The Real Deal New York

Going in for the kill

Everyday bankruptcies bring new business
By Cathaleen Chen | May 17, 2017 01:00PM

Retail has seen brighter days. But one company’s loss may be another’s gain.

As more retailers shutter in the wake of shifting consumer patterns, the rampant store closures provide an unprecedented opportunity for brokers and attorneys to seize new business, unearthing a ripe market of backfilling, subleases, concession negotiations and litigation.

Brokers and consultants working for both tenants and landlords say they’ve seen a surge in such business.

“Every day I get a list of companies filing for bankruptcies,” said Leslie Mayer, an executive director of retail services at Cushman & Wakefield’s West Los Angeles office. “But these situations create an opportunity for both landlords and other tenants.”

On the tenant side, brokers and bankruptcy attorneys can capitalize on retailers that want to optimize cash flow from their real estate assets. In many cases, this means hiring disposition teams to negotiate out of leases.

On the landlord side, leasing brokers have the opportunity to backfill vacated spaces and potentially bring in investors to reposition entire retail developments into mixed-use complexes.

“We’re seeing an uptick in litigation as well as strategic counseling and negotiation,” said Y. David Scharf, a partner at Morrison Cohen, a Manhattan law firm that represents both retail tenants and landlords. “The tensions are higher now than I recall seeing them in many, many years.”

Losing liquidity

For the likes of Payless, BCBG and American Apparel, filing for bankruptcy can indicate that companies were not able to downsize in time, experts say. If retailers were more conscientious about how their leases affect their operations and hired the right disposition team, bankruptcy could be avoided.

“The smartest companies get way ahead of it, but the typical company is in denial,” said Thomas Mullaney, managing director of JLL’s retail restructuring services in Manhattan. “Like a patient on a gurney, they continue to lose blood — liquidity — month after month after month until they finally collapse into bankruptcy.”

In bankruptcy proceedings, retailers have two choices with their leases: Assume the lease or surrender it to the landlord.

Within 60 days of filing, they must assess the performance of each retail location and make the decision to stay or to shutter it.

The bankruptcy filing will protect retailers from legal action and eviction by their landlords, and may excuse them from unpaid rent from the previous few months leading up to the bankruptcy. But when the petition is filed, the retailer is liable for every cent of rent owed from that point on.

However, a bankruptcy doesn’t have to be the end of the world.

“Bankruptcy doesn’t mean you’re going out of business, it just means you’re going to restructure,” said Mullaney, who works with retailers that want to consolidate.

More than a decade ago, Mullaney and his team helped the Houston-based crafts store Garden Ridge work through its bankruptcy. The company went public in 2016.

There are also strategic-closure bankruptcies, in which retailers will have already picked out real estate companies to work with to evaluate which leases to assume, which to reject and which to assume and then assign subleases, according to Garrick Brown, Cushman & Wakefield’s director of retail research in the Americas.

“Among the entire brokerage community, the second we hear a retailer is going bankrupt, we try to get a list of their store locations and evaluate how good the real estate is,” Brown told TRD. “We have corporate services that specialize in this. There’s nothing new here except for the sheer number of bankruptcies — it’s unprecedented.”

Now, Brown added, every major national brokerage has groups that focus on distressed retailers and their leases. Still, nine times out of 10, it’s best for all parties involved if bankruptcy can be avoided.

Damage control

For the tenant at risk of bankruptcy, the first strategy is to look for a broker, according to Scharf, and make a contingency plan.

“A broker will see what the market is going to bear in terms of getting replacement tenants for your leases. You may have assets in only some of these leases, and certain locations may be liabilities,” he said. “If there’s going to be a bankruptcy, you’ll have to make decisions very early on, which leases you’re assuming and which ones you’re rejecting.”

Next, with the broker, the retailer will want to engage its landlords and try to renegotiate lease terms.

“Very often landlords will want to negotiate some kind of arrangement or discount because of the concern that if one tenant leaves and then another leaves, other tenants have an opportunity to legally cancel their lease,” Scharf explained. “So very often the larger tenants have leverage over landlords.”

Scharf and his firm were recently tapped by Kenneth Cole to represent the designer in a lawsuit filed by Simon Property Group, which sought to keep 43 outlet stores open after Cole made the decision to shutter them.

There are several strategic issues that arise in the case of closures, the attorney said. An empty or dark store obviously looks bad for mall operators, so they’ll likely invoke contractual obligations such as the “go-dark provision,” which says a tenant cannot cease operations at an ongoing lease.

In that case, however, a tenant may choose to “dress the window” and keep the light on but still halt the operation of the store, Scharf said. This tactic satisfies the obligation, but landlords hate it, which gives tenants a window for negotiating concessions on rent or other accommodations.

A lot of companies may not realize that the capitalized value of their leases may be as big as their bank loans or overall bonded indebtedness, according to Mullaney. But unless a retailer has an internal real estate department, like Macy’s or Sears, managing leases is typically too great a feat to handle.

“It’s entirely possible that a company has a borrowing capacity with Wells Fargo for $250 million, and that this is something the chief financial officer can deal with him or herself,” he said. “But when it comes to leases, they could have hundreds with countless different landlords. That’s a logistical nightmare, and that’s where our firm comes in.”

Mullaney operates a 10-person team scattered throughout the country to negotiate on behalf of retail chains. On the other side of the negotiations, the landlords have their own consultants as well.

Backfill patrol

When a tenant leaves, the landlord’s biggest fear is a domino effect — with tenants leaving one after another. This means that it must “consider providing concessions and abatements to keep [the store] operating…even if it means forgiving past rent,” Scharf said.

But when a big tenant leaves, it could be a golden opportunity for the mall operator, according to Larry Jensen, JLL’s director of development, operations and tenant coordination.

“There are so many options today that if it’s a piece of real estate, you really don’t have to worry about it,” said Jensen, whose team works with mall landlords to fill and sometimes even reposition large spaces vacated by struggling department stores.

Like the strategies employed on the tenant side, it’s best to have preemptive ones in place.

“[As a landlord], you constantly assess the performance of your existing retailers. If this person leaves, if that person leaves, what do you do?” he told TRD. “You, the broker, have those discussions with the owners of that property. It might even trigger a landlord’s desire to sell the property.”

Jensen worked with a Midwestern mall owner a couple of years ago to buy back a department store and redevelop the space into a mixed-use center with a theater, restaurant and a handful of smaller retailers including a Talbots, a DSW shoe store and a salon.

“When there’s an empty space, typically your first thought is entertainment. Can you add a theater? If so, can you add a restaurant, a Dave & Buster’s? And then you look at other options — a Dick’s, T.J. Maxx or a Home Goods,” he said. “Grocery stores and health clubs are other options.”

For smaller spaces, there are retailers interested in taking what are called second-generation spaces.

Mayer, of Cushman in L.A., represents Skechers, a retailer that takes advantage of vacated properties.

“It’s kind of a bit of a musical-chairs situation,” she told TRD. “Skechers is one of the retailers taking advantage of these second-generation spaces…these are great opportunities for Sketchers to come in and say, ‘We move fast and have great credit.’”

At the end of the day, the retail industry has no choice but to accept the changing market. But change isn’t anything new.

“If you went to a shopping center in the 1980s, you saw Stride Rites and Naturalizers. All of those guys are dinosaurs now,” said JLL’s Jensen. “The mall has been reinvented three times. So that’s what’s new? We aren’t scared of it, we just deal with it — let the young eat the old.”