A Massive Glut of Retail Space Grows as the Retail Apocalypse Continues
The fall of the Toys “R” Us chain, with more than 700 U.S. stores, shows how much retail real estate has changed in just the last decade. When KKR & Co., Bain Capital, and Vornado Realty Trust took over the company in 2005, the buyers justified the $7.5 billion price, in part, because of the supposedly valuable properties that came with the deal. Real estate can put a floor under the value of a retailer and make it easier for the company to borrow. Maybe a particular store concept does not work out as consumer tastes change, but in that case, investors can always sell the land and buildings to someone with a better plan. Long-term leases can be similarly valuable. But what if the problem is not that a particular store is out of fashion, but that consumers are just shopping less at brick-and-mortar retailers in general? As more storefronts empty, the valuation floor will look less solid.
The ultimate fate of Toys “R” Us locations will be sorted out as the company sells off its various parts; Isaac Larian, the founder of a toy company, announced on April 13 a last-minute bid to save part of the chain. But the stores would not be the only vacancies hitting the retail market. While it is not going out of business like the toy seller, J.Crew Group Inc., which leases its locations, says it is closing a net of nine stores this fiscal year, after shuttering a net 41 in 2017. Walmart Inc.’s Sam’s Club in January said it will close 63 locations, about 10% of its total. At last count, U.S. store closures announced this year reached a staggering 77 million square feet, according to data on national and regional chains compiled by CoStar Group Inc. That means retailers are well on their way to surpassing the record 105 million square feet announced for closure in all of 2017.
And with shifts to internet shopping and retailer debt woes continuing, there is no indication the shakeout will end anytime soon. “A huge amount of retail real estate in the U.S. is going to meet its demise,” says James Corl, managing director and head of real estate at private equity firm Siguler Guff & Co. Property owners will “try to re-let it as a gun range or a church—or it’s going to go back to being a cornfield.”
Even though retailers have been retreating for years, the country still has about 24 square feet of shopping space per person, many times more than any other developed nation, according to research firm Green Street Advisors. Consumers are not spending enough offline to support such a generous amount. Vacancies are headaches for landlords, of course, but they also have a mushrooming effect. People may steer clear of a mall that has lost an anchor tenant or has an abundance of “for lease” signs in smaller spaces. Deserted big-box stores, their facades naked and parking lots barren, can spread a sense of blight for blocks around. Who wants to open a business next to a place that has gone out of business?
Shopping space is not completely done for. Amazon.com Inc., blamed for the death of so many bookstores, has opened more than a dozen of its own and is betting on the grocery market with its purchase of Whole Foods. Apple Inc.’s stores are packed, and internet retailers such as Warby Parker and Blue Nile are trying out physical locations.
There is a silver lining of a sort in the dead real estate as some investors see other uses for it. “Certainly, lease values have come down,” says Andy Graiser, co-president of A&G Realty Partners. “But for owned property, the range of interested parties has gotten a lot wider.” Some retooling is under way. Simon Property Group Inc., the largest U.S. retail landlord, recently filed plans to redevelop an aging mall north of Seattle into a complex that includes offices and apartments. Reimagining retail real estate is also part of Brookfield Property Partners LP’s agenda in its takeover of GGP Inc., the No. 2 mall owner.
But not every deserted retail property can be turned into a gym, theater, or boutique outlet of a tech company. That reality will weigh on any investor thinking about scooping up a struggling chain with real estate assets today—especially buyers in private equity, who borrow heavily to finance their deals. “Retailers cannot support large debt loads,” says Perry Mandarino, head of restructuring at B. Riley FBR, an investment bank that has worked on retail liquidations. “Add to that the possibility of a decrease in the value of other collateral, such as real estate, and the successful execution of a retail-leveraged buyout may be almost impossible.”
Is a “Super Rally” for Commodities Underway?
Threats of a trade war and continued signs of global growth are combining to create myriad opportunities for investors in one long-dormant asset class: commodities. In fact, the geopolitical turbulence and market volatility putting downward pressure on the stock market is working out just fine for the commodities market, which languished for years under slow economic conditions and a general trading malaise. One popular commodities index just hit a 2½-year high, and investors in the space see the trend continuing.
“Long-term when you look at the global picture, it sets itself up for a measured supercycle,” said Mike Wilkins, commodities expert for Fidessa, a London-based trading technology provider. “Beyond the rhetoric and saber-rattling, there is a good, compelling story for growth and continued uptake in the end for commodities, especially base metals.” The group has rallied sharply since an early-February dip. The PowerShares DB Commodity Index Tracking exchange-traded fund is up about 9 percent since then and some 16 percent over the past 12 months. The CRB Commodity Index has risen similarly and is at a peak not seen since late-2014.
Commodity booms bring bigger returns for traders and investors along with higher prices for consumers, contributing to expectations that inflation is about to accelerate. Bond king Jeffrey Gundlach, of DoubleLine Capital, went into this year forecasting that commodities would outpace stocks, and so far he’s been right. There are multiple explanations for the current run, with some pointing to short-term bursts off headlines and others signaling longer-term trends about economic fundamentals. Another factor is the threat of a U.S.-China trade war that almost certainly would restrict global flows and push values higher.
Aluminum prices, for instance, have surged following U.S. sanctions against Russian company Rusal, the second-largest global firm as measured by output of the metal. At the same time, copper prices recently have turned around amid hopes that the synchronized global growth theme remains intact, while the market for grains and other agricultural products also have been steady gainers as production has dropped and farmers retool for more demand ahead. “Prices had been relatively depressed over the last 3½ years. It’s been a down type of market mainly because we have dealt with at or near-record production just about everywhere around the globe,” said Mark Schultz, chief analyst at Northstar Commodity. “That is now reversed, and you’re starting to see things build back up.”
Of course, the area that often takes the most focus in commodities is energy, and oil prices are up nearly 15% for 2018. That has come amid record-breaking demand for gasoline to fuel the global expansion. “Some of the additional sources of supply or excess supply that would normally keep a lid on prices are having issues,” John Kilduff, Again Capital founding partner, said recently. “Now the Saudis are really again going for the jugular here and trying to goose the price higher.”
Another focal point in the commodities sphere is gold. The yellow metal is pushing higher this year, gaining more than 2.5 percent before dipping Thursday, and is considered a bellwether indicator of inflation. Rising interest rates often can spell trouble for the gold trade, but not this time around. “Normally inflation and gold have an inverse relationship. However, when inflation is rising more quickly than interest rates, causing real yields on government bonds to decline or turn negative, gold can flourish,” said Lindsey Bell, CFRA investment strategist. “This is a key example of gold as a store of value.”
Finally, there are trading patterns that are influencing commodities. Technicians watch the price movement of assets independent of fundamentals for clues as to what might be in store. Paul Ciana, technical strategist at Bank of America Merrill Lynch, said a number of chart formations are pointing to further price upside. “A rally so far has been led by energy and metals, the rallies in gold and silver are young while oil and copper have room to trend,” Ciana said in a research note. While he said a wider rally will depend on how agricultural commodities perform, a look at a broad index, he said “suggests commodity markets are on the verge of signaling a secular bull trend.” He further pointed out that commodities generally do well when the Federal Reserve is raising interest rates. The central bank already has enacted one increase this year and markets are betting on at least two and perhaps three more. Ciana said one of the few periods where commodities rose when rates didn’t was in 2010-11.
The Good News Is . . .
- Mortgage applications increased 4.9 percent from the previous week, according to the Mortgage Bankers Association’s seasonally adjusted weekly reading. Mortgage refinance and purchase applications strengthened, despite the fact that interest rates have been stuck in place for weeks. Applications to refinance a home loan, which are most rate-sensitive, increased 4% for the week. Mortgage applications to purchase a home jumped 6% for the week and were 10% higher than a year ago. That is the strongest reading since January, signaling that the spring market may finally be hitting its stride.
- Celanese Corp., one of the nation’s largest hedge fund managers, reported earnings of $2.79 per share, an increase of 54.1% over year-earlier earnings of $1.81 per share. The firm’s earnings topped the consensus estimate of analysts by $0.43. The company reported revenues of $ 1.9 billion, an increase of 26.0%. Management attributed the results to strong growth in its Engineered Materials group due to pipeline commercialization and successful integration of recent acquisitions.
- Procter & Gamble announced it had agreed to acquire Merck KGaA’s consumer health unit for $4.2 billion, giving it vitamin brands such as Seven Seas and greater exposure to Latin American and Asian markets. The maker of Pampers diapers and Gillette razors said the deal would help it expand its portfolio of consumer healthcare products which includes Vicks cold relief. The Merck unit includes vitamin brands Femibion and Neurobion. Prescription-free remedies offer stable sales due to customers’ brand loyalty, albeit at lower margins than pharmaceuticals. But intense price competition online, mainly from Amazon, as well as cheaper store-brand products have weighed on profits in the U.S. and other Western markets.
Guide to Reverse Mortgage Alternatives
If you are 62 or older, you may be able to convert the equity in your home into cash with a reverse mortgage. This loan lets you borrow against the equity in your home to get a fixed monthly payment or line of credit (or some combination of the two). Repayment is deferred until you move out, sell the home, become delinquent on property taxes and/or insurance, the home falls into disrepair or you die. Then the house is sold and any excess after repayment goes to you or your heirs. Reverse mortgages can be problematic if not done correctly and require careful attention to the rights of the surviving spouse, if you are married. There are other ways to tap into your home’s equity that are worth considering, as well. Below are some alternatives to reverse mortgages. Be sure to consult with your financial advisor to determine if these strategies are appropriate for your situation.
Refinance Your Existing Mortgage – If you have an existing home loan, you may be able to refinance your mortgage to lower your monthly payments and free up some cash. One of the best reasons to refinance is to lower the interest rate on your mortgage, which can save you money over the life of the loan, decrease the size of your monthly payments and help you build equity in your home faster. Another perk: If you refinance instead of getting a reverse mortgage, your home remains an asset for you and your heirs.
Take Out a Home-Equity Loan – Essentially a second mortgage, a home-equity loan lets you borrow money by leveraging the equity you have in your home. It works the same way your primary mortgage does: You receive the loan as a single lump-sum payment, and you cannot draw any additional funds from the house. For tax years up to and including 2017, interest on a home-equity loan for amounts up to $100,000 is generally deductible regardless of how you used the loan, be it for credit card debt or student loans. And if you use the loan for what are called qualified purposes–which are to “buy, build or substantially improve the residence that secures the loan”–you could take tax deductions on up to $1 million (including any first-mortgage debt you have). However, the new Tax Cuts and Jobs Act narrowed the eligibility for a home-equity loan deduction. For tax years 2018 through 2025, you will not be able to deduct home-equity loan interest unless the loan is used specifically for the qualified purposes described above. It also dropped the level at which interest is deductible to loans of $750,000 or less.
Take Out a Home Equity Line of Credit – A home equity line of credit, or HELOC, gives you the option to borrow up to your approved credit limit on an as-needed basis. Unlike a home-equity loan, where you pay interest on the entire loan amount whether you are using the money or not, with a HELOC you pay interest only on the amount of money you actually withdraw. HELOCs are adjustable loans; your monthly payment will change with fluctuating interest rates. The rules about deductibility and qualified purposes are the same as for a home-equity loan. As with a home-equity loan, your home acts as collateral and could be foreclosed if you default.
Sell Your Home (and Maybe Downsize) – The above options keep you in your existing home. If you are willing and able to move, however, selling your home gives you access to the equity you have built. This option may be especially appealing if your residence is larger than you currently need, too difficult or costly to maintain, or has prohibitively expensive property taxes. The proceeds can be used to buy a smaller, more affordable home or to rent, and you will have extra money to save, invest or spend as needed.
Sell Your Home to Your Children – Another alternative to a reverse mortgage is to sell your home to your children. One approach is a sale-leaseback agreement, in which you sell the house, then rent it back using the cash from the sale. As landlords, your children get rental income and will be able to take deductions for depreciation, real estate taxes and maintenance. Another approach is a private reverse mortgage, which works like a reverse mortgage except the interest and fees stay in the family. Your children make regular payments to you, and when it is time to sell the house, they recoup their contributions (and interest). Although it is not free to set up this type of arrangement, it is typically much cheaper than getting a reverse mortgage through a bank, and the home remains an asset for you and your children. Selling to your children has tax and estate-planning ramifications, so it is important to work with a qualified tax specialist or attorney.