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How retailers are inviting other stores to take their spaces

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Macy's, like this store in Plymouth Meeting, Pa., is looking to profit by inviting other retailers — and even new-concept department stores — into their old spaces.
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PHILADELPHIA — Empty nesters often downsize into space better suited to their new needs.

So do ailing department stores that sit empty because of new competition and the rise of digital shopping.

Last month, Macy's Inc. announced it was forming a strategic alliance with Brookfield Asset Management to increase the value of its real estate portfolio. That portfolio is getting trimmed as falling traffic means fewer bricks-and-mortar stores.

Macy's — similar to Sears — suddenly is taking on more the role of landlord than department store. Both are looking to profit by inviting other retailers — and even new-concept department stores — into their old spaces.

"It's part of a long-term shift as the department store struggles to be more relevant," said Eric Rothman, portfolio manager at CenterSquare Investment Management in suburban Philadelphia. "They need to close stores in unprofitable locations, and a big part of their value is the real estate. They can sell, re-lease or reinvigorate these properties to free up capital" with the aid of real estate firms.

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Soon after Christmas, the parent of Macy's and Bloomingdale's is expected to identify the 100 Macy's stores that will close in early 2017 — on top of 38 that closed earlier this year.

Macy's knows much of its inventory sits on prime real estate, and it has to better manage its remaining stores.

Enter Brookfield, which has experience in managing assets in retail, office, multifamily, industrial and hospitality.

Under the partnership, Brookfield has exclusive rights for up to 24 months to create a "predevelopment plan" for each of about 50 Macy's stores. The retailer can add stores and land to the deal.

Partnering with Brookfield "is the best way to unlock the potential of those assets," said Terry J. Lundgren, Macy's Inc. chairman and CEO.

Jeff Green, who consults retailers on long-term strategy, said: "Macy's has begun to realize that, like Sears, the value of their company is in their owned real estate." So Macy's needs to "unlock" some value "by either subleasing portions of their store, or, more likely, selling the box and dirt it sits on to real estate investors."

This raises two key questions, Green said: Is Macy's still a retail company? And what will be the ultimate size and use of its "box"?

He said executives could shrink traditional Macy's selling spaces or chunk them off and open its off-price Backstage format somewhere in the four-wall box.

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Sears, another faded mall anchor, also has been in paring mode for the last few years. In July 2015, it created New York-based Seritage Growth Properties, an independent real estate investment trust, or REIT, to better manage its remaining assets.

Seritage's growth strategy is based on taking space away from Sears. The trust bailed out Sears Holdings by buying 266 Sears and Kmart stores for $2.7 billion. Seritage gets 78 percent of its rent from Sears Holdings, which occupies all but 11 of the stores.

Sears pays Seritage rent of $4.31 per square foot on average, which is far below market rate.

Seritage aims to capture higher rates by slicing up Sears anchor stores into smaller spaces and re-leasing them.

Third-party tenants within malls pay an average of $11.23 per square foot, and newly signed third-party tenants pay $18.95.

Seritage has the right to "recapture," at no cost, up to 50 percent of the space now occupied by Sears in 224 properties. It can recapture all of the space at 21 locations for a termination fee.

Mall owners such as PREIT and developers call this "repurposing" the space.

Forming the REIT "is consistent with our plans to focus on our best stores, reward our best members and pursue our best categories," said Sears Holdings spokesman Howard Riefs.

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Playing a big role in Macy's transition is PREIT, which has been "replacing many Sears department stores throughout its portfolio with popular retailers across various segments," PREIT CEO Joseph Coradino said.

In 2012, Coradino said, PREIT malls had 27 Sears stores, and today, the firm has 11. He said he expects PREIT to get back up to five Macy's stores from throughout its portfolio among the 100 anticipated to close nationally and that demand for their spaces was "robust."

"Certainly, there's the possibility of new-to-market department stores," he said. "There's off-price retailers — of the luxury as well as more traditional variety — popular, big-box and large-format stores, grocers, as well as lifestyle, dining and entertainment offerings."

The sky's the limit, but what these stores won't be is a Macy's or Sears.

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