In the throes of a deep recession in consumer spending, savvy retailers and shopping center owners are finding ways to capitalize on the fallout. Declining retail sales and rising vacancies have tenants scrambling to restructure their leases, often resulting in lower rents. Meanwhile, a rash of store closures is creating opportunities for shopping center owners to backfill properties with tenants that have a strong credit rating.

When Goody's Family Clothing went bankrupt and vacated its store at Bernard Court Shopping Center in Jonesboro, Ark., in February, owner Stonemar Properties was left with a 35,000 sq. ft. empty box. Hobby Lobby, the arts and crafts retailer that already occupied 52,000 sq. ft. at Bernard Court, partially filled the void.

As part of a store expansion, Hobby Lobby took an additional 10,000 sq. ft. formerly occupied by Goody's, raising its footprint at the shopping center to 62,000 sq. ft. The remaining 25,000 sq. ft. vacated by Goody's is being marketed to national retailers. One added bonus for Stonemar: Hobby Lobby will pay a higher rent than Goody's for the space.

“Hobby Lobby is a well-capitalized, conservative company. It's a great tenant to have,” says Emmet Austin, chief investment officer for New York-based Stonemar Properties, which has ownership interests in 11.5 million sq. ft. of shopping center space in 21 states.

Stonemar invests in retail centers in secondary markets that are economically diverse such as college towns, state capitals, or cities that serve as the county seat. Jonesboro, for example, is a regional medical and banking hub and home of Arkansas State University.

“We look to buy properties that have seasoned leases — leases that have been in place for 10 or 15 years. Typically, you are going to have leases below market,” says Austin. The bankruptcy of Goody's was both a blessing and a curse for Stonemar, he adds. The stress of dealing with a bankrupt tenant was offset by the chance to rejuvenate the center with more stable retailers and at higher rents.

Goody's was a tenant in two other centers owned by Stonemar, but Austin is confident that the owner can backfill the spaces.

More volatility to come

The drama in Jonesboro is hardly an isolated case. In the first quarter, major retail chains announced 2,577 store closings, according to NREI's sister publication Retail Traffic.

The number of store closures by major retail chains announced in the first quarter is in line with the totals notched in the first quarter of 2008. For all of 2008, there were 6,100 major retail chain stores closings, according to Retail Traffic.

The distress in the shopping center industry gives financially healthy retailers an edge. “I'm seeing the Dollar Trees, the Dollar Generals, the discount retailers going from Class-B and C locations into more of the A locations. They're the ones expanding, they're the ones who have cash,” says Austin of Stonemar.

But the discounters aren't alone in exercising their clout. During a recent earnings call to discuss fourth-quarter results, the management team of Barnes & Noble pointed out that the giant bookseller has 80 to 100 leases up for renewal over the next 12 months and that it has more leverage now with landlords than ever before.

With Barnes & Noble's profit down nearly 30% year-over-year in the fiscal fourth quarter ending Jan. 31 and down 44% for all of 2008, the company will undoubtedly be seeking favorable lease renewal terms.

“At this point we have great relationships with the landlords,” remarked Barnes & Noble COO Mitchell Klipper during the earnings call. “They know it's a long race, it's a long partnership together and they're all working with us because they don't want us to leave.”

Bill Bauman, who heads up the national retail services group for Studley from the firm's Los Angeles office, says much of the firm's business today centers on helping retailers evaluate their lease portfolios by looking for cost inefficiencies. Issues such as the reimbursement of common area maintenance charges or the amortization of capital improvements through a tenant's lease are under close review today.

In some cases, retailers are strategically relocating stores, says Bauman. “They may take a surplus Linens 'n Things or a Circuit City that's in a better location and that they can get at a better rate.”

Dearth of dispositions

While some retailers still vow to open new stores in the year ahead — Barnes & Noble will open a 55,000 sq. ft. flagship store in Manhattan in 2010 — expansion plans pale by comparison to recent years. The sharp drop is causing a slowdown in the disposition of excess retail space.

“When you're disposing of surplus space, somebody that is expanding has to take it, or the landlord has to terminate a lease with the belief that he will be able to put another tenant in the space who is expanding,” says Michael Wiener, president and CEO of Excess Space Retail Services based in Lake Success, N.Y.

A severe credit crunch has slowed retailer expansions significantly, explains Wiener. “Without credit, which is the grease to the wheels of small and big business alike, the wheel comes to a grinding halt. Nobody expands because nobody knows where you are going to get business from.”

While Wiener's company has had a lease restructuring division in place for several years, it's become a much bigger part of the overall business. In 2009, Excess Space Retail Services will likely restructure up to 3,000 leases on behalf of 20 to 30 retailers, Wiener says, compared with 500 to 1,000 leases in a normal year.

Because the commercial real estate market can lag job growth by as much as 18 months, says Wiener, he isn't expecting a decrease in retail vacancy and an uptick in rent until late 2011 or early 2012 at the earliest.

That sobering reality is lost on some landlords, Wiener explains. “Sometimes we call two years ahead of time to negotiate a lease and the landlords will say, ‘Call me closer to the lease expiration, or the notice date.’

“The reality is that if you call them a year from now, you are probably calling them under circumstances where the rents are lower, the market is more depressed, and the retailer's expectation is that he will achieve an even bigger rent reduction,” concludes Wiener.