By KRIS HUDSON And AL YOON
When mall company Macerich Co. walked away from the aging Valley View Center mall in Dallas, investors holding securities tied to the $125 million mortgage were left in the lurch.
Although the mall was eventually sold last year, it fetched just $33 million, leaving investors with one of the biggest losses on a single retail property in recent years.
That bitter experience helps explain why some investors are steering clear of mortgage-backed securities tied to retail real estate. As a result, commercial mortgage bonds, including these shaky malls, have lagged behind a recent rally and retail loans in new deals are getting greater scrutiny from investors and rating firms.
Overall, default rates on mortgage securities backed by shopping malls, shopping centers and other retail properties are lower than on most other commercial-real-estate categories—7.7% of the $172.5 billion in retail loans outstanding in bonds are delinquent.
But when individual retail properties get into trouble, their values plummet faster than other property types, which can result in greater losses for investors. According to Trepp LLC, a research firm, investors in securitized mortgages on retail properties sold at a loss since 2010 recouped 49.7% less than they were owed on those debts. That is a worse recovery than most other commercial-property types in that period, ranging from a 36.6% average loss for office buildings to 48.8% for hotels, according to Trepp.
Losses are greater on troubled shopping centers and malls largely because the properties can't be easily turned around once they begin to slide. Often, when a mall starts to lose shoppers, major tenants such as department stores leave. After that, the property's other tenants often demand rent concessions or lease terminations, further sapping the mall's cash flow. Unlike properties such as hotels or office buildings, such declines often are irreversible.
"If the business case is to make the mall a better mall, that's a hard case to make today," said Spencer Levy, executive managing director of capital markets for CBRE Group Inc. Otherwise, "if you're going to demall it, it's so capital-intensive that it drops the value" of the property.
The rapid growth of online shopping and a glut of retail space mean more shopping malls will be vulnerable in the future, even some that appear viable today. As a result, investors tend to favor the strongest mall companies such as Simon Property Group Inc. and Taubman Centers Inc., which own the highest-quality U.S. malls and have the most clout with retailers. The top-quality malls often owned by such well-regarded owners typically average annual sales per square foot of $500 or more and account for only a quarter of the roughly 1,100 enclosed malls in the U.S.
The lower-quality mall companies are a hard sell for investors. "It's just kind of a dying business model," said Jeffrey Klingelhofer, a portfolio manager at Thornburg Investment Management. "I'm not a fan. Given the online retail experience, it just becomes tough for these suburban malls to compete."
This reticence may illustrate why commercial mortgage bankers are reducing retail properties as a percentage of newly issued securitized mortgages. A securitized mortgage is chopped up and sold to thousands of investors as bonds. In 2010, 56% of newly issued securitized mortgages were on retail properties, according to Darrell Wheeler, head of CMBS strategy at Amherst Securities Group. By the fourth quarter of 2012, that percentage had declined to 33.4%, retail's lowest share since 2008.
One example of mortgage investors' pain came with the sale last November of the Parmatown mall in the Cleveland suburb of Parma, Ohio. Holders of the mall's $61.6 million securitized mortgage received proceeds of $5.9 million from the sale, 90% less than they were owed.
Parmatown mall, opened in 1962, had struggled since the SouthPark Mall opened 10 miles away in Strongville, Ohio, in the 1990s. Parmatown's previous owners, founders of Forest City Enterprises operating as RMS Investment Corp., had redeveloped the mall and added Wal-Mart Stores Inc. in an anchor location long abandoned by Dillard's Inc.
Based on an appraisal in 2004, just before the commercial-mortgage-bond market began its explosive growth, Parmatown was valued at $111.50 a square foot. That was reduced to $17 a square foot at last year's sale to Cincinnati-based mall owner Phillips Edison & Co.
The story is similar for Dallas's Valley View Center. Built in 1974 by Sears, Roebuck & Co. development arm Homart, the mall dominated north Dallas until the Galleria Dallas opened just a mile away in 1982. In the next 20 years, several malls opened within 15 miles of Valley View. "You went from one mall in that area to 10 in a matter of 15 years," said Rick Vita, a regional senior vice president specializing in retail at Jones Lang LaSalle who served as receiver for Valley View from 2010 to 2012.
Macerich bought Valley View in 1996 for $85 million. The mall's death knell came when it lost both Dillard's and Macy's as anchors in 2008, leaving it with only Sears and J.C. Penney Co. In 2010, Macerich forfeited Valley View to the special servicer overseeing its securitized mortgage, reasoning that the mall wasn't worth its mortgage balance. Dallas-based Beck Ventures bought the mall on the cheap last year with plans to start redeveloping parts of it in three years and to replace it with offices, hotels, shops and apartments over the next 30 years. "If Macerich couldn't make it work as a mall, it's probably not viable over the long term as a mall," said Scott Beck, Beck Ventures president.
A version of this article appeared January 15, 2013, on page C10 in the U.S. edition of The Wall Street Journal, with the headline: Investors Strip Malls Off Shopping Lists.