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Lost in a Supermarket: US Malls Could Trigger Next Big Recession

Falling customer traffic, low occupancy rates and declines in sales are all plaguing the reality of the once-great all-American shopping mall, rendering many such properties unprofitable, while highly-leveraged and prone to collapse, possibly affecting the entire US economy.

Kristian Rouz – A residential mortgage bubble kick-started the Great Recession back in 2007 with enormous levels of indebtedness having turned into non-performing loans (NPLs), and the resulting wave of foreclosures dragging the entire economy to the bottom of contraction.

While this time around the US economy seems to be more resilient, the decline of the shopping mall concept could deal a massive blow to the banking sector yet again: many commercial properties are failing to achieve the performance levels of their glory days, and overleveraged property owners are seeking ways out.

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In the 1990s, the shopping mall used to be not only a major local retail hub, but also the ultimate meeting spot, providing customers with entertainment, food and beverages, and lots of space to hang out. With the recent advent of e-commerce, many consumers switched to online shopping, while improvements to in-home entertainment, primarily services such as Netflix, have severely decimated the public’s eagerness to leave their dollars at the mall.

The shopping mall has therefore become an almost redundant concept, and the entailing decline and abandonment of brick-and-mortar retail has spurred multiple mall defaults across the US. Meanwhile, most investors are either betting against or actually selling commercial mortgage-backed securities (CMBS), since indebted malls, unable to generate sufficient revenues, are becoming a toxic asset.

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Suburban America, sprawling for dozens of square miles around city centres in most US metropolitan areas, is losing interest in brick-and-mortar retail not only because of the success of the likes of eBay and Amazon and convenient home delivery services with multiple returns and exchange options, but also because the all-American culture of consumption is wearing down.

Since the start of 2017, over 1,500 retail outlets have closed across many shopping mall locations, including such stores as Abercrombie & Fitch,

American Apparel, Sears, Macy’s and JCPenney. The reason being, people are not coming out to the mall to buy anything at all. Whilst the chain store retailers are closing outlets in order to minimize their expenses, the shopping malls that used to host their outlets are facing the grim reality of impending collapse.

“Lower productivity centres are increasingly at risk of obsolescence,” analysts of real estate research company Green Street Advisors reported. “The top 300-400 malls by quality should fare well for the next several years, but it is reasonable to assume that several hundred lower quality malls will either close or become irrelevant retail destinations over the next 10 years.”

US malls are divided into four categories based on their performance and leverage: the ‘A’ and ‘B’ level malls boast higher sales productivity and are typically low-leveraged, whilst the ‘C’ and ‘D’ category malls, which represent some 30pc of all US shopping centres, are struggling with low occupancy rates, declining customer traffic, and dismal sales productivity.

The US has roughly 1,070 malls, and whilst 310 of these are ‘A’-level malls, another 334 fall into the categories of ‘C’ and ‘D’ malls.
The main issue, however, is not that the people are buying less and do not go to the mall on a date or a night out with their mates. The greatest challenge is debt – many struggling malls are dangerously high-leveraged.

“Loss severities on mall loans have been meaningfully higher than other areas,” Michael Yannell of Gapstow Capital Partners said.

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The total size of the US CMBS market is $365 bln, and mall-related debt securities are just a small fraction of it, which means an across-the-board crisis will hardly hit the economy very soon if the malls continue closing down (and they will). The problem is, however, dismal mall performance might affect other commercial properties, as developers will be facing greater difficulties obtaining financing for their projects, because viability concerns are rife in slowing consumer markets.

From the beginning of this year, $985 mln worth of the riskiest types of CMBS were purchased, which is five times that in the 4Q16, according to data by Depository Trust & Clearing Corp. Buyers of such contracts win when shopping malls default on their obligations, as mall owners have to pay monthly premiums to holders of such securities. Banks and other lenders typically hold these contracts, but the skyrocketing transaction amounts mean that, first, banks are anticipating more mall collapses, and, second, they are eager to steer away from anything mall-related.

“These malls are dying, and we see very limited prospect of a turnaround in performance,” Alder Hill Management said in their January report. “We expect 2017 to be a tipping point.”

What could possibly save a mall on the verge of a collapse is a remodelling of the commercial property to serve other purposes than simply hosting retail outlets. American suburbia is oversaturated with consumer goods, but is lacking proper real-life entertainment experiences, as the faceless reality of endless residential neighbourhoods is hardly deemed amusing. Yet, amidst the current trends, most malls are still bound to collapse as financing of ‘C’ and ‘D’ category malls would hardly be possible to obtain given the rising US Fed interest rates and the CMBS market anxiety.

Subsequently, mall debts, sold and resold, might easily turn into NPLs, and even the sale of the bankrupt properties might not be enough to cover their debt. The death of the mall, however, will likely be only enough to rock the boat of the commercial property market, but it takes greater volume of NPLs to capsize it and bring on the next recession.

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