Lease Restructuring Increasingly Common in Today’s Retail Market, Says Gordon Brothers’ Mark Dufton

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summary-date June 2017

As a specialist in lease mitigation and restructuring for retailers who are closing or relocating their stores, Gordon Brothers’ CEO of Real Estate Mark Dufton has represented dozens of retailers in the market for new or smaller spaces.

In his 25-plus years in the business, Dufton has mitigated or restructured more than 1,500 leases, saving his clients more than $100 million. Northeast Real Estate Business sat down with Dufton of Boston-based Gordon Brothers during the International Council of Shopping Centers’ RECon event in late May in Las Vegas to pick his brain on how brick-and-mortar retailers facing heavy store closures can minimize financial losses.

Northeast Real Estate Business: How do you measure success at a conference like this?

Mark Dufton:
We had a great day yesterday. The retail world is in a fair amount of turmoil, and that’s our space. We do lease valuation, disposition and restructuring work. So it’s been pretty heady times for us in this environment.

NREB: DJM Real Estate changed its name about a year ago to Gordon Brothers. Can you walk me through what led to the transition of the company name?

Dufton: DJM Real Estate was a stand-alone real estate company. It got bought by Gordon Brothers in 1998 and it kept the DJM name until last year, and then we converted over to our parent company name. We were a small subsidiary of Gordon Brothers, so we just rolled up into their name.

Our parent company is involved and has really deep retail roots. It’s a 100-plus-year-old company. They do a lot of in-store inventory work, inventory dispositions, new store openings, furniture fixtures and equipment disposition and inventory appraisals for asset-based lenders for retailers. We do some lending — second lien loans to retailers too. So we’re a pretty broad scope of services as it relates to retail, and then of course we do the real estate side.

NREB: Why did this transition occur last year specifically? What changed last year from all those other years?

Dufton: We were trying to put together a more integrated approach to retail and store closings. And that’s what drove it more than anything. We had a well-established brand in DJM, but that’s really what drove it. This is probably the best show we’ve had in a number of years just because of the nature of the business at this point.

NREB: With regard to the scope of services you offer, what are you most widely recognized for?

Dufton: We’re known for lease mitigation and restructuring. To give you an example, we do a lot of work for Toys ‘R Us when they’re closing stores or relocating. So, we sell their vacant properties or mitigate the remaining balance of their leases. In conjunction with that, we will do a valuation of the property, owned or leased. So I’d say that’s our sweet spot is lease restructuring, lease mitigation, property sales. Yum Brands is a big client too, so we do a lot of work in the quick service restaurant (QSR) space.

NREB: In that prior example, you say that you mitigate the remaining balance of the lease. Can you explain that process a bit more?

Dufton: If retailers have a non-performing store or portfolio of stores that they want to close down to mitigate their losses, we help them find a solution for the balance of the lease obligation.

Sometimes we provide guarantees that their obligation won’t exceed a certain amount, so they have some certainty related to the disposition process. Other times we just take a fee-for-service disposition where our goal in most cases is to negotiate a termination for the retailer.

We run that analysis for them. We give them a budgeted cost of what it’s going to take to exit those stores. They have to make a determination based on how much they were losing at the store level. Does it justify the cost to buy out of those leases? For example, if you’re losing $100,000 at the store level and a buyout is going to cost $200,000, then that would be a good return on your capital. But if it costs you five times as much, then it’s probably not so much of a good return on your capital. That’s the analysis that each of them goes through, and we provide them the data to be able to do that.

I would say more retailers now are coming to the conclusion that it’s not worthwhile just because of the environment, that it’s too costly to exit these locations. When the market was frothy, it cost less to get out of the leases because there were backfill tenants and replacement possibilities. Now it’s not as strong, so it costs more to exit. I think more retailers are exercising kick-out rights, and waiting until the lease expires. That’s been the more prevalent strategy in the last couple years.

NREB: What would be an acceptable loss for the retailers?

Dufton: They typically have some parameters for a return on investment, so it’s whatever those parameters are for the individual retailer.

NREB: How long does it take from the time you’re brought on board to evaluate that situation and reach a resolution?

Dufton: I hate to say it depends, but it depends on the type of portfolio. The quickest it could be is something in the three- to four-month range, but there are some disposition projects that go years. If you have a portfolio of stores, there’s a certain rhythm and cycle to it. You’re going to get a large group of stores done fairly quickly, say three to six months. And then you’ll have the next group take six to 12 months, and then you’ll have laggards that can go on for years and possibly never get resolved. There’s a percentage of that portfolio that will never get resolved because there’s either not an opportunity to buy out, or there are no replacement tenants.

A lot of this real estate gets recycled year after year and there’s no solution for it. Then it goes to another broker and they try to deal with it. But the goal is to get as deep into that curve as you can. We’ve seen other service providers cherry pick the easy deals and leave the client with the bad stuff. Then it just starts chewing through their occupancy costs and the purpose of the initial deal is defeated. We try to structure it so that we have an incentive to get through the portfolio as best you can.

I do want to talk about restructuring a little bit because in the context of today’s market it’s part of the lease renewal process, as opposed to gratuitous restructuring for no apparent reason. It’s usually in conjunction with an end of term or an option that’s available. A lot of our clients are looking more closely at their occupancy expenses through that process.

For example, if there’s a lease option or renewal that’s 18 months out — and now retailers are looking further out from the expiration or option periods to try to restructure  because of the environment — we’ll go in to value that lease and determine where the leverage points are in the negotiation and try to restructure that deal so that more profit will go forward for the retailer.

I think retailers aren’t doing as much store opening work, so they’re more focused on their renewal and lease administration processes. They’re auditing their leases, they’re focusing more on renewals. That’s really what’s happening. And most of them are looking at smaller prototypes if they are going to open stores going forward. Can they capture a significant percentage of sales in a smaller footprint?

NREB: Right now we’re seeing a lot of department store closures. Each story is a little different, The general press is saying malls are in trouble. But retail real estate experts say it’s not as bad as the newspaper headlines indicate because landlords can re-tenant vacant space if there’s a better use out there. What are your thoughts?

Dufton: That’s true to a certain extent. In the case of the malls, it’s true for two-thirds of the malls in the country. There are about 1,200 malls, and we probably need to get down to about 800. Those 800 are still viable malls, and you’ll have some trouble within that 800 too.

But there’s an opportunity for repurposing. If the demographics are right and the rents are right, you can justify splitting the box and having alternative uses. You may get higher rents from that.

So that is true, but you still have the bottom one-third of the portfolio that’s a complete disaster, that may not be a mall at all anymore. So there’s big trouble with the bottom one-third of malls.

NREB: To be clear, are you saying the highest and best use for the bottom one-third of existing malls may not be retail?

Dufton: It might not be retail. It could be a school, it could be torn down for residential, it could be a medical facility. Or it could be nothing. The land could have no value, which is going to be the case for some places.

NREB: What led us to this point? Is it a series of factors? Did e-commerce simply exacerbate existing problems for some retailers?

Dufton: The online is the primary component to it. But I think there have also been some shifts demographically and generationally. Part of that is driven by online, but I know the millennials prefer experiences. They’re much more likely to go to dinner or go bowling as opposed to shopping or going to a mall.

I think that is really a big part of it. I used to be in the entertainment business and I noticed a resurgence in Dave & Buster’s, which is interesting because it had struggled. Now it’s on a roll and I think it’s really related to the changing demographics.

NREB: We hear all the time that online is only 10 percent of retail sales, but is that 10 percent growing rapidly or is it plateauing?

Dufton: I think that if online can find a way to do better in the apparel space in terms of sizing, it will be a game-changer.

There are two things, sizing in apparel and grocery delivery, that remain an issue for the online world. If those two things get more perfected in the marketplace, it will change retail dramatically. If a better program for delivery emerges, many grocery-anchored centers will be in trouble because a lot of people feed off that traffic. If online does better in terms of sizing, then I think apparel is in even more trouble than it is now.

NREB: Is grocery-anchored retail, which historically has been a safe haven, no longer a safe haven?

Dufton: Everybody sells food now — dollar stores, pharmacies — they’re nipping at grocers’ heels. And now you have the deep discount grocery guys like Lidl and Aldi that are really penetrating the market. I don’t think they are safe havens in the long term. Delivery has not been perfected to a point that people are comfortable with it yet.