Breaking Bad: Why Has Retail Space Doubled as Incomes Drop - and Other Tales of the New Economy

Let's begin by stipulating that most investors aren't stupid. Ok, they can be wrong and emotional and misinformed and overconfident. But by and large, they arent idiots (we will ignore the human fascination with gold for the time being).

So how could an economy built on information and the analytical power of computing lead to the doubling of available retail space in the US as incomes are dropping? Oh, and at the same time as that internet thing is reported to possibly be selling stuff to interested parties? Or to put it in more personal terms, how is it that the amount of retail space per consumer in the US is 47 square feet, approximately 3 to 8 times more than anywhere else in the developed world? By comparison, the number is 12 square feet in Germany. Yeah, hmmm.

Aside from the fact that this sounds like an awesome opportunity for distressed real estate investors, how could this happen?

We think you can guess. Yes, financialization and the creative urge to privatize gains while socializing losses. The search for yields and the offloading of risk. Remember CDOs and other financial innovations from back in the palmy days of  2008? Prepare to learn more than you ever wanted to know about 'retail operating leases.' As the following article explains, they are another faux security designed to meet short term opportunities with long term obligations. Just smile when someone tells you this time its different. JL

David Stockman comments in Contra Corner:

At the time of the S&L fiasco around 1990 there were only about 5 billion square feet of shopping space in the nation—meaning that capacity tripled during the subsequent a quarter century. Yet this was a period when the real incomes of the middle class were essentially dead in the water. So what market signals could have possibly given rise to such a disconnect?
The ultimate evil of monetary central planning is that it drastically distorts pricing signals in capital markets, thereby inducing vast malinvestments in the real economy—-mistakes that eventually result in uneconomic returns and losses which must be someday written off. Accordingly, what is recorded as a boost to GDP by our Keynesian policy overlords in the front-end of the malinvesment cycle results in a reduction of national wealth when it’s all said and done.
Needless to say, if central bank induced financial repression is carried on long enough the level of capital market deformation and main street malinvestment can become monumental. In fact, there are four bell-ringer statistics among the macro-economic data that dramatize perhaps the greatest of these central bank induced investment errors, but they are never published in the main street financial press—–probably because they explain far too much in one glance.
The skunks in one of the nation’s greatest uneconomic woodpiles are: 100k, 1 million, 15 billion and 47 square feet. Those stats measure the collective girth of America’s shopping emporia, and designate, respectively, the number of shopping centers and strip malls across the land; the number of retail stores spread among them; the total retail space occupied by the nation’s shopping machinery; and the amount of space at present for every man, woman and child in the nation.
It does not take much analysis to see that these bell ringers do not represent sustainable prosperity unfolding across the land. For example, around 1990 real median income was $56k per household and now, 25 years later, its just $51k—-meaning that main street living standards have plunged by about 9% during the last quarter century. But what has not dropped is the opportunity for Americans to drop shopping: square footage per capita during the same period more than doubled, rising from 19 square feet per capita at the earlier date to 47 at present.
This complete contradiction—declining real living standards and soaring investment in retail space—did not occur due to some embedded irrational impulse in America to speculate in real estate, or because capitalism has an inherent tendency to go off the deep-end. The fact that in equally “prosperous” Germany today there is only 12 square feet of retail space per capita is an obvious tip-off, and this is not a teutonic aberration. America’s prize-winning number of 47 square feet of retail space per capita is 3-8X higher than anywhere else in the developed world!
When the aggregate level of shopping space is looked at during the above longer-term time frame, the aberration is even more apparent. At the time of the S&L fiasco around 1990 there were only about 5 billion square feet of shopping space in the nation—meaning that capacity tripled during the subsequent a quarter century. Yet this was a period when the real incomes of the middle class were essentially dead in the water. So what market signals could have possibly given rise to such a disconnect?
The answer is the relentless drive for yield among fixed income investors during a period when time and again the Fed intervened in financial markets to prevent the benchmark rate—that is, the 10 year treasury note—-  from finding its natural economic price/yield in what was becoming a savings parched economy. Accordingly, there developed a massive tidal wave called “retail operating leases” that quenched this thirst for yield—helped along by accounting loopholes which allowed trillions of these operating leases to be kept off borrower balance sheets and which thrived on the illusion that the proliferating chains of new retail concepts served up by the Wall Street IPO machine were “national credit tenants” That is, these overnight sensations had such solid and sustainable “business models” as to imply blue chip credit status—meaning such attractive terms (10-15 years) and interest rate spreads over benchmark rates that retail occupancy costs were dirt cheap relative to the true long-run economics and risks.
Suffice it to say that operating leases and national credit tenant financing by banks and institutional fixed income investors like insurance companies and pension funds account for virtually all of the stupendous gain of 10 billion square feet of retail space since 1990. And all of the cheap debt which funded this vast deformation will not be found on the balance sheet of any known retailer.
One of the great “success” stories of retail during the last quarter century, for example, was the Walgreen Co. drug chain which grew from a few thousand outlets centered in the mid-west to more than 40,000  nationwide units today. What seems to be a financial miracle about this staggering growth—the fact that WAG has only $2 billion of net debt—actually is nothing of the kind. In truth, Walgreen’s stores are almost all on operating leases, and the latter represent a present value obligation in the range of $25 billion—or 25X its reported “debt”.
Self-evidently, were the Walgreen drug store empire ever to falter due to any number of factors—demographics, economics, public policy, new technologies and delivery modalities such as Amazon’s putative “drones”, the “national credit tenant” myth would be  blown sky-high. In fact, that is the true story materializing in the retail space today.
Like in every other case, the main stream financial press has a stunning case of recency bias with respect to retail. It remains obsessed with short term variations from analyst projections of quarter by quarter trends, and is focused on a few high end chains which service the top 10% of households. It thereby completely misses the drastically deteriorating trends just below the surface.
But a 40-year perspective can do wonders.  Since 1970 when the US economy became increasingly a creature of fiat central banking, real GDP per capita has doubled, but retail space has grown from 2 billion square feet to 15 billion or 7.5X, and by 5X per capita after accounting for population growth. Stated differently,  a day of reckoning is coming for our massive over-built, debt-bloated retail sector.
In his usually trenchant and fact-driven manner, Jim Quinn has laid out the overwhelming evidence just from the Q1 SEC filings that retail party is already over, and that sales per square ft. are falling in virtually every mall and big box based retailer in America. As shown below, these trends range from Wal-Mart to the “go to” names of just a few years ago like Target, Kohl’s and JC Penney, to hapless basket cases like Sears, Staples and Best Buy.
The obvious implication is that unless these trends reverse, the massive mountain of operating leases behind these names will become deeply impaired, and then the great retail leverage unwind will gain powerful, unstoppable momentum. Failing chains will enter chapter 11, massive store closures will occur and mall and power center traffic will continue to decline, thereby perpetuating the viscous financial cycle already underway.
Moreover, as Quinn further documents, the great baby boom retirement wave now underway—10,000 new retires per day each and every day until 2030—will perform the coup d grace.  Retirees don’t go to malls in the first place, and won’t be able to afford it in any event. The statistics presented below on lack of retirement savings among the overwhelming share of the population 50-64 is truly shocking.
Nor should bubblevision’s obsessive focus on the still positive results of a handful of high end chains like Michael Kors, Nordstrom, Tiffany, Saks, Ralph Lauren, etc. confuse the matter. The  top dozen or so high end retail chains in America including the above and Whole Foods occupy hardly 50 million square feet or well less than 1% of the total.
As the debt-burdened middle class continues to struggle with a job insecurity, rising living costs, lack of savings and approaching retirements, shoppers will counting dropping from what will become even more dismal same store “comps”. And as shoppers drop, so will the whole edifice of retail malinvesment and debt on which America’s 40 year consumption party was based.

By Jim Quinn at the Burning Platform 
The definition of death rattle is a sound often produced by someone who is near death when fluids such as saliva and bronchial secretions accumulate in the throat and upper chest. The person can’t swallow and emits a deepening wheezing sound as they gasp for breath. This can go on for two or three days before death relieves them of their misery. The American retail industry is emitting an unmistakable wheezing sound as a long slow painful death approaches.

It was exactly four months ago when I wrote THE RETAIL DEATH RATTLE. Here are a few terse anecdotes from that article:

The absolute collapse in retail visitor counts is the warning siren that this country is about to collide with the reality Americans have run out of time, money, jobs, and illusions. The exponential growth model, built upon a never ending flow of consumer credit and an endless supply of cheap fuel, has reached its limit of growth. The titans of Wall Street and their puppets in Washington D.C. have wrung every drop of faux wealth from the dying middle class. There are nothing left but withering carcasses and bleached bones.

Once the Wall Street created fraud collapsed and the waves of delusion subsided, retailers have been revealed to be swimming naked. Their relentless expansion, based on exponential growth, cannibalized itself, new store construction ground to a halt, sales and profits have declined, and the inevitable closing of thousands of stores has begun.

The implications of this long and winding road to ruin are far reaching. Store closings so far have only been a ripple compared to the tsunami coming to right size the industry for a future of declining spending. Over the next five to ten years, tens of thousands of stores will be shuttered. Companies like JC Penney, Sears and Radio Shack will go bankrupt and become historical footnotes. Considering retail employment is lower today than it was in 2002 before the massive retail expansion, the future will see in excess of 1 million retail workers lose their jobs. Bernanke and the Feds have allowed real estate mall owners to roll over non-performing loans and pretend they are generating enough rental income to cover their loan obligations. As more stores go dark, this little game of extend and pretend will come to an end.

Retail store results for the 1st quarter of 2014 have been rolling in over the last week. It seems the hideous government reported retail sales results over the last six months are being confirmed by the dying bricks and mortar mega-chains. In case you missed the corporate mainstream media not reporting the facts and doing their usual positive spin, here are the absolutely dreadful headlines:

Wal-Mart Profit Plunges By $220 Million as US Store Traffic Declines by 1.4%

Target Profit Plunges by $80 Million, 16% Lower Than 2013, as Store Traffic Declines by 2.3%

Sears Loses $358 Million in First Quarter as Comparable Store Sales at Sears Plunge by 7.8% and Sales at Kmart Plunge by 5.1%

JC Penney Thrilled With Loss of Only $358 Million For the Quarter

Kohl’s Operating Income Plunges by 17% as Comparable Sales Decline by 3.4%

Costco Profit Declines by $84 Million as Comp Store Sales Only Increase by 2%

Staples Profit Plunges by 44% as Sales Collapse and Closing Hundreds of Stores

Gap Income Drops 22% as Same Store Sales Fall

American Eagle Profits Tumble 86%, Will Close 150 Stores

Aeropostale Losses $77 Million as Sales Collapse by 12%

Best Buy Sales Decline by $300 Million as Margins Decline and Comparable Store Sales Decline by 1.3%

Macy’s Profit Flat as Comparable Store Sales decline by 1.4%

Dollar General Profit Plummets by 40% as Comp Store Sales Decline by 3.8%

Urban Outfitters Earnings Collapse by 20% as Sales Stagnate

McDonalds Earnings Fall by $66 Million as US Comp Sales Fall by 1.7%

Darden Profit Collapses by 30% as Same Restaurant Sales Plunge by 5.6% and Company Selling Red Lobster

TJX Misses Earnings Expectations as Sales & Earnings Flat

Dick’s Misses Earnings Expectations as Golf Store Sales Plummet

Home Depot Misses Earnings Expectations as Customer Traffic Only Rises by 2.2%

Lowes Misses Earnings Expectations as Customer Traffic was Flat

Of course, those headlines were never reported. I went to each earnings report and gathered the info that should have been reported by the CNBC bimbos and hacks. Anything you heard surely had a Wall Street spin attached, like the standard BETTER THAN EXPECTED. I love that one. At the start of the quarter the Wall Street shysters post earnings expectations. As the quarter progresses, the company whispers the bad news to Wall Street and the earnings expectations are lowered. Then the company beats the lowered earnings expectation by a penny and the Wall Street scum hail it as a great achievement.  The muppets must be sacrificed to sustain the Wall Street bonus pool. Wall Street investment bank geniuses rated JC Penney a buy from $85 per share in 2007 all the way down to $5 a share in 2013. No more needs to be said about Wall Street “analysis”.
It seems even the lowered expectation scam hasn’t worked this time. U.S. retailer profits have missed lowered expectations by the most in 13 years. They generally “beat” expectations by 3% when the game is being played properly. They’ve missed expectations in the 1st quarter by 3.2%, the worst miss since the fourth quarter of 2000. If my memory serves me right, I believe the economy entered recession shortly thereafter. The brilliant Ivy League trained Wall Street MBAs, earning high six digit salaries on Wall Street, predicted a 13% increase in retailer profits for the first quarter. A monkey with a magic 8 ball could do a better job than these Wall Street big swinging dicks.
The highly compensated flunkies who sit in the corner CEO office of the mega-retail chains trotted out the usual drivel about cold and snowy winter weather and looking forward to tremendous success over the remainder of the year. How do these excuse machine CEO’s explain the success of many high end retailers during the first quarter? Doesn’t weather impact stores that cater to the .01%? The continued unrelenting decline in profits of retailers, dependent upon the working class, couldn’t have anything to do with this chart? It seems only the oligarchs have made much progress over the last four decades.

Retail CEO gurus all think they have a master plan to revive sales. I’ll let you in on a secret. They don’t really have a plan. They have no idea why they experienced tremendous success from 2000 through 2007, and why their businesses have not revived since the 2008 financial collapse. Retail CEOs are not the sharpest tools in the shed. They were born on third base and thought they hit a triple. Now they are stranded there, with no hope of getting home. They should be figuring out how to position themselves for the multi-year contraction in sales, but their egos and hubris will keep them from taking the actions necessary to keep their companies afloat in the next decade. Bankruptcy awaits. The front line workers will be shit canned and the CEO will get a golden parachute. It’s the American way.
The secret to retail success before 2007 was: create or copy a successful concept; get Wall Street financing and go public ASAP; source all your inventory from Far East slave labor factories; hire thousands of minimum wage level workers to process transactions; build hundreds of new stores every year to cover up the fact the existing stores had deteriorating performance; convince millions of gullible dupes to buy cheap Chinese shit they didn’t need with money they didn’t have; and pretend this didn’t solely rely upon cheap easy debt pumped into the veins of American consumers by the Federal Reserve and their Wall Street bank owners. The financial crisis in 2008 revealed everyone was swimming naked, when the tide of easy credit subsided.
The pundits, politicians and delusional retail CEOs continue to await the revival of retail sales as if reality doesn’t exist. The 1 million retail stores, 109,000 shopping centers, and nearly 15 billion square feet of retail space for an aging, increasingly impoverished, and savings poor populace might be a tad too much and will require a slight downsizing – say 3 or 4 billion square feet. Considering the debt fueled frenzy from 2000 through 2008 added 2.7 billion square feet to our suburban sprawl concrete landscape, a divestiture of that foolish investment will be the floor. If you think there are a lot of SPACE AVAILABLE signs dotting the countryside, you ain’t seen nothing yet. The mega-chains have already halted all expansion. That was the first step. The weaker players like Radio Shack, Sears, Family Dollar, Coldwater Creek, Staples, Barnes & Noble, Blockbuster and dozens of others are already closing stores by the hundreds. Thousands more will follow.
This isn’t some doom and gloom prediction based on nothing but my opinion. This is the inevitable result of demographic certainties, unequivocal data, and the consequences of a retailer herd mentality and lemming like behavior of consumers. The open and shut case for further shuttering of 3 to 4 billion square feet of retail is as follows:

• There is 47 square feet of retail space per person in America. This is 8 times as much as any other country on earth. This is up from 38 square feet in 2005; 30 square feet in 2000; 19 square feet in 1990; and 4 square feet in 1960. If we just revert to 2005 levels, 3 billion square feet would need to go dark. Does that sound outrageous?

• Annual consumer expenditures by those over 65 years old drop by 40% from their highest spending years from 45 to 54 years old. The number of Americans turning 65 will increase by 10,000 per day for the next 16 years. There were 35 million Americans over 65 in 2000, accounting for 12% of the total population. By 2030 there will be 70 million Americans over 65, accounting for 20% of the total population. Do you think that bodes well for retailers?

• Half of Americans between the ages of 50 and 64 have no retirement savings. The other half has accumulated $52,000 or less. It seems the debt financed consumer product orgy of the last two decades has left most people nearly penniless. More than 50% of workers aged 25 to 44 report they have less than $10,000 of total savings.

• The lack of retirement and general savings is reflected in the historically low personal savings rate of a miniscule 3.8%. Before the materialistic frenzy of the last couple decades, rational Americans used to save 10% or more of their personal income. With virtually no savings as they approach their retirement years and an already extremely low savings rate, do retail CEOs really see a spending revival on the horizon?

• If you thought the savings rate was so low because consumers are flush with cash and so optimistic about their job prospects they are unconcerned about the need to save for a rainy day, you would be wrong. It has been raining for the last 14 years. Real median household income is 7.5% lower today than it was in 2001. Retailers added 2.7 billion square feet of retail space as real household income fell. Sounds rational.

• This decline in household income may have something to do with the labor participation rate plummeting to the lowest level since 1978. There are 247.4 million working age Americans and only 145.7 million of them employed (19 million part-time; 9 million self-employed; 20 million employed by the government). There are 92 million Americans, who according to the government have willingly left the workforce, up by 13.3 million since 2007 when over 146 million Americans were employed. You’d have to be a brainless twit to believe the unemployment rate is really 6.3% today. Retail sales would be booming if the unemployment rate was really that low.

• With a 16.5% increase in working age Americans since 2000 and only a 6.5% increase in employed Americans, along with declining real household income, an inquisitive person might wonder how retail sales were able to grow from $3.3 trillion in 2000 to $5.1 trillion in 2013 – a 55% increase. You need to look no further than your friendly Too Big To Trust Wall Street banks for the answer. In the olden days of the 1970s and early 1980s Americans put 10% to 20% down to buy a house and then systematically built up equity by making their monthly payments. The Ivy League financial engineers created “exotic” (toxic) mortgage products requiring no money down, no principal payments, and no proof you could make a payment, in their control fraud scheme to fleece the American sheeple. Their propaganda machine convinced millions more to use their homes as an ATM, because home prices never drop. Just ask Ben Bernanke. Even after the Bernanke/Blackrock fake housing recovery (actual mortgage originations now at 1978 levels) household real estate percent equity is barely above 50%, well below the 70% levels before the Wall Street induced debt debacle. With the housing market about to head south again, the home equity ATM will have an Out of Order sign on it.

• We here the endless drivel from disingenuous Keynesian nitwits about government and consumer austerity being the cause of our stagnating economy. My definition of austerity would be an actual reduction in spending and debt accumulation. It seems during this time of austerity total credit market debt has RISEN from $53.5 trillion in 2009 to $59 trillion today. Not exactly austere, as the Federal government adds $2.2 billion PER DAY to the national debt, saddling future generations with the bill for our inability to confront reality. The American consumer has not retrenched, as the CNBC bimbos and bozos would have you believe. Consumer credit reached an all-time high of $3.14 trillion in March, up from $2.52 trillion in 2010. That doesn’t sound too austere to me. Of course, this increase is solely due to Obamanomics and Bernanke’s $3 trillion gift to his Wall Street owners. The doling out of $645 billion to subprime college “students” and subprime auto “buyers” since 2010 accounts for more than 100% of the increase. The losses on these asinine loans will be epic. Credit card debt has actually fallen as people realize it is their last lifeline. They are using credit cards to pay income taxes, real estate taxes, higher energy costs, higher food costs, and the other necessities of life.

The entire engineered “recovery” since 2009 has been nothing but a Federal Reserve/U.S. Treasury conceived, debt manufactured scam. These highly educated lackeys for the establishment have been tasked with keeping the U.S. Titanic afloat until the oligarchs can safely depart on the lifeboats with all the ship’s jewels safely stowed in their pockets. There has been no housing recovery. There has been no jobs recovery. There has been no auto sales recovery. Giving a vehicle to someone with a 580 credit score with a 0% seven year loan is not a sale. It’s a repossession in waiting. The government supplied student loans are going to functional illiterates who are majoring in texting, facebooking and twittering. Do you think these indebted University of Phoenix dropouts living in their parents’ basements are going to spur a housing and retail sales recovery? This Keynesian “solution” was designed to produce the appearance of recovery, convince the masses to resume their debt based consumption, and add more treasure into the vaults of the Wall Street banks.
The master plan has failed miserably in reviving the economy. Savings, capital investment, and debt reduction are the necessary ingredients for a sustained healthy economic system. Debt based personal consumption of cheap foreign produced baubles & gadgets, $1 trillion government deficits to sustain the warfare/welfare state, along with a corrupt political and rigged financial system are the explosive concoction which will blow our economic system sky high. Facts can be ignored. Media propaganda can convince the willfully ignorant to remain so. The Federal Reserve can buy every Treasury bond issued to fund an out of control government. But eventually reality will shatter the delusions of millions as the debt based Ponzi scheme will run out of dupes and collapse in a flaming heap.

The inevitable shuttering of at least 3 billion square feet of retail space is a certainty. The aging demographics of the U.S. population, dire economic situation of both young and old, and sheer lunacy of the retail expansion since 2000, guarantee a future of ghost malls, decaying weed infested empty parking lots, retailer bankruptcies, real estate developer bankruptcies, massive loan losses for the banking industry, and the loss of millions of retail jobs. Since I always look for a silver lining in a black cloud, I predict a bright future for the SPACE AVAILABLE and GOING OUT OF BUSINESS sign making companies.