Post-Recession Leasing Could Prove Challenging for Discounters

By Michael Havdala, mhavdala@hsacommercial.com

When the Circuit City and Linens N’ Things spaces began to go dark in 2008, many landlords wondered who would step up to take their places. These concerns only deepened as the economic downturn cast doubt over retail leasing prospects.

But a new batch of opportunistic junior box players emerged to breathe life into dying shopping centers: discount retailers. These discounters recognized the recession’s potential to help them exploit unprecedented low rents and lock in those rates long term. Unlike many retailers, the discounters were in a financial position to leverage these unfortunate circumstances and accelerate their expansion plans.

To their credit, discounters were able to salvage spaces that may have otherwise remained unutilized for years before the economy reversed its course. Gordman’s, a low-price department store, has set up shop in former Wicke’s Furniture and Cub Foods buildings. Goodwill Stores has opened locations in spaces previously occupied by Linens N’ Things. While regional electronics retailers such as Hhgregg and Tiger Direct snapped up many Circuit City spaces, discount stores such as Ross Dress for Less, Big Lots and Savers also found that these backfill opportunities provided easy and affordable access to new -- and previously impenetrable -- markets.

At the expense of their intended merchandise mixes, many landlords were eager --some perhaps too eager -- to stem losses from these new vacancies by striking discounted deals with discount retailers. Net rents for suburban junior box space collapsed in 2008, dropping as low as 50% below pre-recession levels in some cases, according to industry data.

However, the wave of chain store closures has more or less ended in 2011 -- with a few notable exceptions. As the remaining vacancies are being absorbed, landlords are starting to regain their leverage, with asking rents reversing a two-year downward trend and net rent comps for junior box space seeing a sizeable year-over-year gain.

For the most part, the Circuit City and Linens N’ Things facilities have been leased up, and those that are vacant remain so for good reason -- usually an inferior location or lack of demand in a given market. With strong levels of absorption taking place in recent months and rents once again on the rise, current trends beg the question: Is the window of opportunity closing for discount retailers?

The headlines seem to have changed in early summer 2011. Premium sporting goods retailer REI announced a new lease in a former Circuit City in South Carolina -- its first store in the state. In neighboring Georgia, LA Fitness is said to have taken a former Circuit City space as well. Near Seattle, Wash., boutique grocer Trader Joe’s recently opened its doors in a building shuttered by the electronics retailer. Likewise, a Linens N’ Things location in Michigan is to be repurposed as a Dick’s Sporting Goods, scheduled to open in September.

These moves suggest that premium and midmarket retailers are active again and are now competing for the remaining mid-box vacancies, posing a challenge to discounters seeking cut-rate rents in advantageous locations. This affords landlords the opportunity to reassert themselves in lease negotiations, which they appear to be doing.

With all these trends converging, it is highly likely that we will see a bifurcation in the retail market. Highly visible, well-located shopping centers will reap the benefits of resurgence in leasing activity, while less-attractive centers in exurban markets will continue to appeal to discounters. Population density is proving to be a key factor in determining whether landlords can fill vacant boxes with the type of premium and midmarket tenants they might prefer and which pay higher rents.

The first test will come with the raft of Borders stores coming onto the market in the wake of the bookseller’s Chapter 11 bankruptcy filing. These vacancies are in both infill and greenfield markets, and the ensuing leasing will be a bellwether for gauging retail strength in those areas. Although we can expect strong demand for these spaces from active discounters such as Ross Dress for Less, retailers such as TJX Cos’ HomeGoods have announced new stores and could be motivated to pursue the more attractive Borders locations.

As this bifurcation continues, unoccupied anchor locations in exurban markets are likely to remain vacant for another six to 18 months before occupancy improves, but areas with positive retail fundamentals should start to see new development as a result of a stronger lending environment. Landlords and owners can sleep more easily knowing that demand and, more important, rental rates are being restored to previous levels. Though we may not see the peak pre-recession pricing for several years, the trend is certainly positive and could offer some defense in future lease negotiations.

Michael Havdala is senior VP, retail brokerage, at Chicago-based HSA Commercial Real Estate (hsacommercial.com), a diversified, full-service real estate firm specializing in office, industrial, retail and health care real estate leasing, management, marketing, development and financing on a national basis.