Class A Malls Standing Tall

The only sure thing about trends is that they change.  Almost every retail concept is vulnerable to a new trend that could reverse years, or even decades, of profits.  We have published extensively on the opportunities and threats that have been created by the growth of ‘omni-channel’ retailing, most recently in December 2015 in a piece titled, “Buckle Up! Retail REITs are Traffic Drivers”.  We applaud REIT management teams that are taking responsibility for bringing consumers to their tenants, and subsequently creating their own brands that are ‘alive’ – as opposed to a ‘dead’ or ‘dying’ mall often characterized by low occupancy, struggling department store anchors, and slowing foot traffic.

Proactive mall landlords have been much more forward-thinking, considering the role of a mall in ten or twenty years with each leasing decision or dollar of marketing spend.  How will department stores fit into the consumer’s spending habits?  How will driverless cars have an impact?  Will e-commerce keep shoppers away from bricks-and-mortar retail?  We believe that most predictions about the future of retail are impossible to prove or disprove, but we are confident in our thesis that high quality locations owned by forward-thinking landlords that are willing to reinvest in their properties will be more valuable than they are today.

Over-Retailed and Over-Malled

According to the International Council of Shopping Centers (or ICSC), the US has the highest retail gross leasable area (or GLA) per capita among all developed countries, totaling over 24 square feet (or sqft) per person.  Canada is a distant second at 15 sqft per person, and some of the most mature economies in Europe range from 2 to 5 sqft per person, as shown in Figure 1.  Not surprisingly, the US also leads the world in retail sales per capita, but the margin is nowhere near as wide.  According to Planet Retail and Knight Frank Research, the retail sales per capita in the US were $11,687 in 2015, which contrasts to developed European countries at $7,000 to $8,000.  Thus, there is not enough sales revenue to justify the amount of square footage.  For the past 60 years, as suburbs grew in population, competition between retailers to capture the incremental US retail spending dollar drove the sqft per capita to where it is today, and we can be sure that the competition will be similar as the market adjusts downwards to equilibrium.

Besides the normal ebb and flow of retailers, there will be entire portions of retail real estate that will have to be converted to an alternate use.  One of the easiest to see disappearing in large swaths will be the low quality malls, a favorite headline story for many media outlets.  According to Green Street Advisors, there are 1,085 malls in the US, of which 589 are graded ‘B’ or higher.  It is entirely possible that we will see many of the remaining 496 malls downsized or repurposed in the next 10-20 years.  Some of these malls are considered the ‘only game in town’ which will help them to survive, but it is fair to say that a majority of these will be gone.  The total square footage of malls rated B-minus or lower is close to 320 million.  So, even if all of them disappear, it would only decrease the average retail sqft per capita by one, assuming a US population of 319 million.  More than likely, most of the decline in retail square footage per capita will have to come from power centers or strip centers with the most vulnerability to e-commerce threats.

The decline in lower productivity malls will be a boon for the surviving malls.  The B-minus or below malls have a weighted average sales per sqft of ‘inline’ (or non-anchor) space of $276.  Assuming sales of $75 per sqft for anchor space, retail sales of approximately $56 billion would have to find a new home.  Assuming 20% of their sales goes to e-commerce (versus only about 10% today) and 20% to power centers and strip centers, there would be almost $33 billion that could theoretically be reallocated to the surviving malls or other retail properties.  Assuming sales per sqft of $100 for the higher productivity mall anchor space and inline sales per sqft of $574, the potential increase in sales from the shuttering of lower quality malls would be over 15%, as shown in Figure 2.

Anchors Dragging

According to General Growth Properties (NYSE: GGP), sales at the department store anchors in its portfolio have declined by 10% over the past 10 years (2005 to 2015).  To mall owners, the recent news of struggles at the department stores is nothing new considering that department stores have been consolidating for over 25 years.  The interesting wrinkle is that their struggles are good for GGP and other high quality mall owners like Macerich (NYSE: MAC), Simon Property Group (NYSE: SPG), and Taubman Centers (NYSE: TCO).

In contrast to the department stores at GGP malls, inline stores in its portfolio were able to increase sales by 33% over the same period.  Similarly, traffic to GGP malls is hitting highs since the company began tracking the metric.  Therefore, GGP and other class A mall owners would contend that they no longer rely on anchors to drive traffic to their malls.  Unfortunately, removing an underperforming anchor is not an easy process.  Unlike shorter seven to ten year leases for the inline tenants, anchor leases can be twenty to thirty years in duration, and at rents that are a fraction of inline tenants.  In many cases, the department stores own the real estate.  The lower rent or occupancy cost therefore makes the sales revenue threshold for staying open much easier to achieve and helps explain why it is taking so long to modernize the retail experience at many malls.  Accordingly, it is tough buying real estate “on the cheap” from the likes of Sears (NASDAQ: SHLD) and JCPenney (NYSE: JCP).

It is for this reason that the recent woes of even the strongest department store anchors such as Macy’s (NYSE: M) and Nordstrom (NYSE: JWN), combined with the well-documented struggles of Sears and JCPenney, are actually a good thing for class A mall owners.  Cash flow troubles at Sears have caused the company to sell stores at several of their top locations.  One of the most notable transactions occurred in 2012 when GGP purchased eleven boxes for $270 million from Sears.  Last year, Sears bundled up 246 of their stores into a new REIT called Seritage Growth Properties (NYSE: SRG). Concurrently, SRG entered into joint ventures for 31 boxes with Simon, General Growth, and Macerich to set the stage for redevelopment and/or re-tenanting of many locations at some of the best malls in the country.  Though JCPenney, Macy’s, and Nordstrom have yet to announce any plans to negotiate with class A mall owners, Sears’ recent decisions show what is likely to occur should they continue to struggle.  It will be interesting to observe if the recent change in leadership at Macy’s will result in the much needed investment into its stores versus the billions spent on stock repurchases over the last several years.

Department Store Pain Equals Class A Mall Gain

If mall owners are able to get back some of this high quality space, there are concerns about who will take these large footprint, multi-story boxes.  Easy answers could be some of the more upward-trending department stores like Saks Fifth Avenue (NYSE: SKS), Bloomingdale’s, or Neiman Marcus.  However, class A mall owners are already thinking ‘outside the box’ with some other replacement tenants.  For example, Apple (NASDAQ: AAPL) and Tesla (NASDAQ: TSLA) are producing the highest sales per square foot of any mall tenant and are acting as major traffic producers.  Fast fashion retailers such as H&M, Zara, and Primark, movie theaters, Dicks Sporting Goods (NYSE: DKS), Restoration Hardware (NYSE: RH), and even grocery stores are popping up in malls.  Mall owners are also emphasizing restaurants, fitness, and residential to further boost traffic, as these tenants are much more experiential in nature.

The end result for the mall owner is better profitability.  According to GGP’s March 2016 investor presentation, the company has redeveloped 79 vacant department store boxes totaling 5.9 million sqft for a total cost of $1.3 billion, generating an 11% annual return.  At SPG, the company had underway $3.5 billion ($2 billion at SPG pro rata share) of redevelopment/expansion projects, including the addition of new anchors, at 33 properties with an expected return of 8% at stabilization.  Simon’s portfolio includes malls, outlet centers, and The Mills power centers.  With cap rates in the 3-5% range for class A malls, the profit margin on redevelopment for class A mall REITs is averaging 50-100%!


In addition to allocating capital to redevelopment projects, forward-thinking mall landlords are investing in technology.  Technology is likely the single-most scalable expense, but the upfront or fixed costs can be prohibitive.  In self storage, technology has made it nearly impossible for mom-and-pop owners to compete with the larger owners.  Retail real estate, particularly the malls, will be the next sector where scale will be a major advantage.  Whereas the owner of just a few malls would be hesitant about spending $10 million or even $1 million on trying out a new concierge app or a customized map with recommended parking, this has and will become routine for the large owners.  For example, GGP CEO Sandeep Mathrani estimates that GGP will spend $250 million on technology in the next 10 years.  Simon Property Group even has its own private equity group, called Simon Venture Group, with the sole purpose of funding new retail concepts and real estate tech!

In a survey conducted by the Baker Retailing Initiative at the Wharton School of the University of Pennsylvania in 2008, over 80% of respondents reported a ‘problem’ when shopping at a mall.  The top ‘problems’ were: inadequate selection of restaurants, a lack of anything unique, too many stores carrying the same products, a too-limited range of stores, and difficulty finding adequate parking.  It’s fair to say that the mall REITs have been working extremely hard to prevent these problems.

Simon, Macerich, and General Growth are making large investments to make shopping more convenient for customers.  Specifically, Simon Venture Group invested in Sensity, a company that installs efficient ‘smart’ LED lighting systems that provide real time data on weather, security, traffic, and parking.

GGP has partnered with Jibestream, a platform with ‘waypoints’ that give turn by turn directions to a particular store, including directions to the closest parking spot.  Jibestream claims its platform is ‘future proof’, meaning it maintains an open architecture that can accommodate any third party applications that are developed as the Internet of Things (or IoT) technology ramps.  Eventually, the technology within self-driving cars will be able to use this platform to guide cars to open parking spots.

Macerich has partnered with Kipsu, a virtual concierge that will respond within 45 seconds to customer texts  about locations, sales, gift ideas, and suggested parking spots.  The virtual concierge has a very concrete benefit, as it has freed up valuable space that physical mall concierges used to occupy near the center of the mall.  These 150 to 250 sqft areas that were cost centers are now being leased to tenants at hefty rent levels.

What’s in Store for the Stores?

For a glimpse into the ‘future’ of brick-and-mortar retailing, one only needs to look at the online retail experience.  Much of the technology for bricks-and-mortar retailing focuses on duplicating the online shopping experience.  One such example exists at Santa Monica Place, a MAC-owned mall located just  west of Los Angeles.  MAC has leased an 8,000 sqft space to WithMe, a company that has designed a pop-up shop that measures interaction with merchandise similar to a website’s ability to monitor how long a customer looks at an item, or if it went into an online shopping cart but was never purchased.  Using interactive walls and scales, WithMe can offer retailers even more data than a website could.  In addition, the space is eye-catching, which helps to raise brand awareness.  There is even a virtual reality station where customers can “try on” clothes without even having to change.  Tenants of WithMe can use data from the pop-up shop to create new go-to-market strategies, or make changes to current strategies, which makes the return on investment appealing to many retailers.  WithMe’s first occupant at Santa Monica Place is Century 21, an East Coast department store retailer, and there is already a waiting list for those wanting to occupy the space after Century 21’s 2-month lease is over.

Despite much of the negative press about brick-and-mortar retailing, the environment for class A malls is as strong as it has ever been.  While we do believe that a reduction in the retail sqft per capita in the US will provide a boost to sales at class A malls, landlords must continue to be at the forefront of consumer trends and continue to improve the look and feel of the shopping experience augmented by heightened service for the customer.  We believe that winners and losers will not only be determined by location, but also by platform.  The mall ‘experience’ is facing more competition than ever before, and landlords who become reactive to trends will be left behind.  If Amazon (NASDAQ: AMZN) is the competition, the market has shown it is willing to accept lower near-term profits in exchange for higher reinvestment in the business.  We similarly believe tenants in such innovative malls will also be willing to pay up for space that makes their brands relevant, driving sales both inside and outside of their brick-and-mortar locations.


Parker Rhea,, (713) 243-3211

Matthew R. Werner, CFA,, (713) 243-3234

Bruce G. Garrison, CFA,, (713) 243-3233

Blane T. Cheatham,, (713) 243-3266


RMS: 1904 (1.31.2017) vs. 1904 (12.31.2016) vs. 346 (3.6.2009) and 1330 (2.7.2007)


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