The "Big Short" Trade is Back: Malls Are On the Cusp of Imploding - Again

Over the last 48 hours, several big names in the American mall industry said they will be slashing store counts to the tune of over 300 stores, according to Bloomberg.

Gap Inc. said during its earnings call that it is going to shutter 230 locations over the next two years, just hours after JCPenney said that it would close 18 of its department stores. This news came after L Brands said they were going to close 53 Victoria’s Secret stores in North America this year. And finally, the icing on the cake was when "disruptor" Tesla recently announced all of its sales would be moving online, which is a nice way to say that almost all of its retail locations were going to close, leaving its "visionary" and "world changing" retail employees at their local unemployment lines.

Of course, these store closures follow a number of bankruptcies in the space: Payless Inc. just went bankrupt, names like Sears and Brookstone are teetering on the fringe of bankruptcy, aggressively cutting the size of their operations – and once American mall staples like Gymboree, RadioShack, Bon-Ton Shoes and Wet Seal have all filed for bankruptcy over the last half decade. Payless is going to be abandoning its 2500 stores, while Things Remembered will also be closing most of its 400 stores.


Put simply, malls are becoming nothing more than vacant lots, a few scattered fashion retailers, Apple Stores and food courts, primarily just feeding Apple employees. Mall owners, landlords and industry executives, having difficulty facing reality, insist that American malls are simply "evolving", as opposed to imploding.

Michael Guerin, senior vice president of leasing at mall-owner Macerich said: “You hear so much about shopping centers are dying. There definitely needs to be attrition, and there’s too many in the U.S. The mall just needs to evolve.”

Although the idea of malls imploding isn’t brand new, the industry did seem to stabilize at one point as the cost of gas fell and consumer confidence rose. But now, it feels as though the tide is heading out once again. Vacancy rates at US malls were 9% in the fourth quarter of 2018, up from 8.3% the year prior. This number was at 9.1% in the third quarter, due to Sears shuttering some of its locations.

But malls continue to fight the trend, trying to adapt. Macerich has started offering 180 day leases to encourage pop-up stores and it recently added 32,898 square feet of co-working space to a plaza that it owns in Scottsdale. The space, which occupies two floors, was formally a Barneys New York. Non-traditional tenants like bowling alleys and movie theaters are also finding their way into malls. Even companies that traditionally do business online are starting to also look at setting up an "offline" footprint at some of these opportunistic spaces. 



Guerin continued, face in the wind: “They need brick and mortar -- we’re hearing that loud and clear -- when they open a store their online sales go up. A lot of the stores you’re seeing now weren’t there five years ago.”

In Q4, mall landlords increased rent by 0.8% from a year prior as they make plans to re-develop spaces for alternative uses. Companies like Planet Fitness are taking advantage of the closings as mall landlords and REITs approach fitness centers as potential tenants. Planet Fitness believes that its business is immune to e-commerce, according to the CEO Chris Rondeau.

“Our business can’t be Amazoned. We’re un-Amazonable,” he said on Bloomberg Television. We'll see about that, Chris. 

Recall, back in 2017, we dubbed these U.S. retail store closures as the next "big short". We said that "just like 10 years ago, when the "big short" was putting on the RMBX trade, and to a smaller extent, its cousin the CMBX, we noted that some were starting to short CMBS through the CMBX, a CDS index which tracks the values of bonds backed by various commercial properties. We explained our reasoning for putting on this short through CMBX versus stocks:

The trade, as we discussed before, is not so much shorting the equities where a persistent threat of a short squeeze has burned the bears on more than one occasion, but going long default risk via CMBX or otherwise shorting the CMBS complex. Based on fundamentals, the trade indeed appears justified: Sold in 2012, the mortgage bonds have a higher concentration of loans to regional malls and shopping centers than similar securities issued since the financial crisis. And because of the way CMBS are structured, the BBB- and BB rated notes are the first to suffer losses when underlying loans go belly up.

This was the price action in March 2017 that initially caught our attention. 

 

By early 2018, spreads for the BBB- and BB rated components of the CBMX had continued to widen.