Stiller believes that the pandemic has hit the “reset” button on this sector and will serve to do away with inefficient business models and make room for those that are more suitable to serve the public. His optimism is long term. He is aware that not only are inferior businesses struggling, but he believes that there is a light at the end of the tunnel and that the situation will return to pre-COVID conditions in the next 3 to 5 years.
Ryan Morfin: Welcome to Non-Beta Alpha, I’m Ryan Morfin. Today’s guest, we have Duane Stiller. Duane is the CEO and founder of Woolbright Development, one of the largest retail owners in the state of Florida. Today, he’s going to talk to us about the mall apocalypse and the future of retail. This is Non-Beta Alpha.
Duane, welcome to the show. Thanks for joining us today.
Duane Stiller: Hey, thanks, Ryan, for having me. Great to see you.
Ryan Morfin: Great to see you. So, the real estate market has been a little choppy. There’s a lot of talk in the retail sector that there’s critical real estate convenience, real estate grocery anchor tenants really stepped up during the pandemic. But there’s also a lot of retailers who just aren’t paying rent. I think you saw Gap recently get thrown into a lawsuit for two months of unpaid rent, about $66 million. So, it really is a tale of two cities. You’re one of the best real estate retail investors we know, would love to pick your brain about what’s going on in Florida and other parts of the country.
Duane Stiller: Sure, Ryan. Well, it is a tale of two worlds. People ask me, “What do we think is going to happen?” I ask them first and foremost, “Well, what time paradigm do you want to use? Do you want to talk about the world of retail in 2025? Because I think it looks a lot like the world of retail in 2019, with some important changes. Or, do you want to talk about the world of retail at Christmas time in 2020? Because that’s going to be very different than many past years.”
So, retail, Ryan, is made up of two primary ecosystems; the mall, everybody listening to this call’s been to the mall. It’s only 10% of the space, and the mall is 80% apparel and accessories. It’s a giant clothing store. We have over 1,000 malls in the United States. In Florida, we have 60 malls. We can think of the malls as the powerful class A mall. That’s the mall where you’ve got your Saks Fifth Avenue, and your Nordstrom, and your Neiman Marcus. Those malls aren’t going anywhere.
Then, you have your class B and C mall. Those are anchored by J. C. Penney, by Sears. We know that those two retailers have gone bankrupt, and that those malls, which are two thirds of all the malls that are out there, are really hurting right now.
Now, on the other hand, you talked about the essential retailers. That’s the world where I participate in, the open air shopping centers. That’s where 90% of the space is. That’s where the grocery stores are, the home improvement stores, the Walmarts, the Costcos. Before COVID, they were at all time highs in terms of occupancies. They had been a part of an 11-year expansion and rental growth, and yet, they’re going through really, really hard times right now. It’s not because Gap isn’t paying rent in the mall, right? So, it’s a tale of two worlds, and we can get into either aspect, whatever you want to explore first.
Ryan Morfin: Yeah. So, I think it’s interesting. Let’s talk about maybe grocery anchored. So, it was like 96% occupancy. It seems to be… the grocery sector has gone through a lot of changes. Amazon bought Whole Foods. But it really, I think this pandemic, brought out the importance of local business, local inventory supply chain for consumers, because Amazon was coming to a bottom in some materials. Maybe you can talk about where you see that sector going given that the public, I think, has acknowledged that our grocery store anchored strip centers are critical.
Duane Stiller: Yeah. You bring up Amazon, and that’s really the 800 pound gorilla in the room. What is Amazon… Because so often I hear people talk about retail and they said, “Duane, you live in an industry that’s in a retail apocalypse.” The minute that Amazon bought Whole Foods, all the grocery store stocks fell by 30%, companies like Kroger with 90 billion in grocery sales. I’m thinking to myself, “Wow, this is going to change the world of grocery stores.”
Of course, here we are a few years later after Amazon’s purchase of Whole Foods, and in my state of Florida, there are still only 30 Whole Foods serving 20 million people, and there are 30 Costcos serving those 20 million people. Of course, there’s 60 malls. So, you might argue, “Well, if we can take care of everybody with 30 Whole Foods or 30 Costcos, do we need that many malls?”
But that brings us to the concept of eCommerce and what was so critical during the pandemic, which was that contactless ability to shop. Your ability to take an app out, order your groceries from your favorite grocery store, in our case in Florida, it’s Publix quite often, have some service, be it Shipt that’s now been purchased by Target, be it Instacart. Getting those orders to those stores, getting those orders filled, and getting that merchandise back to the customer within an hour or two.
I remember when I first signed up for Amazon, I was giddy because we had a two-day delivery window, and it was free. Today, my expectations changed. I want it in two hours, I want it to follow the Domino’s Pizza rule. It’s 30 minutes to my door hot, or it’s free. If Domino’s could do that for the last generation with an army of guys with tattoos and vape pens delivering those pizzas, then my local grocery store has to wake up and realize that we are in a transformational space, and that you can’t just serve your customer through your front door. You’ve got to have the delivery guys, which by the way, we’re also ubiquitous within the auto parts space.
Every auto shop gets half of its goods moved out the back door through that little delivery truck to the repair shop nearby. So, half the merchandise side of your auto parts store goes out the front door, half the merchandise goes out the back door. Clearly, in the case of Domino’s, almost all the merchandise goes out the back door, so to speak. Very few people come and pick up the pizza, but that’s the case.
In the land of grocery stores, Amazon realized that with just 3% market share, they needed to get into the grocery space, but getting in the grocery space meant that people like you and I were going to order our groceries from some vendor, and we wanted them, in some reasonable time, brought to our house. So, this pandemic showed people like my dad, who’s 81 years old, sitting in Boca Raton, how important it is to get that cell phone out, use that app, order your hamburgers, order your paper towels, order whatever you need, and have those Instacart delivery people get it to your house.
So, in 2019, this had been happening. The retailers realized that they had to have an omnichannel delivery system. What do I mean? Walmart didn’t open a single new store in Florida in 2019. Where was Walmart investing their capital? Because I assure you, as the nation’s largest retailer, they are no dummies in Bentonville, Arkansas. They were putting the money that they would normally spend on building these stores into the critical infrastructure needed to get walmart.com to get your family the goods that you want to your house in two hours or less.
Walmart has been very effective at doing that, as has McDonald’s. McDonald’s, of course, you can order using the app, it will start cooking your food. The minute you pull into the parking lot, you don’t have to do anything, it knows when you arrive. Starbucks has a robust staff. This is going to be a really important initiative that every retail company has to take on investing massive amounts of capital to have a delivery channel.
You can see that, Ryan, not just with these big companies like Walmart, McDonald’s, and so on, but you can see it now with the pizza guy. The pizza guy had to live through this pandemic with curbside pickup and delivery. They all realized they didn’t have the software, and app, and delivery person infrastructure, and they’ve had to retool their businesses to be more Domino’s-like. So, my local Houston’s restaurant itself in that way.
So, Ryan, that’s the new world order, is, stop opening new stores, invest in your delivery mechanisms, make the experience more frictionless for a customer, allow them to pick up stuff curbside, allow them to have things brought to their house, and so on.
Ryan Morfin: Were you ever worried about the supply chain during the pandemic about food access, getting any truck, whether it was the truckers or the meat processing plants? Were you, at any point, as a landlord, talking to tenants who were, at any point, worried during the pandemic, that there may be a shortage of food?
Duane Stiller: Every year at this time, we have hurricanes, and every year at this time, I watch gels emptied out of bottled water, batteries, plywood, generators. Of course, Walmart, through their software, has learned like, “Oh, gee, there’s a hurricane coming. We need to order more strawberry waffles or whatever.” Whatever it is that the craziness happens.
The answer to your question is yes and no. In other words, I live in a land of hoarders, and they all think, “Oh, my God, we need to have 20 gallons of water stockpiled. We have to have batteries for the next two years.” Of course, they decide this only when the hurricane is a week away. They have all year to shop for this stuff, and they do it all at the same time, and they empty out the stores of the same stuff. I’m still confounded by how the world came to think toilet paper was the holy grail that was going to protect them. I still can’t find napkins, dinner napkins, in my local grocery store. I don’t know what that is.
The answer is no. Basically, no, because the United States is not going to run out of food. The United States feeds the world. Will there be disruptions? I live in Florida, at times of hurricanes, there’s disruption. But I knew if this went on for months, we were very unlikely to run out of food. What were going to be the big problems? It was information, Ryan. I began this pandemic, and I went to the grocery store saying, “All right, I gotta stock up, I don’t know for how long.” I put my lab coat on. I put my lab goggles, and I have a pair left from engineering school, got my N95 mask, my hat, all my gloves. Threw everything, when I got home, in the washer. I was really scared.
But within a few weeks of being in the virus, I started to put my data scientist hat back on, and I started to download the Dade, Broward, and Palm Beach County fatality characteristics from COVID-19. I could see some really important factors in the case of this virus. One, I could see that no one in my community of 6 million people under the age of 30 had died. Then this was three weeks into the thing, we had to about five or 600 deaths.
I could see that the people that were aged 30 to 65 were accounting for 20% of the deaths. Within that space, almost all of those deaths were males, but the females were… whatever was happening for the 30 to 65 year old mom, she had a very low fatality chance. The vast majority of the deaths were people that were over 65, 80% of them. Of course, we now know that the vast majority of those people were in nursing homes.
So, I was not worried about the supply chain. Now, of course, if your supply chain was robust as a grocery store, you made a lot of money. If you had a poor supply chain, you missed out on a fantastic opportunity when everybody was stockpiling goods. So, I wasn’t worried about that. But I can tell you going forward, I’m worried about things that weren’t obvious at the onset.
So, for example, 10% of the retail space is rented to restaurants. The restaurant that you want to go to with your wife to celebrate your anniversary, the restaurant you want to go with your children to celebrate their birthdays, those restaurants shut down for several months. As a group, they laid off 6 million Americans. They’ve brought back one and a half million of them during May, thankfully. These folks who are my tenants, Ryan, they are not doing enough business… These small entrepreneurs, these aren’t the Walmarts… to be able to pay their rent.
Now, the good news is, they’re fighters. These folks are clawed back. But the guy that’s the investor in the shopping center, man or woman, their income has fallen by 10% because these restaurants are suffering. The question is, how long will it be before they can come back? There’s some green shoots because they were at zero, and many of them have crawled back to 70 or 80% of their original volumes. Still not getting enough to make a profit for the business owner, not getting enough to pay the rent, but how are they getting there?
Well, half of their volume is now curbside pickup and delivery, where historically, that was only 10% of their business. Ryan, I’m pretty confident if you look at the charts of the recoveries… Deutsche Bank put out a study, and when you look at Texas, Georgia, or Tennessee, so the early states to reopen, in each instance, if you extrapolate the growth trend for the restaurants, we think sometime in September or October, the restaurants get back at least to a break even point. They’re back to being able to pay their rent. Hopefully, they’re back to employing some of those four and a half million people that are still at home that were previously working for restaurants.
Although I gotta tell you, some of my friends in this business are struggling to get workers back because they’re being paid so much on unemployment. They’re earning 40, $50,000 a year to stay at home. That’s kind of hard when they’re going to come back to a 15 or $20 an hour dishwashing job. But without dishwashers, you can’t run a restaurant.
Ryan Morfin: Yeah. I do think there’s some perverse incentives out there for people who are in that service sector to prefer to be unemployed. I know the President came out on Friday saying that there was going to be some new maybe subsidies or a new stimulus program for restaurants, but I think the treasury department is looking into that right now. It’s going to be interesting to see what they do, because they’re saying that half of the service and the restaurant service professionals aren’t going to be coming back, that the companies that they used to work at are unemployed. But that’s good.
I know we’ve been trying to eat out or order in, if you will, just to support the restaurants in local area. I think it’s critical to do that now more than ever. Otherwise, you’ll be stuck eating your own home cooking.
Duane Stiller: Forever, right?
Ryan Morfin: Yeah.
Duane Stiller: Ryan, just imagine, the restaurant business is a really tough business. If you had to identify the hardest working entrepreneurs in the United States, it’s the guys running restaurants, the men and women running restaurants. If I had a bet on somebody with ingenuity to survive this kind of social distancing morass, the restaurant owners are going to ultimately figure it out. For sure, five years from now, Ryan, we’re going to have the same number of bars and restaurants. When we go to new Orleans again, one more time like we did in the past, there’ll be just as many bars and restaurants in those cities as there were in 2019. But the restaurants are going to have a hard time.
Now, the other thing that’s happened from the pandemic is, we had 11 years of economic expansion, and we had really low interest rates during that economic expansion. Lots of retail companies in the United States gorged on that cheap debt. We have seen, obviously, Toys”R”Us, Sears collapse, Radio Shack. We could go on. The list is long.
Although we have to recognize that retail hat is the land of creative destruction. Thankfully, if you look at the list from 1990 of the 10 biggest retailers in the United States, and you compare it to the list today, only three of the people that were in the top 10 companies in 1990 are still in the top 10 list today. Walmart remains at number one, Target remains on the list, and Kroger remains on the list. Everybody else in the top 10 list of retailing today in the United States is new to the list; Costco, Home Depot, Lowe’s, CVS, Walgreens, Amazon. These folks showed up in the list only over the last 30 years.
If we were stuck with the old people, Ryan, we’d have a miserable retailing environment. So, we’d live in the… But I’m going to tell you, there are a lot of retailers right now that are swimming naked, and the water is going out. In July and August when J. C. Penney has been finally able to reopen… because you can’t reorganize a retailer when you’re closed, because you need to have going out of business sales in order to get rid of your excess inventory and reorganize your platform. So, J. C. Penney’s getting rid of a third of the stores, Tuesday Morning is going to get rid of a third of their stores. Office Depot has announced the reduction of workforce of 13,000 people, haven’t told us yet how many stores are going to go away.
So, you can look in Florida, there are 105 brands that are operating 15 or more big box locations, 105 brands; Walmart, Walgreens, go through the list. Right now, Moody’s has rated 20 of those 105 brands in a distressed state, CAA1 or less. So, this tide’s going out. These retailers, many of them have had three months of no sales. The essential retailers that were open during the pandemic, the Home Depots, the Lowe’s, the Publixs, they’re all fine. They’re not the ones that are… It’s the Joanne Fabrics, it’s the Pier 1 Imports, it’s the Tuesday Morning.
We’re going to see lots of retail space empty out. It’s going to empty out on the mall space where the vast majority of publicly-traded companies that own mall portfolios are now trading with essentially negative equity to their debt. That cash on the books of those companies is their market capitalization. So, there is going to be an apocalypse in the mall space. I call it apocalypse, like the plague, where you kill one third of your population, not one out of 100 or one out of 1,000. So, an apocalypse is happening in mall land, and it will continue to happen over the next five years.
Then in the open air centers, we had 8% vacancy rate. We are going to 12 or 16%. Only the best operators in a land where there used to be 105 big box brands to go out to, and now there’s only going to be 80, only the best operators… Just like in a competitive game of musical chairs, when there’s three people circling the one chair, you better have sharp elbows if you expect to have your project recover in this environment. So, we had those sharp elbows in 2009, 2010, 2011. We have a playbook because we went out and made sure that we could continue to compete and lease in what was one of really the most difficult recessions in my lifetime.
We’ve got that playbook dusted out now. We have too much retail space. We have too many malls, and we are going to bulldoze them down and turn them into houses. We have too much open airspace, and we’re going to bulldoze down sections of shopping centers and convert them into apartments. So, we’ll make, essentially, a horizontal mixed use project, but this reset will be ultimately good for the country. Our retailers will get much better at getting new stuff in two hours or less. There will be lots of Domino’s out there. The business that we take away from these 20 brands that are likely to collapse post-pandemic, these brands were accounting for 6% of the space, and only 3% of the sales. They were horrible retailers.
When everybody else is outperforming you, and this is natural for retail, is that we vote those people off the island so that that space is available for the stronger players. But if you’re an operator right now, 2020, 2021 is going to be miserable. It’s going to be miserable because your restaurants and your movie theaters are going to struggle to pay your rent. It’s going to be miserable because a lot of businesses that you were counting on are not going to pay you any rent because they’re gone. The tide’s gone out, and they’re swimming naked. Now, you’re going to have to put new capital into your project to rebuild your project so that in 2025, you are better than 2020.
You can do that, but you can only do that with the right operators. The question is, are these publicly-traded companies the right operators? Is it the entrepreneurial operators? We’re the guys that are partnering with Principal Insurance and Prudential Insurance to deploy capital, because we think that those big institutions have learned that it’s the Navy seals on the ground that operate these things, but it’s important as an institutional investor to pick the right group of Navy seals because not all soldiers are created equally.
Ryan Morfin: Well, you touched on a point about landlords and tenants, and Simon just sued Gap. Gap has $115 million months rental expense. I guess they stopped paying 66 million of it for their shuttered stores. At what point… What’s the right solution here? Do landlords… I actually had a call yesterday with somebody who’s a big owner of rooftops of single family rentals. It seems like Fannie and Freddie and HUD are looking at instead of going into forbearance or starting foreclosure processes waiting like three or four months of no rent payments and not even putting it on the back end of the lease, or-
Duane Stiller: Let me give you the playbook, Ryan, because it moves across the spectrum. The first thing you did was everybody’s brain was exploding on April 1st. As a retailer, whether you are Ross Dress For Less with a billion dollars in your bank account or TJ Maxx, every one of them, whether you were Starbucks, Panera Bread, Cracker Barrel, you sent all your landlords the same letter. It always started with, “Hello, partner.” Magically overnight, you moved from landlord to partner.
Now, when they were making billions of dollars of profits, they never wrote me one letter to say, “Hey, partner.” This instance was, “We’re closed. We don’t care what the lease says, we’re not going to pay you the rent.” Now, within a matter of weeks, people realized that their businesses were not going to be closed forever. The data was coming out on the pandemic, this was not going to be a plague where two and a half million Americans were going to die, or a third of the people like in the Black Death in history.
So, they shifted and said, “Oh, yeah, we do remember that agreement we made with you. We’ll actually honor our promises to pay you, just like you’ve been honoring your promises to pay your mortgage.” But we get into a few categories. So, almost everyone, particularly the large well-organized companies, ask you to forgive the April, May, and June rent and repackage it either over the following 12 months or the remainder of the lease term, which is usually three to five years, and on an interest free loan basis. “Hey, partner, make us an interest free loan. We’ll give you the rent. We’ll pay you back the rent over the next three to five years.”
Now because retail properties are valued at some multiple of that future income stream, that was a pretty win-win solution. I’ve got a bigger rental stream going forward, because I’ve repackaged this three months of rent into the future three to five years at a 15 times multiple. This was a win-win. I’ve created more value. I have more valuable asset as long as you are the retailer paying.
That’s what generally was done, small business owner, big business owner. Then there’s a group of people like the gyms, the daycare centers, the movie theaters, and the restaurants. Now, in that instance, repackaging that rent and adding burden to them over the next three or five years. What do you do to AMC Theater? What do you do to Regal when they can’t pay? Now, the good news is only one out of 30 shopping centers has a movie theater. In the United States, they only account for 15 billion in sales. So, they are a tiny fraction of the retail ecosystem.
In that instance, Ryan, you have to accept you’re not getting any rent. You’re not getting any rent for April, May, and June, and you’re going to have to work with these businesses because otherwise, as a landlord, you’re going to get back an empty movie theater. You’re not going to… there’s no other movie theater that’s going to want to expand and move into it. It’s very expensive to get rid of that stadium seating and make a flat floor to have a clothing store. Unless you believe that movie theaters are gone from our ecosystem, you should probably come up with, as a landlord, some way to work with them. The solution isn’t to do with Simon bid and to sue the movie theater, because that’s not going to get you anywhere.
The gyms, some of them have behaved well, like LA Fitness and Planet Fitness. Some of them, like 24-hour Fitness, can’t even figure out how to pick up the phone call and call their landlord back. We’ve been three months of them not sending in a rent check. We all know that, according to news reports, they’re going to file for bankruptcy, but let’s keep a dialogue open so we can know what it is you’re up to. So, you had some real bad behavior out there. Some people are still having to learn how to pick up the phone after not paying the rent for three months, and you’ve had some good behavior out there. But everybody threw the lease in the trashcan and thought that the person that should bear the burden was the landlord, regardless of what that lease contract said.
Everybody has more or less recovered from that, and now you’re looking at a property that has only 90% of the income that it used to have. Why? Because of the movie theaters, the gyms, the daycares, and the restaurants. Should we be able to recover from that? Sure. When the parents can go back to work, they’ll put their kids back in the daycare, but right now, it’s cheaper for them to stay home and get that big government stimulus check and unemployment check. So, my daycares are operating at 25% capacity right now.
But we need people to get back to work in this country. We can’t live with 13% unemployment. We shouldn’t, we won’t. I don’t think we will. I think we can talk about where we’re likely to go for recovery, but that’s what happened in rent. All my brother and the landlords spent all of the last few months thinking about nothing except collecting rent. I think that’s a mistake. I think they failed to focus on the fact that a number of the retailers are going to be gone, and they need to bring in new capital and plan to refill certain spaces and rebuild their projects. That’s coming, but it seems like people have been ignoring that aspect of the crisis.
Ryan Morfin: Well, before we move off of the landlord and then the credit on the rent roll, what happens in bankruptcy, typically? 12 months of rent is what you’re able to claim?
Duane Stiller: So, what happens is as follows, bankruptcy is great for someone like J. C. Penney. You look at your… you have 850 stores… we’ve got more or less 900… and you say, “I’ve got a third that are really profitable, a third that are breakeven, and a third that are losing money. I need to get rid of this third that are losing money, but I’m on these longterm lease obligations. So, in bankruptcy, I can cancel those leases. Just mail the keys back into the landlord.”
Now, it may be that some of those unprofitable stores, those leases might run for another 20 years, and I might be able to find a Home Depot that wants to take that store over at a premium to my rent. So, I can sell my lease to Home Depot during bankruptcy of that unprofitable store, and create cash and improve the recovery for the creditors. So, the retailer comes into bankruptcy and has a period to accept or reject the leases. If they reject the leases, the contract is kaput, and the landlord can go back. It’s not going to get any payments under the lease stream.
Judges will give tenants a relatively long period of time. I think they are only given 90 days to decide which ones they’re going to accept or reject, but judges will typically extend that deadline. Now, during bankruptcy, you’ve got to keep paying the rent on the leases that you haven’t rejected. So, it’s in the retailer’s best interest that if you’re not going to keep this lease because you’re not going to find anybody that wants to buy it from you for a premium, it’s better to just get it out of the mix.
So, J. C. Penney has quickly identified 150 stores that they’re closing. They’ve announced those in the last few days, even though they’ve told us all they’re going to close 300, right? So, you try to do that. Then what they’re ultimately going end up with is a company that emerges from bankruptcy with 600 stores, not 900 stores. They’re going to, hopefully, trim expenses and be able to operate those 600 stores profitably, and then rebuild the business from there.
Only a tiny fraction, Ryan, of the retailers that file bankruptcy and up liquidating all the stores. So, we finally saw that after the third bankruptcy with Toys”R”Us. But in the case of companies like Sears and J. C. Penney… Give example, in my area, Winn-Dixie filed for bankruptcy. They emerged from bankruptcy with 10% fewer stores, and they continue to operate a seven to $10 billion grocery platform.
So, bankruptcy can be pretty good. Now, you’re going to wipe out your shareholders, and your bond holders are going to own your company. Hopefully, they’re going to go out and hire really good operators, really good executives. United States gives people to have a second chance. So, that’s the bankruptcy provision. Landlords, obviously, hate to be in this state of limbo where they don’t know whether their lease is going to be accepted or rejected, because if it’s going to be rejected, they need to find a new business for that space fairly quickly, because nobody wants to give value to a zombie space. But we’re going to spend the rest of 2020 with hundreds, maybe thousands of these zombie stores that have to get resolved. When we get into 2021, we are all going to wake up with lots of empty space and very little demand for that space.
What happens when those conditions are there? Rents fall. What happens when rents fall? The value of the publicly-traded rates go down, the value of retail projects go down, but that creates opportunities to invest opportunistically. That’s really what our company is built around.
Ryan Morfin: What percentage of the square footage do you think goes dark and then finally gets, like you said, bulldozed or repurposed?
Duane Stiller: I think, Ryan, you could see somewhere around a third of all malls are gone. They just don’t realize it yet. So, you got three malls in your town, one of those three malls are gone forever, and it becomes residential. There’s no retail use for that. In the case of open air centers, I bet you, 10% of the space, Ryan, is repurposed. That’s a remarkable total. That’s one out of 10 centers getting repurposed.
Now, it’s probably going to be that all 10 centers live there, and some number of those 10 centers are significantly shrunk down. You repurpose seven or eight acres in the summer between 200 and 300 apartments, those two to 300 apartments are worth somewhere between 60 and $90 million. So, you take down 80,000 square feet, which would equate to the eight acres of space, and you put back… which by the way, at $200 a square foot, that 80,000 feet was worth 16 million bucks. You replace it with apartments that are valued at 60 to $90 million. Hopefully, your land cost, that $16 million worth of land cost, you can repurpose it and make a profit because you were never going to get more retail demand to refill that 80,000 feet.
That 80,000 feet was probably a closed Kmart. It was a closed Sear store. It was a closed whatever. That’s because there won’t be enough demand because retailers have learned like Costco, like Whole Foods, you can serve… In Florida, there are 900 McDonald’s, 900 Starbucks, 900 Dunkin Donuts, 900 Publixs, 900 Walgreens, and 900 CVSs, but there’s only 30 Costcos and 30 Whole Foods. The retailers are learning, you can serve 20 million people, you don’t need to have 900 stores. Your company can be really profitable if you get the size right now.
Remember, Ryan, you’re going to have to couple that with… in the world of autonomous driving vehicles, and in the world of technology and Uber, we can use an old technology like Domino’s, you are going to… Retailing used to be about cutting costs, using scrap paper instead of PostIt notes, resaving the paperclips. Retailing was just obsessed with cost reduction as a way to drive profitability. That’s gone. When Amazon came into the game, the game got to be, you need to use technology. You need to… Kroger’s gone from 300 programmers to 1300 programmers. They are getting the email.
Walmart has made massive investments in technology, so has McDonald’s. This is a game now, not just about supply chains and logistics, but this is about having smart programmers. So, Amazon demonstrated it. They are the biggest employer in the retail space of programmers, but if you’re a Publix in Lakeland, Florida, you better hire a lot of programmers. I think it’s easier to get programmers to move to Seattle than it is to Lakeland, Florida, but you’re going to have to do that if you want to compete in this retail environment going forward,
Ryan Morfin: Before we move over to real estate tech, I know you’re a pretty tech savvy guy. So, the landlord, tenant conversations that were handled well and handled poorly, those are going to definitely leave a mark in people’s memory of who are good partners. But how do the banks talk to the landlords? Were you guys saying, “Hey, listen, we can’t do this,” or were you digging into equity to service the debt? What kind of flexibility did the banking sector provide?
Duane Stiller: That’s a really great question. It was very different than 2008 and 2009, when the banks were armed with baseball bats, and they came out for the developers demanding that their loan be reduced by 50%. This was very different. First of all, the regulators came in and told the banks, “If you give an interest rate forbearance period for the next 90, 120 days, however you feel, we will not classify those assets as distressed assets.” Because, Ryan, in 2019, there were next to no defaults within the retail property space, maybe a few of the trouble malls, but in the open air center space, everybody was making their payments. Record high rents, record high occupancies, there was no issue.
So, we chose, and many of the developers that I’m connected with through some email and industry sharing networks, all committed to make those mortgage payments. But every one of our banks reached out to us and said, “If you need to skip a few interest payments, we will roll them into the loan. You can pay them back in the end.” Now, the CMBS lenders didn’t have that flexibility. People that had CMBS loans… We had none… were really worried because they didn’t want to get kicked into special servicing. They didn’t want to trigger the fault under their loan agreement. Those bonds structured mortgage backed securities are very tricky.
Most of those loans have lots of reserves set aside for retrofitting tenant space, replacing roofs, and people realized, in this crisis, it would be better served by redirecting some of that capital towards some interest payments. The question was whether the servicer had the latitude to do that without sending the loan to special servicing. But this was a very different initial period with the lenders.
Now, I think by the end of the year, that has to change because if you’re a lender and you have a property that’s no longer worth the value of the mortgage because a number of retailers closed, that property is likely to end back on the books of the lender. There are lots of investors like us that are looking to acquire those whole loans at a discount. We did that successfully in 2010, ’11, ’12. There’s a mechanism for dealing with that because not every landlord… For example, in Florida, open air retail centers, the average 70% of the owners have three or less projects. So, they’re not well-positioned to deal with a 30% loss in their occupancy.
They’re all sitting there scratching their heads, going, “Wait a minute, we always have one or two pizza guys go out every year. We’re not set up to deal with our J. C. Penney moving out, or Kmart closing, along with our Pier 1s, and Party City, and Tuesday Morning. We don’t have any idea how to fix this.” In fact, those are going to go back to the bank. It’s not going to be a huge percentage. It’s not going to create the strain on the banking system, the systemic risk that we saw from the housing crisis in 2008, but it will create some interesting investment opportunities for those that know how to reposition those assets.
Now, on the other hand, when you see the malls get foreclosed, and they will, and they already are, in that instance, Ryan, the solution isn’t to have a skilled operator buy and repurpose the retail space. There it is to demolish the project and put in residential. Because, fortunately, the US population is still growing, and at some point, that population growth will fuel need for more retail space.
But initially, as we shift the demand away from a brick and mortar store to an omnichannel model where my grocery store sends 15% of the food out the back door with the guys with tattoos and vape pens, and sends the remainder out the front door, then that creates capacity for a growing community without adding more square footage of physical retail space. It allows those retailers to be much more profitable because retail is growing in the United States at 3.75% a year. Half of that growth is inflation, they just raise prices, but the other half is more bags of goods moving out of that store. If you have retailers that, in the next 10 years, experience 3.75% growth, that means those retailers experience 40% growth in sales.
Now, half that growth was raising prices, but the other half was real volume growth. So, this is a really great time to be a retailer in the United States with one caveat, you’ve got to figure out technology. If you don’t, you are only going to benefit from inflation, raising prices, and your competitor will get the inflation piece and the volume piece right, and they will eat your lunch, and you will get pushed out of business as has been the case for retailers since the beginning of time. There’s a reason that only three people from 1990 live in the top 10. It is a dog-eat-dog world, and retailers are really good at knocking off their competitors.
Ryan Morfin: Yeah, it’s amazing what Walmart’s been able to do to recreate itself. So, maybe you can give me some silver linings. We’ve talked about getting rid of space, bulldozing malls. You talked about the growth of retailers, but in a macro-economic standpoint, how fast do you think this recovery is going to be, or are we in for a very long sideways shift?
Duane Stiller: So, Ryan, we’re in for what I imagine to be low interest rates for a very long period of time. Assuming that we don’t have an inflationary spike, $3 trillion of stimulus should make people cautious. That’s why I want to keep an eye on gold prices, although having oil prices such that you can buy gasoline at $2 a gallon is a windfall for the US consumer. So, my expectation is, is that this is, for retailers, for the restaurants, for the movie theaters, for the daycare centers, this is an 18 to 24 month crawl, fight, struggle back to normalcy. They’re not all going to make it. By 2025, we’ll have the same number of daycare centers and movie theaters, reasonably, and gyms, and so on. But it may not be the same people that we have today.
If you’re an investor, the next two years are going to be quite difficult because your income streams have deteriorated. First, in 2020, because you couldn’t collect the rents. In 2021, because you have higher vacancies than you normally had. Those should heal themselves over the next three to four years provided you have best-in-class operations. Not everybody’s going to win the musical chair game, not everybody’s going to get a seat. That’s true not only in the retail space, but that’s true in the operator space.
It took us eight years for the rents to come back in the great recession. I think we’re in for 20% rent cuts, potentially, as we have increased space vacancy with reduced demand. Will it take us five years to recover? Probably. How long is it going to take us to get the occupancies back up? Well, in 2008 and 2009, it took us 11 years, and we still weren’t back at the 2007 levels. We were close, right? This could be three to five years.
Now, many things though will be more V-like. I expect that the restaurants, if it was one month down and six months up, that feels like a V to me, that’s not some horror show. Same thing for the daycare centers. One month down, six months to get back up. Same for the gyms, your LA Fitness, your Planet Fitness. That still, to me, Ryan, feels like a V. It took us a year to go down and to come back.
But there are these other things that are lingering. You want to sign a new lease with Ross Dress For Less, it takes you six months to build that store. So, you lost your Stein Mart, it takes you six months to negotiate a new lease, six months to build the store. It’s a year before you get that new retailer open.
Now, what do you want to do as an investor? You want to go out and buy opportunistic deals in 2021 and 2022 with the hope of selling them in 2025. Cap rate, that’s the tricky question. Mr. Market is telling us that all apartments, based on pricing for apartment rates, and all retail properties have declined in value about 25%. I don’t believe that. I don’t see how the property value’s declined by 25% as a result of the COVID virus. So, I think this could be a great time for getting in early when people are still of the mindset it’s an apocalypse. The apocalypse is happening, it’s happening in the mall space. It’s not happening at your local Wegmans, or Publix, or Walmart, or Costco.
There is an apocalypse if you own a restaurant, there’s an apocalypse if you own a daycare center. It’s going to fix itself in the next year, you’ll make it through it. You’re a tough operator. If you don’t, there’ll be somebody in a few years to take that space. So, that’s how I see it. A lot of money will be made, Ryan, through investments, capital deployed in 2021. We had $250 million worth of projects lined up to be sold in 2020. People are asking me, “When are we going to sell them?” I’m like, “When the market price is such that we can beat 2009 levels.” That’s a tough question to answer.
My motto is a little bit Sam Zell-asky. In the SNL crisis, he would stay alive to 95. My thing is, make it through to ’22. That’s it. From a disposition standpoint, do not rush to sell anything right now, you are going to get a horrible price. I will think it’s a good price. It will be a horrible price for you if I buy it from you.
Ryan Morfin: Any good books that you’re reading right now through the summer?
Duane Stiller: I’m reading Albert Camus, The Plague. I don’t think that… I read The Stranger before. It’s great because I can understand The Plague much better now that I’ve been through a plague. I’m going back to Andrew Robert’s book, Napoleon, it’s sitting up behind me there. But a lot of… Listen, this was a short-term crisis, but the resolution to this is from first principles, right? So, working hard, watching the data, stepping back, not falling for decision-making in the fog of hysteria, but thinking through this fog of war and making the strategic decisions for it.
It was a tough time. It was scary. We had very little information. A health pandemic, that’s a tough… that’s like fighting ghosts and goblets. It’s hard to identify the target to shoot at in that instance.
Ryan Morfin: Well, Duane, this has been a phenomenal conversation. I appreciate it. I’d love to invite you back for another episode in months ahead about real estate tech. It’s going to become more and more critical, like you said. Thank you so much for your time.
Duane Stiller: I have the largest IT department of any real estate company. I was one of the few operations research engineers. I went to Cornell for operations research, then ended up in the real estate business. So, I was a big data guy when big data wasn’t cool, but I’ve been advocating for big data in retail since the beginning. So, I look forward to having a tech talk with you, Ryan, and it was great speaking with you today. Have a great [crosstalk 00:51:47].
Ryan Morfin: Great to see you.
Duane Stiller: I’m glad that we’re all through this healthy and happy, and I hope we stay that way.
Ryan Morfin: Me too. Thanks, Duane. Will talk to you soon. Appreciate you.
Duane Stiller: You’re very welcome, Ryan. See you soon.
Ryan Morfin: Thanks for watching Non-Beta Alpha. Before we go, please remember to subscribe and leave us a review on Apple podcasts or our YouTube channel. This is Non-Beta Alpha, now you know.
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