Moody’s Analytics: To survive, malls must share in the risks of their tenants

American malls must attain average sales per sq. ft. of at least $520 to stay in business—minus the sales of high-volume tenants like Apple and Lululemon.

That’s just one of the many new goals mall operators must accomplish to survive and thrive in an era in which just 20% of the 1,000-plus malls in the nation will continue to operate as classic malls, according to a new report from Moody Analytics called “The Mall of the Future.”

“Retailers’ profit margins are very tight, generally ranging from 2% to 6%. As a result, it becomes very important for stores to have either a strategic advantage or high sales volumes,” says the report. “So while $400 per sq. ft. of sales per year may have been acceptable five or 10 years ago…a retailer will generally expect north of $500 per sq. ft. in a store now to remain in a given mall.”

In-line tenants in malls, therefore, will continue to seek more flexible lease provisions such as percentage-in-lieu-of-rent, in which a standard base rent is replaced with a payment based on a percentage of sales.

Retailers will also, Moody’s says, seek performance-based “kick-out” clauses based on the performance of the mall or the store that gives the tenant the opportunity to terminate a lease early if certain agreed-upon thresholds are not met.

With standard five-or-10-year leases not as common as they once were in malls, successful operators in the decade ahead will have to become more actively involved in facing the risks of their tenants.

“They will need to invest in more active management of their properties than under the traditional mall model, particularly when sales are distinctly declining and store footprints are shrinking for many brick-and-mortar retail categories,” Moody’s holds.

The report points out that average mall lease terms declined from an average of about 8.3 years in 2017 to about 6.4 years in 2021. But most of that decrease was the result of an increase in specialty leasing—mostly pop-up stores signing for only months at a time—which backfills space for landlords but also saddles them with financing issues from their lenders.

Here’s what Moody’s predicts will prove to be more winning strategies for mall operators:

• Help retail tenants grow their omnichannel structures. Provide tech infrastructure for omnichannel marketing and last-mile distribution of products. One of the best ways malls can energize this effort is to seek out more tenants that already possess robust omnichannel operations. 
• Consider creating logistics centers in malls that would allow retailers to create fulfillment arrangements using store inventory, thereby delivering online orders much faster and at a lower cost.
• Continue to consider nontraditional tenants such as medical offices and facilities, multifamily housing, and distribution centers. Even if they’re added to the center as outparcels, they’ll serve as generators of new traffic.
• And, as always in real estate, location-location-location is crucial-crucial-crucial.

A successful mall needs to be positioned in a market with strong demographics, high population density, and above-average household incomes. But, cautions Moody’s, malls can’t run on high-powered demographics alone.

“It is increasingly important to be the dominant mall in a ‘trade area,’ which is roughly a 30-45 minute drivetime radius,” the report advises. “For many markets, that means only one or two large format regional malls will get the lion’s share of customer foot traffic and therefore survive going forward.”

Moody's Analytics is a subsidiary of Moody's Corporation established in 2007 to focus on non-rating activities. It provides economic research regarding risk, performance, and financial modeling, as well as consulting, training, and software services