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For owners of weaker Toys R Us locations, 'decisiveness is key'

? The amount of retail space that will go dark with Toys R Us' liquidation will have a significant impact on the retail real estate market.

? Toys R Us' liquidation is not a total surprise outcome of the bankruptcy process, but there is a mixed level of preparedness among property owners.

? For landlords of the weaker-quality locations, decisiveness with property repositioning plans will be paramount.

SNL ImageHessam Nadji, president
and CEO, Marcus & Millichap
Source: Marcus & Millichap

Hessam Nadji is president and CEO of the commercial real estate brokerage, research and advisory firm Marcus & Millichap Inc. S&P spoke to Nadji after the veteran toy retailer Toys R Us, which filed for bankruptcy protection in September 2017, said it would have to liquidate, effectively ending its U.S. operations and shuttering more than 700 storefronts.

What follows is a transcript of that conversation.

S&P Global Market Intelligence: Toys R Us' troubles, as online retail sales platforms have gained market share, were well known. What, if anything, is significant about Toys R Us' move to liquidate?

Hessam Nadji: With the move to liquidate, we now know the scope of the trouble on the horizon, and it is significant. That many store closures will definitely have an impact on the retail real estate market.

In similar cases where there have been a large number of store closures, it has taken landlords some time to re-tenant the dark space. I think this case will highlight the growing property quality gap favoring urban infill locations, for which there is a much higher level of demand.

There will be of course some significant repositioning opportunities for those higher-quality locations. But the further removed a property is from population centers, as you move into the suburbs and exurbs the tier 3 locations the situation will be more and more challenging. The market is already hugely adjusting the pricing in those cases.

Is Toys R Us really a victim of the encroachment of online sales platforms, or is the specialty toy store simply a moribund business model?

It was a double hit for Toys R Us. Amazon and other e-commerce players have certainly put pressure on retailers like Toys R Us to provide faster and more convenient service. But kids' habits also have changed rapidly and are still changing. What was a five- or 10-year-old's ideal toy five or ten years ago has changed dramatically because of mobile and gaming technology. Kids today are different than any generation of kids before them.

How significant of a problem is the Toys R Us' liquidation for owners of weaker-quality properties?

For many old-school retail players, the Toys R Us situation is not a surprise. It's a long time in the making. And there are other retailers that are struggling to keep up with the rapid and deep changes underway: more efficient footprints, the demand for greater convenience, robust online sales platforms. However, I don't think Toys R Us' liquidation accelerates any of these revolutionary changes or takes the trends in a different direction.

It's worth noting that there are several successful repositioning stories. Best Buy, which had been struggling with the changes, was able to successfully reconfigure its footprint and inventory layout and fight back. Look at the way, too, Walmart has caught up with e-commerce and grocery delivery. Brick and mortar is effective think of all the successful discount stores, and the e-commerce giants expanding their physical footprint — but the rules have changed.

Do you have a sense for how prepared landlords on the whole were for the liquidation announcement?

I would think the majority of the marketplace is not surprised by the news. That said, people's preparedness was mixed, from my vantage. Some of our clients prepared way ahead and had a plan B and plan C in place, but some were blindsided.

Some analysts have said the Toys R Us closures, for some landlords, will be relatively easy repositioning projects, given Toys R Us' low annualized base rent — it will be easier to best that figure with a new tenant. Is that perhaps a silver lining here?

That low rent level clearly will work in some landlords' favor. But having to replace a lower rent is one thing, and the time it will take landlords to fill it with anything — is another. The longer a space is vacant and not collecting rents, at any level, the more distress it puts on the owners' ability to keep up with loan payments. I don't anticipate a major wave of defaults, but there will be some in those tier 3 locations, where the space may be vacant for more than a year.

The most important thing for owners of those assets is to update strategy. Determine if a given property is really a hold or if one should bring in a partner to reposition an asset, or maybe sell it. For those weaker locations, decisiveness is key.