As other retail formats struggle to keep vacancies in check, regional mall owners are aiming to take advantage of current market conditions to siphon off tenants.

Over the past 12 months, retailers that have traditionally operated freestanding stores or taken locations in power and lifestyle centers have increasingly signed leases at enclosed regional malls, say four property owners and three consultants Retail Traffic spoke to. If the trend continues, it could help regional malls remain retail mainstays in their trade areas, these sources say.

This coming October, for example, CBL & Associates Properties Inc., a Chattanooga, Tenn.-based REIT, will welcome a 46,500-square-foot Dick’s Sporting Goods store to its Layton Hills Mall in Layton, Utah. The retailer will take over a space vacated by Mervyn’s in December 2008. Meanwhile, Bed Bath & Beyond is currently hiring employees for its soon-to-open store at General Growth Properties’ Rogue Valley Mall in Medford, Ore. And Simon Property Group expects to open a 23,000-square-foot Container Store at its SouthPark mall in Charlotte, N.C. in the fall.

All of these retailers have operated in malls before, but typically have preferred freestanding locations or spots in neighborhood and power centers. A unique combination of market forces has made it an opportune time to expand into regional malls, according to Jeff Green, president of Jeff Green Partners, a Phoenix, Ariz.-based real estate consulting firm.

To begin with, there is available space. In the first quarter of 2011, the vacancy rate at regional malls reached 9.1 percent, up 40 basis points from 8.7 percent in the fourth quarter of 2010, according to Reis Inc., a New York City-based research firm. Vacancy for anchor stores stood at 4.8 percent. Vacancy for in-line spaces was at 11 percent. According to data from the CoStar Group, a Washington, D.C.-based research firm, over the past three years vacancy at regional malls spiked by 67.7 percent compared to its levels prior to the recession.

That has meant that whereas previously there were few opportunities for users of large spaces to build presences at malls, now the market has plenty of empty department stores to accommodate their needs, says Anthony Cafaro Jr., co-president of the Cafaro Co., a Youngstown, Ohio-based privately held mall owner.

It’s also made the idea of bringing in power center and lifestyle center tenants more palatable to mall managers and landlords.

“The old idea that it just has to be mall-based retail has to be thrown out the window because there is somewhat of an over-supply of space in the market,” Cafaro notes.

Some tenants, meanwhile, have been concentrating on shrinking their square footage, a trend that has made it more challenging for them to find appropriate size boxes at power centers, says Gerry Mason, executive managing director with the New York City office of Savills, a real estate services provider. For example, prior to the recession, Dick’s Sporting Goods would often open stores as large as 70,000 square feet.

But in the current climate, most large tenants prefer going smaller and enclosed regional malls offer a greater range of store sizes for them to choose from.

Finally, the change in market conditions happened to coincide with the end of many 10- and 15-year power center leases signed in the mid and late 1990s, notes Green. So at the precise moment that big-box retailers have begun looking at smaller prototypes, many of them found themselves unencumbered by previous lease agreements.

As for the regional mall owners, power center and lifestyle center tenants present an opportunity that is two-fold. At a time when many of them are struggling to fill holes left over by failed department store anchors such as Mervyn’s, tenants that are looking to lease tens of thousands of square feet can help drive down vacancy levels.

More importantly, however, bringing in stores normally associated with other retail formats helps regional malls to regain their footing as the dominant shopping destination in their trade area, says Richard S. Sokolov, president and COO of Simon Property Group, the Indianapolis-based regional mall REIT with the largest mall portfolio in the country.

“We are constantly trying to upgrade the mix of our tenants to enable us to maximize our market share,” Sokolov notes. In the past, “the mall just didn’t have the square footage to accommodate those users. But as there was an increasing number of department store boxes that ceased to be, that opened up a new opportunity. Then, as those tenants opened in the malls, they found their stores were productive and that encouraged them to pursue more opportunities” of that kind.

New partnerships

Dick’s Sporting Goods has been among the most frequently mentioned newcomers to enclosed regional malls. In fiscal 2011, the company plans to open 34 new Dick’s stores and three new Golf Galaxy stores.

Virtually every major mall owner Retail Traffic spoke to mentioned that it has either signed leases with the chain or is currently in negotiations for new deals. The retailer operates stores that average 50,000 square feet and signs leases for a term of 10 to 25 years, with multiple five-year renewal options.

Bed Bath & Beyond is another fresh addition to mall rosters. The retailer operates stores that range between 20,000 and 50,000 square feet, with lease terms that start at 10 years. In fiscal 2011, the company plans to open approximately 45 new stores across all of its concepts, including Harmon Face Values and buybuy BABY.

Mall owners are also increasingly bringing in department store Kohl’s, which formerly gravitated toward freestanding units, discounter Target, electronics category killer Best Buy, furniture seller Crate & Barrel and The Container Store.

“If you go to a lifestyle center or a strip center [today], you might see a Dick’s Sporting Goods, a Kohl’s, or Bed Bath & Beyond,” says Chris Macke, senior real estate strategist with the CoStar Group. “If you can pull a couple of those into a mall it makes the mall very competitive.”

At the moment, the trend is in its infancy, says Mason, but regional mall owners are definitely working on expanding their tenant lists.

“What we are seeing is a lot of discussion, a lot of back and forth,” he notes. “If you can take someone like PetSmart of GolfGalaxy, which traditionally went into 30,000-square-foot or 40,000-square-foot boxes and put them into a 20,000-square-foot space at the regional mall, it’s a real win for the mall.”

Making it work

The challenge, according to both Macke and Mason, is working out deals that make economic sense for the mall owners. Category killers like Dick’s and Bed Bath & Beyond drive hard bargains on rents and tenant improvement allowances, Mason notes. A tenant of that stature would look to pay about half the rent of an in-line mall tenant and would likely want to get a sizable build-out allowance from the landlord.

Moreover, expanding retailers currently have plenty of properties to pick from for new store locations, so they are likely to consider only class-A regional malls as their new homes. Owners of class-B and class-C centers will find themselves out of luck.

There are instances, however, when bringing in a lifestyle or power center tenants, or better yet, a handful of them, can work out to the mall owner’s benefit even if their pay below-market rents. Retailers like Dick’s, Target, Bed Bath & Beyond and Best Buy tend to be traffic drivers, and the regional mall, more than any other retail format, depends on creating cross-shopping opportunities for its tenants, Mason says.

The strategy could be a particularly good fit for owners who have added open-air lifestyle components to their enclosed regional malls and therefore already have appropriate spaces to house these new tenants in without having to spend too much on build-out allowances.

“They do absorb space and the economics probably work because of the traffic those boxes bring in,” Mason notes. “The mall owners want you to come into the space, shop at one of these market leaders and pick up a few other things while you are there.”

The rents and TI dollars mall owners are willing to put into these kinds of deals vary with the property, but Sokolov says Simon wouldn’t be pursuing the new partnerships if they didn’t make sense.

“Every negotiation is different, but obviously we are able to strike financial deals that we think work for us and the tenant thinks works for them,” he notes. “The nature of the deal is a function of the quality of the location, and the quality of the property and the business the tenant thinks they can do at that location.”