Macy's Store Closings Could Generate a Big Windfall

By Markets Fool.com

Three months ago, Macy's (NYSE: M) stated that it plans to close about 100 stores in early 2017. It said that it would close a mixture of locations where sales and profitability are in persistent decline and locations for which the underlying real estate is worth more than the store.

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By closing nearly 15% of its locations, Macy's has an opportunity to direct shoppers toward its best stores. That could help the company improve its profit margin by increasing sales per square foot. However, an overlooked aspect of Macy's store closure plan is that it will provide a great opportunity for the company to turn some of its undervalued real estate into cash.

Mall owners are looking to buy

Investors in mall owners like Simon Property Group (NYSE: SPG) and General Growth Properties (NYSE: GGP) initially panicked when Macy's announced its store closures. Yet these companies are happy to see department stores downsizing.

Mall owners are happy to buy space that Macy's doesn't want. Image source: The Motley Fool.

First, Macy's owns most of its stores, while the rest tend to be leased at below-market rates. For malls that are performing well, owners have opportunities to bring in new -- and often non-traditional -- mall tenants that are willing to lease space at market rates. Thus, when Macy's wants to close stores, mall owners can boost their revenue by purchasing stores that the retailer owns and buying out the leases on properties it rents.

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Second, many of the new tenants that might replace Macy's would drive more traffic to those malls. Since mall owners typically charge tenants rent based on a percentage of their sales, they have an incentive to pay Macy's to close stores that aren't stimulating as much mall traffic as the potential replacement tenants would.

Macy's starts to unload stores

Last week, Macy's announced that it had sold five stores to General Growth Properties. Of those five, one store has already closed, three more will close in early 2017, and Macy's will continue to operate the last one on a short-term lease. Macy's received $46 million in Q3 from selling these stores.

The sales may have had more to do with General Growth Properties' opportunities than Macy's needs. Of the five stores in that transaction, only one was initially on Macy's internal store closure list, according to General Growth Properties CEO Sandeep Mathrani. General Growth Properties approached Macy's about buying the other four stores.

More deals are in the works

Other mall owners seem equally eager to buy back some of Macy's space in order to make room for new tenants. Pennsylvania Real Estate Investment Trust said it supports Macy's decision to downsize and is looking forward to redeveloping three to five stores. PREIT is particularly interested in adding more dining and entertainment tenants that can drive traffic to its malls.

CBL & Associates expects to recapture five to seven stores from Macy's. It sees the store closures as an opportunity to upgrade those malls with new tenants that more closely reflect what consumers are excited about right now.

Washington Prime Group, which tends to own smaller malls with lower sales per square foot, expects Macy's to shutter three stores in its malls. Even though these are probably weaker malls, Washington Prime sees good opportunities to redevelop these properties.

Simon Property Group, which has Macy's stores in more than 100 of its malls, only expects the retailer to close one store among its properties. That's a reflection of Simon's position in the retail real estate food chain -- it mainly owns high-performing malls where Macy's is probably doing very well. Even so, Simon Property Group may try to recapture some space from Macy's in its malls through a sale-leaseback or joint venture arrangement.

Sale proceeds could add up

As Macy's looks to sell off the stores that it is closing, it will tend to get more money for high-quality locations that mall owners actively want to redevelop and less for stores in malls that are struggling. Most mall owners seem fairly eager to replace Macy's stores in their properties with new (often non-traditional) tenants. This could tilt the balance of store closures toward more valuable properties.

Macy's received $46 million from General Growth Properties even though only one store was in a top-tier mall. With 100 stores closing, Macy's could potentially rake in over $1 billion if mall owners continue to be very interested in buying back Macy's stores in their properties.

Macy's is likely to give an update on its real estate progress when it reports its Q3 earnings this week. If the core retail business produces decent results and Macy's can demonstrate progress on its real estate efforts, the stock could start to gain traction. With a modest market cap of less than $12 billion, Macy's doesn't need much good news for the stock to post big gains.

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Adam Levine-Weinberg owns shares of Macy's. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.