Appraisal Matters

Over time, regional malls and other types of shopping centers go through a life cycle.  This has been discussed in professional journals, so it is no secret.  I’d like to put my spin on the topic to address what life cycle means to profitability and market value.

Pre-Stage 1 - The Catalyst…

Before I address the “decline scale”, let’s look at the catalysts that start this process in motion.  A mall may be sitting in a great competitive position - solid anchors, lots of national tenants, no material vacancies and it’s a cash cow.  Physical characteristics include good quality construction materials, good layout and lots of parking.

The primary catalyst for starting a decline is competition.  A development group decides to do something bigger and better.  Perhaps its a much larger regional mall with a better tenant mix.  Or maybe it’s a “racetrack” type of mall or “town center”.  Even before that center is built, the development group will be actively marketing to national retailers for anchor space, which also include the anchors in our unblemished subject mall.

Another catalyst is a slow decline in the physical condition of the mall or the look becomes “dated”.  This is easy to overlook for mall management because it does not make financial sense to renovate a mall that is fully occupied and has among the best tenants in the market.  This creates the opportunity for a new and better concept using more modern construction materials, layout and design, hence we’re back to the new mall competitor being developed.

Approvals for development are obtained and the new mall is built.

Pre-Stage 1 - Before the Exodus…

So what happens now is that the word gets around that “such and such” will be moving to the “new mall”.  It gets around to the tenants first.  Then employees tell customers that “we’ll be moving”, typically to a larger store.  This happens during construction of the new mall.  At some point, a banner will be hung or a new sign will appear on the mall under construction announcing the tenants that will be moving there.  Of course the local media is keen to pick up on this information.  You won’t hear it on the evening news, but you will see it in the local paper.  You could say it becomes public record and common knowledge at this point.

Pre-Stage 1 - Tenant Talk

As you can imagine, it is common for tenants to start a dialog about these changes.  Although they don’t have public forums, store managers take breaks and talk to other store managers.  They might have lunch together in the mall.  Not all of them are part of the “rumor mill”, but enough of them are to begin wondering how sales will be impacted - especially if they receive bonus pay from the store sales volume.  They have no additional leverage with management to renegotiate their leases unless they have a clause in their agreement that a certain type of tenant or even specific tenant be in the mall.

What does change at this point is that lease renewals will consider the possibility of moving.  The emphasis is on consider.  If they’re a national chain, they will at least investigate the possibility of moving.  Most don’t, but they do consider it.  It is not uncommon for them to sign a shorter lease just to see what is going to happen at the new mall.  Some might make a commitment to move, but since it is much easier and quicker to move an inline bay store than a mall anchor, the word may not get out that they are moving until only a few months before the new mall is open.

Pre-Stage 1 - The Effect on Income and Market Value

So how does this affect profitability and market value?  Expenses don’t change and income is not affected until after the mall opens and whatever tenants have committed to move then vacate.  Still, market value is negatively impacted, but only slightly.  Risk is higher and the probability of renewal for some tenants is lower.  If an anchor or two has announced it will be leaving, this is a factor.  The capitalization rate increases to reflect the higher risk and if long-term projections are made (as in a discounted cash flow analysis), income projections will be lower due to the lower probability of renewal and the built-in downtime between leases.  So even if the first tenant has yet to vacate, the market value has dropped somewhat.

Part 2 of this series will focus on the first stage of mall decline - the vacating anchor.

John Simpson, MAI