The closure of all 2,300 of Payless ShoeSource’s (Payless or the Company) stores in the United States and Canada seems like a minimal event on its surface. Looking a little closer, we see that the loss of another major in line tenant may begin to threaten some regional malls’ cash flow as retail closures build in 2019. DBRS research suggests that only one commercial mortgage-backed securities (CMBS) loan over $25.0 million, Payless and Brown Industrial Portfolio, is at immediate risk from this closure. However, because this news comes on the heels of closures at Gymboree, Charlotte Russe and Gap, DBRS is concerned about the ongoing loss of in line tenants at some properties. Although the closures of anchor stores make the headlines and triggers co-tenancy clauses, it is often the in line tenants that make up a large part of the revenue for a regional mall. The loss of one or two in line tenants is often manageable, but as closures expand, backfilling the spaces becomes increasingly difficult, especially for Tier 2 and Tier 3 malls, which tend to have sales below $400 per square foot (sf ).
Payless, which was acquired by two private equity firms in 2012, has already had one trip through the bankruptcy court in 2017. The first filing reduced the Company’s debt by $435.0 million, which resulted in the closure of 673 stores and left the retailer’s creditors with ownership in the reorganized company. Although this was expected to provide Payless with time to rebuild its brand, a computer failure in 2018 and an oversupply of inventory forced the Company to discount prices below cost in order to clear its shelves, which may have led to the Company’s ultimate liquidation.
Primarily because Payless is not one of the five largest tenants at most properties within CMBS, there are only 28 loans with exposure to Payless (a significant decrease from 2017’s exposure amount of 56 loans as reported in the Payless Inc. CMBS Exposure Report). Payless is usually included in servicer reports in small retail strips and grocery-anchored centers where it typically occupies less than 5,000 sf. The median balance of the reported exposure is $7.3 million. However, Payless is also a tenant at many regional malls — many of which have had exposure to other troubled in line tenants.
Payless and Brown Industrial Portfolio
This loan, which is in the GSMS 2010-C2 transaction, has a balance of $26.8 million and is set to mature in November 2020. The two distribution centers that back the loan are in Brookville, Ohio, which is 16.0 miles northwest of Dayton, Ohio, and Lebec, California, which is 30.0 miles south of Bakersfield, California. The Brookville property has 801,651 sf of rentable space and, at issuance, the Payless lease accounted for 65.3% of the portfolio’s base rent. The Company announced that the Brookville distribution facility will close. As a result of the bankruptcy, DBRS expects the Company to reject the lease, which will reduce the net cash flow significantly.
However, the risk of default may be mitigated by the fact that this is a high-quality industrial asset that was built in 2008 with 32-foot clear ceiling heights and 76 dock-high doors. The property is along I-70, near the Dayton International Airport, where other firms have established logistics operations. The market rent for distribution space in Dayton is $3.24 per square foot (psf ), according to Cushman & Wakefield. While this is below the in-place rent of $4.71 psf, the loan debt service coverage ratio was 2.70 times (x) as of September 2018 and it would be able to cover debt service at the market rent. The borrower could decide to keep the loan current in order to re-lease it. However, with loan maturity about 20 months away, there is little time for the borrower to achieve this recovery.
Anchor stores may occupy the largest spaces at malls, but revenue from anchor tenants often trails the in line tenants because of ground leased or owned boxes and typically low rent psf on leased spaces. The two risks from anchor loss are often manifested in a poor perception of the mall from shoppers and co-tenancy, where some tenants may be able to terminate their leases or unilaterally reduce their rent as a result of anchor store closures. With the additional loss of tenants via bankruptcy, malls now face the elimination of potentially higher-yielding tenants while they are trying to address the loss of their anchors.
At the Rogue Valley Mall in Medford, Oregon, which backs a loan in WFRBS 2012-C10. The 2017 cash flow dropped 15.2% from issuance even though occupancy has remained high. The mall lost Gap and Gymboree over the last two years and its Payless will now close. With the mall’s tertiary location and relatively low sales, this is a property that may find it difficult to replace national tenants on long-term leases.
Burnsville Center in Burnsville, Minnesota, in GSMS 2010-C1 is another story of in line tenancy loss leading to a decline in cash flow. The property lost its Sears store in 2017, though the retailer paid only $190,000 (or $1.14 psf ) at issuance. Furthermore, the mall’s revenue had fallen by about $2 million prior to 2017. In line tenants, on the other hand, averaged more than $40.00 psf. With Charlotte Russe and Payless slated to close this year, the mall could see an additional loss of cash flow. ABC News reported that the mall owner, CBL & Associates, has presented a redevelopment plan to the city for the entire property. However, this would likely require a payoff of the loan. While the loan may not be underwater, the value may not allow for a full loan takeout without an additional equity injection from the borrower.
While the loss of individual tenants does not look painful, multiple tenants closing can put a mall on the defensive if the space cannot be backfilled. Smaller and weaker malls, which have been fighting a perception problem when anchors close, now may face a more measurable problem as retail bankruptcies pile up. These bankruptcies have been clustered among companies that are owned by private equity firms. While financials are not available to judge their health, finding a way to measure the risk of these small tenants will be critical as malls head into 2019. Malls were emphasizing the importance of keeping anchor tenants, but it now appears that the shoe is on the other foot.
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