News that two credit agencies have downgraded mall REIT CBL & Associates Properties Inc. came as little surprise to market observers, given the strong challenges facing class-B malls.
S&P Global Ratings downgraded CBL’s corporate credit rating to BB+ from BBB- on the heels of the REIT’s weaker-than-expected operating results for the third quarter, and gave the company a stable outlook. The ratings agency affirmed the BBB- rating on CBL & Associates Limited Partnership’s senior unsecured notes. The stable outlook was based on the agency’s expectations that same-store net operating income (NOI) will face more slumps over the following year, but there may be a slowdown in declines with CBL’s efforts to reposition and redevelop its portfolio. Fitch Ratings also downgraded CBL to the same status.
CBL has been facing pressure to grant tenants rent concessions, says Ana Lai, primary credit analyst at S&P, as mall retailers—especially apparel chains and department stores—continue to grapple with operational challenges brought on by e-commerce and other market factors. “As those tenants evaluate their store footprint, they will be asking for lower rent,” Lai says. That dynamic will contribute to continuing pressure on NOI growth.
For the third quarter, CBL, based out of Chattanooga, Tenn., reported a decline of 2.6 percent in total portfolio same-center NOI. A revenue decline was also attributed to more tenant bankruptcies than anticipated, rent concessions to boost occupancy and lower rent from renewed leases, according to S&P.
“Class-B malls still continue to be one of the riskier subtypes of regional malls out there,” says Edward Dittmer, senior vice president at Morningstar Credit Ratings, which does not rate CBL. At malls with weaker sales, it’s difficult to raise the rents on some tenants, he adds.
A spokeswoman for CBL declined to comment. In announcing CBL’s third-quarter results, President and CEO Stephen Lebovitz said its portfolio of market-dominant properties is resilient, and CBL is executing a strategy to replace underperforming retailers with more diverse uses and better-performing tenants. “We have continued to enhance our investment-grade balance sheet, providing further liquidity and flexibility to navigate the challenges we are facing,” Lebovitz stated. “This past quarter, we completed the extension of two unsecured term loans at favorable terms, issued $225 million in additional senior unsecured notes and retired two higher-rate secured loans ahead of maturity. As the quality and size of our unencumbered asset pool increases and our credit metrics strengthen, our strong balance sheet provides us with the financial flexibility necessary to execute our business plan.”
CBL has had a tougher time than REITs operating class-A malls, says Haendel St. Juste, managing director and REIT analyst at Mizuho Securities USA. “It’s not too much of a surprise,” he says of the downgrade. While there are concerns about CBL’s near-term cash flow, Juste says he does not see an insolvency risk. Rather, the downgrading presents a cost of financing issue—the cost of debt financing in the unsecured market has gone up significantly for the REIT.
S&P rates three companies that are directly involved in the mall sector, Lai notes. Simon Property Group, which operates higher-end malls, has an A rating with a stable outlook. “We do view that the higher-quality property will remain resilient,” Lai says. Washington Prime Group, which has a mix of class-B malls and community centers, which tend to have a more diverse tenant base, has a BBB- corporate credit rating and stable outlook, she adds.
Still, the timing for the downgrade could not have been worse, as retailers and landlords around the country prepare for the busy holiday season, which will see many sales completed online, says Howard Davidowitz, chairman of Davidowitz & Associates Inc., a national retail consulting and investment banking firm headquartered in New York City. “There’s just a harder road ahead,” he notes.
While retail chains have invested millions in boosting their online sales, the malls have not done as much as is needed, Davidowitz notes. Now, it may be too little, too late. As more anchor stores, including Sears and J.C. Penney, close, it hurts malls by leaving them with large, vacant spaces to fill and creating a trigger for inline tenants to renegotiate their leases, Davidowitz says. “We’re going through a gigantic problem that honestly has been underestimated by everybody, including the mall developers,” he says.
Over the next five to seven years, it is likely that 44 percent of U.S. mall square footage will be shuttered or repurposed, as e-commerce sales continue to grow, according to a new retail report from CenterSquare Investment Management, an investment management firm. While higher quality malls may find success in repurposing excess space, CBL, which has assets with lower productivity, may have to shutter some of its properties as tenants consolidate their store counts and retailers shift to investing in online operations, says Scott Crowe, chief investment strategist at CenterSquare.
Repurposing may also not work in this case, Crowe says. “One of the things a lot of people miss when repurposing real estate—it’s a very capital-intensive process,” he notes. Sometimes when malls shift more space to food and entertainment—often at a hefty price tag—the returns are not there. “They often don’t pan out,” he says.