In yet another painful example of how difficult it is for some retailers to compete with discounters, Toys “R” Us is closing 146 freestanding Kids “R” Us and 36 Imaginarium stores nationally. While refilling more than 3 million sq. ft. nationally poses a challenge for landlords, analysts say the blow to real estate investment trusts (REITs) will be greatly softened because of their large, well-diversified portfolios.

Kids “R” Us is losing the battle on two fronts, pricing and convenience, says Frank Badillo, senior retail economist with Retail Forward, a research firm in Columbus, Ohio. “Why are you going to pass up five other apparel stores or discount stores to go to a Kids ‘R’ Us, which in most cases is in a less convenient location? You have too many other alternatives that have a better price or better selection,” says Badillo.

The Kids “R” Us unit, which sells children's apparel, reported an 11.4% decline in same-store sales in the third quarter of 2003. Total sales for the third quarter fell to $122 million from $141 million a year ago. Meanwhile, parent company Toys “R” Us,based in Wayne, N.J., reported a net loss of $38 million, or 18 cents a share, compared with a net loss of $28 million, or 13 cents a share, during the same period a year ago.

“Our efforts to reverse significant performance declines within the freestanding Kids ‘R’ Us and Imaginarium stores (which sells education toys) have not met with success,” says John Eyler, chairman and CEO of Toys “R” Us. “The accelerating deterioration in the financial performance of these freestanding stores has led us to conclude that it is in the best interests of our company and our shareholders to cease operations in these freestanding stores.” Most of the stores are expected to close before Jan. 31. Eyler adds that the company may reopen 15 of the Kids “R” Us stores as Babies “R” Us stores.

The net effect on large REITs will not be significant, say commercial real estate analysts. “Since Toys ‘R’ Us is not in bankruptcy, there are likely to be material termination fees recorded in the fourth quarter of 2003 and the first quarter of 2004 to compensate for the future lost income,” says Paul Morgan, an analyst with Friedman, Billings, Ramsey. “For small-cap REITs with above-average exposure, the impact to 2004 funds from operations (FFO) may be more material on a per-share basis.”

Although the 182 stores are widely dispersed across the United States, 59 stores are concentrated in Mid-Atlantic states (New York, New Jersey and Pennsylvania) and another 41 in the Midwest (Illinois, Indiana, Michigan and Ohio), says Morgan. The average size of a Kids “R” Us store is 20,000 sq. ft., so the closings will throw about 3 million sq. ft. of community center space on the market. Morgan believes that could weaken rent growth at community centers in the most affected regions during the first half of 2004.

Four Kids “R” Us stores slated for closure are in the Kimco Realty Group portfolio. The stores are in Miami (22,418 sq. ft.), Sterling, Va. (16,500 sq. ft.), Memphis, Tenn. (15,312 sq. ft.) and Torrance, Calif. (21,319 sq. ft.). “That's a very small figure, considering there are 7,000 leases in the Kimco portfolio,” says Scott Onufrey, vice president of investor relations for Kimco. Onufrey adds that each of the leases is in excess of 10 years. “The tenant will be eager to mitigate any rent expense that it's incurring, so we'll work together to find new tenants.”

Although Toy “R” Us is the eighth largest tenant in the Kimco portfolio, the store closings only account for 0.2% of the base rent within the portfolio, according to Ross Nussbaum, an analyst with Salomon Smith Barney. “The impact to Kimco is further mitigated because these leases will still pay rents once dark.”