Just when it seemed like power centers were building some momentum, Borders had to come along and spoil the party.

The bookseller giant has filed for Chapter 11 bankruptcy protection and it estimates that 30 percent of its remaining 642 stores—about 200—will be shuttered. (A list of the affected locations has already been released.)

The firm, which has $1.28 billion in assets and $1.29 billion in debt, has lined up $505 million in debtor-in-possession financing and hopes to correct its course. Borders also may end up adding another 75 stores to the list of closures. And other scenarios could lead to additional closures, such as sale of the company to rival Barnes & Noble or liquidation.

Seeing a major big-box player close stores is, unfortunately, nothing new for the industry. However, prior to Borders’ announcement, it had been more than two years since a major wave of bankruptcies and liquidations created a glut of big-box vacancies.

In the time since—especially in the last 12 months—the amount of vacant space at power centers had finally begun to diminish as remaining big-box players starting to sign leases for second generation space, partly out of necessity. Newcomers, like electronics seller hhgregg, took advantage of the situation to expand rapidly. That momentum will be put on hold for a while as the sector deals with the Borders vacancies. That means rents will continue to stagnate.

As a result, the outlook for power centers remains murky. The best quality centers in the best markets should do well. But lower quality properties will face continued challenges and may need to be redeveloped or razed. And investors targeting the format will likely not be as aggressive as those looking at other retail property types.

Recent performance

By the fourth quarter of 2010, national vacancy for power centers stood at 6.9 percent, according to the CoStar Group, a Washington, D.C.-based research firm. The figure represents a decline of 80 basis points from the peak of 7.7 percent reached in the fourth quarter of 2009, but is 210 basis points above the sector’s low point of 4.8 percent in the first quarter of 2007.

The challenge is that in the aftermath of the downturn, the power center sector has become bifurcated, according to David J. Larcher, executive vice president with Vestar Development Co., a Phoenix-based real estate developer and manager.

Vestar owns approximately 18 million square feet of power center space. Within that portfolio, centers in established markets have largely recovered from the downturn as Vestar has continued to sign leases with expanding retailers including Michaels, Ross Dress for Less and Hobby Lobby. Larcher estimates that approximately 80 percent of the spaces left over by Circuit City and Linens ‘n Things have by now been leased.

“If you had an A or a B property, you were probably able to lease that space back up and continue in a positive way,” says Steven Yenser, executive vice president and director of the open-air retail group with Jones Lang LaSalle Retail, an Atlanta-based third party property manager. “It’s really about the quality of the location.”

Owners of class-C and class-D properties, however, still have a difficult time convincing retailers to backfill their vacancies. In fact, some class-C and lower quality power centers will eventually have to be razed, according to Gerry Mason, executive managing director with the New York City office of Savills, a real estate services provider.

“I think certainly in secondary and tertiary markets that were overbuilt, some of those centers will get torn down,” he notes. “A good example is Orlando, which is a primary market, but it’s the most over-retailed city in the U.S. If you drive through Orlando, you will see power centers that will never be leased. There are millions of square feet of space there.”

But even at the better centers the leasing momentum came with a trade-off. Rents at power centers fell from 15 percent to 20 percent on a national basis during the recession. They have since risen from the low point, but are not yet back to pre-recession levels, according to Yenser.

At the end of the fourth quarter of 2010, quoted rents at power centers averaged $17.79 per square foot, according to CoStar, a drop of about 13.84 percent from their peak in first quarter of 2007. Rents for all retail properties declined only 4.46 percent during the same period.

Unique product type

Unlike most other retail formats, power centers have faced several challenges at once during the downturn. The biggest issue has been their reliance on big-box tenants—a sector that suffered mightily in recent years.

Big name bankruptcies have taken a toll. Meanwhile, even as the remaining big-box retailers have started to expand, many of them have switched to smaller store formats, notes John Williams, managing director with the New York City office of Savills. Old Navy, for example, previously leased stores ranging from 15,000 square feet to 20,000 square feet. Today, the chain prefers 10,000-square-foot boxes. That means that many of the larger spaces—those that measure up to 60,000 square feet—have been harder to backfill, according to Williams.

Inline space at power centers has also suffered as local retailers have shuttered stores or renegotiated rents, according to Yenser. Jones Lang LaSalle manages between 5.5 million square feet and 6 million square feet of power center space in its 79.7-million-square-foot U.S. portfolio. “I think for power center owners, the next three years will be very challenging,” says Williams.

The stronger big-box tenants are taking advantage of discounted rents to relocate to better locations, or to enter markets that were previously difficult to penetrate. As a result, some landlords and property managers think the best-positioned properties will recover quickly.

Sound investment?

Many in the industry still retain enough faith in the concept to keep buying power centers. Vestar, for example, earmarked $400 million for power center acquisitions over the next two years, according to Larcher. The firm is planning to buy centers that need repositioning, as well as construction projects that were left uncompleted, including those currently in REO.

Regency Centers also plans to spend up to $200 million in equity on new centers this year, including both grocery-anchored centers and power centers that fit its acquisition criteria. In December, for instance, the firm bought Willow Festival, a 405,227-suqare-foot center on the North Shore of Chicago for $64 million.

“What we like about it is that it’s got features that work whether it’s a power center or a neighborhood center,” Smith says. “It’s your location, it’s your demographics, it’s your barriers to entry, it’s your supply vs. demand and it’s the caliber of your tenants. And we like to keep a grocer in either type of property.”

Overall in 2010, 49 power centers traded hands, for a total dollar volume of $2 billion, according to Real Capital Analytics, a New York City-based research firm. The average cap rate for power center transactions last year stood at 7.9 percent, and the average price per square foot was $140.

The figures show a noticeable improvement from two years ago. In 2009, 29 power centers traded hands for a total dollar volume of $1.3 billion. The cap rate on the transactions averaged 8.6 percent and price per square foot was $129.

The bottom line, however, may be that the era when power centers were among the strongest segments of the retail real estate industry is over. Today, grocery-anchored neighborhood centers with their necessity-based tenants offer stability, outlet centers offer value and brand appeal and regional malls offer opportunity for growth in a recovering economy. Power centers, on the other hand, won’t reach the top of investors’ wish list any time soon.