Retail Bankruptcies Pose Pain for Landlords as Headwinds Persist

Landlords hurting from the commercial real estate downturn are heading for more trouble in bankruptcy court as retailers continue to face headwinds from stubbornly high inflation and interest rates.

Teen clothing retailer rue21 filed Chapter 11 on May 2. Clothing company Express Inc., fell into bankruptcy in April and arts and crafts seller Joann Inc. filed Chapter 11 in March. While some, like rue21, are heading straight for liquidation, others like Express are using the tools afforded them in bankruptcy to turn their business around, in part through shedding burdensome leases at underperforming locations.

The advantages a bankrupt company receives in Chapter 11 forces landlords to be on defense, often leading them to demand back rent or challenge a company’s efforts to cancel a lease. But the bankruptcy process typically results in the landlords collecting only a fraction of what they’re owed, though powerhouse landlords tend to have a leg up.

“The whole reason why these companies file bankruptcy is to shed the bad stores,” Shelly A. DeRousse, a bankruptcy partner at Smith, Gambrell & Russell LLP, said.

Distressed retailers have already started to flood bankruptcy courts this year. As of mid-May, 17 retailers had filed for bankruptcy, according to BankruptcyData.com. That’s down slightly from 18 at that time last year, though both numbers are an increase over the three previous years.

“There’s definitely a trend,” DeRousse said. “The only question is how long will it last and how many cases will be filed.”

Leases and Landlords

Bankruptcy law provides retailers with a powerful tool. As debtors, they can terminate leases of struggling locations fairly cheaply.

With so many retail bankruptcies in recent years, commercial landlords have become a regular presence in their tenants’ Chapter 11 cases.

“They’ve become pretty sophisticated players in these cases because they’ve been through it so many times,” DeRousse said about landlords.

The disadvantages smaller landlords contend with in retail bankruptcies contrast with the ability of larger-scale real estate players to take control in these situations. Two of the country’s leading mall operators, Simon Property Group Inc. and Brookfield Properties, offered to buy Express out of bankruptcy, continuing a trend that has seen landlords buy brands including Aeropostale and Brooks Brothers.

It’s a play Simon and Brookfield have run before. During 2020’s “retail apocalypse” they bought J.C. Penney and Forever 21 out of bankruptcy, keeping hundreds of stores across the country open by doing so. Still, Express has said it plans to close 95 of its roughly 500 locations.

Lease cancellations have been a key component in the bankruptcy of pharmacy retailer Rite Aid Corp. as well. Rite Aid, which filed Chapter 11 in October, plans to close more than 520 stores, about a quarter of its total locations, through bankruptcy. The proposed closures drew complaints from some landlords over unpaid rent as well as Rite Aid’s timing and notice of its decision to walk away from its leases.

Joann and rue21 are on opposite ends of the spectrum from each other. Joann says it expects to keep all its locations open, while rue21, which is in bankruptcy for the third time, has said it will close all of its stores.

Inflation, Interest Rates

Bankrupt retailers have pointed to the continued fallout from the Covid-19 pandemic and longstanding challenges to brick-and-mortar businesses that in 2020 forced J.C. Penney, Neiman Marcus, and others into bankruptcy. But they also blamed more recent trends like high inflation and interest rates for their strife.

Retailers paying more for inputs have a hard time passing on those costs to consumers, who are also dealing with higher costs.

“Money is really tight, and so people are spending money on their transportation and on food and their home and not as likely to go shopping,” Allison Day, a partner specializing in bankruptcy at Venable LLP, said.

Rue21, which said its “core customer base” makes about $50,000 in annual household income, said inflation hit its customers particularly hard.

Joann, meanwhile, said it’s highly dependent on imports from China, and paid more for them due to tariffs imposed in 2018 and 2019.

The high-inflation environment means that earnings can be a misleading indicator of a company’s health, Howard M. Ehrenberg, a bankruptcy and restructuring partner at Greenspoon Marder LLP, said.

“Retailers may be generating more revenue but they’re not actually selling more goods,” Ehrenberg said.

Joann’s higher costs only got worse when interest rates went up, CFO Scott Sekella said in a court filing. The company’s interest expense more than doubled from fiscal 2022 to 2024, he said.

Though the Federal Reserve started raising interest rates more than two years ago, the higher rates may just be starting to bite for many businesses that had been locked into existing loans. Now, anyone looking to refinance will have to pay a higher rate, meaning more businesses might be at risk of bankruptcy.

“The cost of that refinancing is increasing,” Ehrenberg said. “That will cut into margins.”

Additionally, Covid-era aid packages that propped up consumers and businesses have since expired.

“It’s better in many ways to pull off the band-aid and let certain companies go under so that capital can be deployed in ways that can make money,” Ehrenberg said.