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Is Sears' Bankruptcy the Joyride Retail REITs Waited For?

Zacks Equity Research
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Retail REITs have got a reason to rejoice as the recent bankruptcy filing of Sears Holdings Corp. SHLD, which is the parent company of Sears and Kmart, has opened up scope for retail REITs to recapture the Sears sites, bank on redevelopment measures, lure new tenants, and charge a higher rent from them.  

Particularly, for Kimco Realty Corp. KIM, which has exposure to 14 leases (three Sears and eleven Kmart), denoting 1.9% of the company’s total gross leasable area, this bankruptcy filing has ushered in opportunities that will help the company benefit from significant mark-to-market and long-term redevelopment prospects.

According to Kimco’s press release, with the average base rent of $5.25 per square foot for the 14 above-mentioned leases, Sears/Kmart pays among the lowest rent in Kimco’s portfolio. Meanwhile, the average tenant in Kimco’s portfolio pays $15.95 per square foot.

Therefore, the recapture of these boxes, which have favorable demographics with a population of 129,000 within a three-mile radius and an average household income of $88,000, raises hopes for significant mark-to-market potential. Specific opportunities include Whittwood Town Center in the densely populated Los Angeles suburb of Whittier, CA, Bridgehampton Commons in Bridgehampton, NY and Kendale Lakes Plaza in Miami, FL.

In fact, Kimco has been proactively curbing its exposure to Sears/Kmart since 2015 and the company gained from the recapturing of eight Sears/Kmart locations and achieved an average rent spread of 211%.The recaptures have also prompted revamp of four of those centers.

Moreover, apart from Kimco, the other well-known retails REITs — Simon Property Group Inc. SPG and Macerich MAC — have also made concerted efforts to revamp the former Sear sites. Leases of several such sites with Sears have been running for long and the rents paid are comparatively low. Therefore, recapturing such Sears sites gives retail REITs the chance to raise lease prices on those spaces.

Admittedly, retail REITs have been struggling for quite some time as mall traffic continues to suffer from the rapid shift in customers' shopping preference to the online channel. In fact, with e-commerce gaining market share from the traditional brick-and-mortar stores, retailers are compelled to reconsider their footprint and eventually opt for store closures, while others unable to cope with competition have been filing bankruptcies. In fact, besides Sears, the recent retail bankruptcies include that of Toys R Us and Bon-Ton Stores. These have raised concerns over cash flows of mall landlords.

Such an environment has also led to tenants demanding substantial lease concessions which mall landlords find unjustified. However, retail REITs are fighting and making immense efforts to boost productivity of retail assets by trying to grab attention from new and productive tenants, and disposing the non-productive ones. They are transforming their traditional retail hubs into entertainment destinations and lifestyle resorts in a bid to lure customers.

These REITs are avoiding heavy reliance on apparel and accessories, and rather expanding dining options, opening movie theaters, offering recreational facilities and opening fitness centers in particular. Also, retail REITs are exploring mixed-use development options, which has gained immense popularity in recent years. Although such efforts are beneficial over the long term, with huge outlay for refurbishments, growth in the profit margins of retail REITs in the near term are likely to be curbed. In addition, hike in interest rates escalate financing costs.

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