How To Tell When a Mall Is In Trouble

A top executive foresees resilient shoppers—but fewer malls.

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It's a tumultuous time for retailers—and the malls they inhabit. With anxious consumers hoarding cash, several major retail chains have bitten the dust, and others may follow. Some malls are likely to go out of business as well. To gauge the damage, U.S. News asked Steve Sterrett, chief financial officer of Simon Property Group, the nation's biggest mall operator, about the retail economy, prospects for a recovery, and the signs of a troubled mall. Excerpts:

How has the recession directly affected your business?

At the end of the day, we own the real estate. As long as we own the best anchored real estate, we're a step away from the economic impact on the retailer.

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Do you think the retail landscape will change permanently after the recession? Will people shop less? Or will things return to the way they were, more or less?

The question is, are we just going through a cycle, or are there systemic changes going on? It's hard to answer in the midst of it. The single best predictor of shopping trends is unemployment. That's why retail has struggled: job losses. Layer on top of that the decline in household wealth. The question then becomes, does it go up or just stabilize at a high level? One thing we're going to have to see for the economy to turn around is job losses to slow and unemployment to peak. My fundamental belief is we're an aspirational society. We want to upgrade from Chevy to Cadillac to Mercedes. I don't think that aspect of American society is going to change.

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Will there be fewer malls once the recession is over?

During times like this, good malls tend to get better and bad malls tend to get worse. Tenants who might not have had a chance to get into better malls suddenly can. Then there are stores like Circuit City and Linens 'N Things [which have both gone out of business]. When an anchor goes away, that typically means there's not enough critical mass. We've had success drawing some of the better merchants away from strip malls or other shopping centers into our malls.

How are the retailers in your malls doing?

The overall health of the tenants in our shopping centers is quite good. Debt levels tend to be relatively low. In many cases, the tenants got good incentives from their landlords. Some have recapitalized themselves through LBOs or other deals. Keep in mind, all tenants are not created equal. Mall vacancy rates are going up at the margin. At the end of the first quarter, occupancy for us was 90.8 percent, down 90 basis points from one year ago. In 2005 and 2006 it was about 100 to 200 basis points higher. In 2000 and 2001 it was about the same.

Are rents coming down? Are you cutting deals with tenants to get them to stay?

No. Our average base rent is $40.29 per square foot, compared to $37.73 a year ago. That's better than industry average.

How do you tell when a mall is in trouble?

There are a couple indicators of trouble: Losing anchor tenants is one, although there are some exceptions. Montgomery Ward, for example [which went out of business in 2001], was in good malls. Lord & Taylor exited Florida and Texas, but they were generally in good malls, too. But in general, if an anchor closes, it's a yellow flag. Another is when you see mainline tenants like Abercrombie close stores. If a chain says 'I'm going to cover New York City with 15 stores instead of 20 stores', look for where the closures are.

We look closely at our own portfolio. Malls change every day. In five years there will be fewer malls, because there's going to be very little new construction. A couple of interesting dynamics: Over the last 15 years, the mall has become more experiential. More casual dining, places like the Cheesecake Factory and P.F. Chang's. We've seen the reintroduction of stadium-style seating at theaters. You want to capture more of the shopper's time because if you capture their time, you capture their money. I think we will have more of that. We could also see the introduction of services, like travel, insurance, spas, and fitness.

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So you're optimistic about the future of malls?

One of the most dangerous things to do is look into the future through the prism of today. It's equally dangerous when you're in the depth of a recession to say, 'This is the way it's always going to be.' This is an aspirational society. The next five years depends on the financial sector returning to normal and how soon credit begins to flow.

You don't buy this idea that Americans have suddenly discovered their inner miser?

I think that's counter to our culture. A number of people are not going to get caught again spending that much more than they earn, but I think we'll go back more or less to normal.