re getting, you know, potentially better retailers better for properties, because they’re getting better retailers. And the property is going to be invested in by these retailers. So I think it’s, you know, there’s some good stuff happening, even though sad to see some of these legacy retailers, potentially not make it.
So how do you think the rents then we’ll we’ll compare between the sites that are being assumed, and then if it were to go back to market and be a brand new site? Is this really at a discount? And then what would that mean for the property owner, if they’re not able to return in the space at market rates? Or do you think it’s more of a wash?
I think some of the retailers who have filed have rents across the board, you know, compared to market, I think, historically, some of the legacy Tuesday morning spaces, they might they were taking some of the less desirable space in a shopping center, potentially, and paying below market rents. And over the last few years, they started to upgrade that and take better spaces and pay market. In the, in the case of Bed Bath and Beyond. I think landlords have been chomping at the bit because, you know, for years in the 2000 to 2010, that Bath and Beyond was such a coveted tenant for shopping center owners, and Bed Bath and Beyond did an amazing job of taking that leverage and using it to get great economic and non economic terms in their leases. So you’re going to see some of the leases that much at ransom, but that’d be at significantly below market, which if they get bought in bankruptcy in an auction, then the landlords will be able to take advantage of that. In the case where they don’t go back to the the they don’t get sold off an auction, they go back to the landlord, I think you’re gonna see some opportunity for landlords to, you know, get to market in a space that was otherwise controlled, with potentially a lot of options at lower than Mark market rents.
When a retailer buys a lease and bankruptcy, you may or may not know the answer to this, do they also have rights to the options under that lease? Can they control the property for the full duration of the lease? Remaining lease term and options?
I believe that you know, I’m not a lawyer, but I believe the answer is yes. I think that’s one of the challenges when they’re buying leases, how much control do they have? Right? Right? You don’t want to pay money for a lease and then only have three years left with no site control, you might get kicked out especially if you invested money. And so, you know, lease term is definitely a component to make sure that they can control the real estate for the year at least in their pro forma for the duration of their what they have been performer.
Are there any of the big headline bankruptcies? I think there’s five or six that have happened this year? Not a tremendous amount. But Are any of those in your mind going to be harder to backfill than others are any more of a concern for retail real estate than the ones we’ve been speaking of?
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I think the theaters, I think theater is the big one because of the significant investment if it goes from theater to non theater, I think, you know, Regal is the one that comes to mind. Right? If if you’re taking that back and you’re talking about that it’s no longer a theater site, I think that’s a bit of a challenge because of the cost to retirement that and what that might be. That would be the biggest one. You know, the other ones are traditional retail. And, you know, the demand in the 20 to 30,000 foot Jr box space of Bed Bath and Beyond is significant. And, you know, we’re seeing from fiber, low pop shelf, that band in that Tuesday morning, David’s Bridal is pretty large. And, you know, from Party City. You know, we’ll see what happens with Party City. I think, you know, I think Party City is going to be around. But you know, it looks like they’re moving toward a good positive resolution. So I think that when I think about which tenants are most challenged, i The theater is clearly the top one.
That makes sense, any special use would be harder to backfill.
So Carly, speaking of theaters have, have you seen any net lease theaters trade on the market? There are a significant amount of net lease theaters that exist and a lot are owned by the net lease REITs and whatnot. But have you seen any trade lately?
It’s a great question. I really haven’t not to say there weren’t any. But I think theaters became especially difficult to finance post COVID. So on the private client market where you’re traditionally tapping into bank financing, and you know, sort of the regular financing channels, it’s much more difficult to trade theatres unless there are strong co tenants, which obviously is a different story with single tenant. So I would imagine some of the REITs traded them direct back and forth is often happens, but I didn’t see any of the private clients space.
After you know, if you know, it looks like you know, Regal emerges, there will be less theaters and some had closed COVID get to what a stabilized theater market? Do you suspect that in 23 or 24? We’ll start to see theaters trade again? Or is the capital markets in a way that it’s going to be a while before theaters start trading on the you know, the public markets?
I think it really depends on the strength of the operator and lender appetite. It all comes back to not really just public sentiment, but how again, those lenders are looking at those deals. So if the the operators are strong, the financials look good, and we have a stable business model, then yes, I think they in every other category will trade if it’s financeable, if it’s not, they’re usually higher price point deals. So that’s where you get into the the liquidity and it becomes very difficult to trade. So all going to be predicated on the financial stability of the operators.
Got it? Okay.
Well say, well, it’s fine. I,
I am long term. I think the theater space is going to be interesting, right? There’s a bit of a consolidation that’s happened. And then you know, their product was as challenged as any retailers product was because such a long time we couldn’t be in person to make movies. And that’s starting to come back now. So and product is, you know, in that space drives everything and much like many retailers, but it’ll be interesting as product starts to come back. But app happened from the real estate perspective as it relates to theaters and product has already started to come back.
I think if we go back to the days of experiential retail being our buzzword, which what was that two dozen? 1819 that’s all anybody talked about. Then yeah, we start really focusing on theatres and gaming and all of that again, it’s still out there. Of course, it’s a big part of of retail and entertainment, but I don’t think we’re quite there yet.
Right. So yesterday, you know, bed bath filed and we had these other filings this year, I would take the converse 20 Headlines that’s like, potentially, you know, what’s going on in retail or retail real estate, I think this is, you know, pretty measured in comparison. And I suspect we’ll still probably have more stores open this year than close, it’s still a pretty, the fundamentals at the property level are still stronger than they’ve ever been.
And I think that is really important to keep in perspective, the data is still suggesting roughly 5100 store openings in 2023, in only 2600 store closures, that’s almost double the store openings versus closures. And this is coming at a time when we still have historically low vacancy levels to begin with. So any, you know, real vacancy, when it has decent underlying real estate, I feel is going to be snapped up pretty quickly, as well. So could be a good thing, unless it becomes more and more widespread. And we start seeing more distress overall and retail properties. But right now, it’s a welcome breath to get some stronger tenants and like you mentioned at the beginning of the show.
Yeah, I think the bed bath one is going to be really interesting, because and I think there’s a wide sentiment that because they were such an iconic, strong retailer for so long. One of the leverage points was they were able to get real, quality real estate. And I think, you know, there’s going to be a lot of different retailers, landlords, and probably some unsuspecting groups showing up to bankruptcy court for some of these leases. You know, when from like, 2010 to the pandemic, it wasn’t like it was like long ago, in the 90s. This was like a such a, a, a pillar in like retail growth strategy was buying up leases for many different retailers. And it really slowed down in the 2010. To 2020 world to have leases go back to landlords then do direct deals with landlords, This bed bath one, you know, bed bath had already closed a bunch of stores over the years. And the ones that kept open, they really, you know, I think they did a pretty good job of getting occupancy cost down where they had the leverage to do so. And, you know, certainly some landlords just opted to take space back, I used to have many more bed baths than we do in our portfolio today. You know, we have the bed baths we have, we only have two and you have waiting list for both properties. So and then they’re in different markets, and we’ll see what happens whether I’m gonna get them back or they’re gonna get bought up in bankruptcy. But, you know, the stores they have left, if you think about what they kept, because this was such a long trend of declining sales and store and announcing store closures and, and getting, you know, when the lease came up, maybe the landlord went a different direction the stores they have left. They fought to keep they fought to keep. And so, you know, I’d venture to say the stores they have left are some of the strongest in history in the history of the bed bath portfolio. So it’s going to be interesting what happens in bankruptcy court and what leases get sold. And then what ended up going direct back to the landlord.
Do you have any say as a landlord, which tenants? When when you have multiple tenants competing for space in bankruptcy court? Do you have any say which tenant wins on a particular space?
You know, not ludicrous, but I don’t believe so. I think the way it works is whoever is the highest bidder wins that lease.
Right? So good luck. Exciting. You might have a brand new tenant, you don’t know who it’s gonna be, but
well as a landlord, you could be one of them. You can be one of the bidders. Got it. So you will see, you will see landlords I unequivocally in this one. You will definitely see landlords at bankruptcy trying to make sure they can control their own real estate and decide who they want to go in the space. I think you will definitely see landlords buying space buying leases back.
Right. And I think that’s the punchline here. You heard it here. First, we are not afraid of the Bed Bath and Beyond bankruptcy. In fact, it could be a great thing for retail landlords with a lot of tenant competition for the available spaces.
Yep. All right. All right.
Thanks so much for your insights Chris and good luck with your two stores can’t wait to see what they become sure it will be fantastic. And everyone listening that was what’s in store. We’re so happy you could join us for our take on retail bankruptcies and what it means for retail real estate. We will see you next month. Thanks so much Chris. Thank you.
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