When Bankruptcy Is A Blessing: Huge Rent Growth Drove Strong Q2 For Shopping Center REITs

Space at open-air shopping centers is so constrained, a major retailer’s bankruptcy may have actually been good news. 

Early in the second quarter, Bed Bath & Beyond went bankrupt and began closing its 480 remaining stores. By Q2’s end, retail REITs had already signed several leases to backfill those locations — with rent increases of 20% or greater.

Real estate investment trusts focused on shopping centers either maintained or increased their full-year earnings projections in Q2 despite expecting vacancy bumps in the third quarter from the final wave of closures from BB&B and Tuesday Morning.

• Kimco Realty Corp. signed new tenants at four former BB&B locations in Q2 at more than 30% higher rents than BB&B had paid, and Kimco has already agreed to leases at seven of the 19 locations it will get back in Q3, with average rent increases of 20%, CEO Conor Flynn said on the company's earnings call. 
• Brixmor saw tenant failures create 300K SF of new vacancies in Q2. But it still set occupancy records for both anchors and small shops across its portfolio, Brixmor President and CEO James Taylor said on his company’s call. 
• Regency Centers averaged a 30% increase in rents for new leases across its portfolio in the quarter, Executive Vice President Alan Roth said on the company’s Q2 call. Kimco averaged 25% higher rents on new leases and 7.6% for renewals and options, Flynn said. Brixmor averaged rent spreads of 22.6% for new leases and 13.6% for renewals, Chief Revenue Officer Brian Finnegan said.
• Acadia Realty Trust, which owns a significant portfolio of urban street retail in addition to shopping centers, revised its 2023 guidance from between 16 cents and 23 cents per share to between 25 cents and 33 cents per share.

Enclosed malls didn't enjoy the same success in the second quarter, seeing 1.1M SF of negative absorption, JLL said in its quarterly national retail report.

Simon Property Group cut its year-end earnings guidance after sales dipped in Q2. PREIT also reported a decline in sales in Q2, but it didn't issue guidance as it deals with an investor revolt and a potentially catastrophic debt maturity in December. 

Other mall owners like Macerich and Tanger Outlets had quarters more in line with the shopping center-focused REITs, but both count outdoor outlet malls among their properties. PREIT and Simon attributed their dips in sales to inflationary pressures, a message undercut by executives from Kimco and Regency reporting on their Q2 earnings calls that those same pressures were easing. 

“One thing we have seen is mall-based retailers moving to open-air shopping centers,” Jefferies senior analyst for the U.S. REIT team Linda Tsai told Bisnow. “And that’s not necessarily new but accelerated during the pandemic because the occupancy cost ratio is lower in open-air centers.”

Perhaps even more encouraging than the level of demand for newly vacated boxes is where the demand is coming from. Rather than needing to split boxes into several smaller leases or overhaul them to suit completely different tenant types, landlords have been backfilling whole boxes with national retailers, specifically off-price brands like Five Below, Burlington, Ross Dress For Less and stores under the TJX Cos. umbrella. 

“I think there’s a lot of junior box retailers that just haven’t had the ability to identify spaces given limited supply and, of course, Bed Bath & Beyond opened a bit of that [up],” Roth said on Regency Centers’ call. 

The wide spread between what BB&B paid in rent and what its replacements will pay is mitigated by the tenant improvements required to bring the boxes back online, Tsai said. 

But 109 BB&B leases were purchased by other retailers through the bankruptcy process — 50 of which went to Burlington for a total of $13.5M, CNBC reported in late June. In exchange for assuming the terms and remaining years of BB&B’s deals, Burlington and the other lease buyers are on the hook for the cost of renovations.

Even stores reverting back into landlords’ hands are getting snapped up much quicker than they had been after the first wave of pandemic-induced bankruptcies, or even in the first wave of “retail apocalypse” bankruptcies in the middle of the past decade, Green Street REIT analyst Paulina Rojas Schmidt said, citing the 2016 Sports Authority bankruptcy.

“Only one-third of the Sports Authority boxes were filled in less than 18 months,” Rojas Schmidt said. “I expect that in this case, it will be completely different and much better. … The fact that here we’re looking at shorter downtime is very material in terms of landlords’ bottom lines.”

Supply hasn’t been so constrained at nonmall shopping centers since before the Global Financial Crisis in 2008, with nationwide availability at such properties dropping to 7.8%, according to JLL’s quarterly report. Retail net absorption hit 10.8M SF in Q2, a 12.6% increase from Q1, while new deliveries dropped 5.1%.

New construction starts totaled nearly 12M SF in Q2, the lowest in the U.S. since 2005.

Such a profound supply-demand imbalance would normally be cause for a development boom, but the rising cost of capital and scarcity of construction financing has made such discussions a nonstarter for many landlords. Yet the capital markets are showing some signs of loosening up in the second half when it comes to acquiring operating properties, some REIT executives said on their earnings calls.

“We're starting to see more sellers willing to meet the market,” Brixmor Chief Investment Officer Mark Horgan said. “From a price perspective, we're seeing assets settle out at pricing that starts to make more sense from our perspective.”

Even when financing becomes more readily available, there is little reason to expect considerable new development, analysts said. After all, shopping center landlords were able to drive profits in an environment of moderate sales growth based purely on rent growth for both new leases and renewals.

“The general view is that supply is going to remain low in retail for a long time, just because it was overbuilt for so long,” Tsai said. “REITs like Federal [Realty Investment Trust] and Regency that are focused on development will be selective, but I don't think interest rates coming down will create a groundswell of new retail development.”