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THE TROUBLE WITH GAP

How are the retailer’s woes affecting developers?

By Kimberly Pfaff

It was not that long ago that Gap was commanding premium space — and premium perks — in centers nationwide. But after posting nearly two straight years of negative comps, the $13.8 billion retailer is making a lot of developers nervous.

“We’re sort of in a holding pattern,” said Bill Hecht, vice president and national leasing director for the Columbia, Md.-based Rouse Co., which has more than 50 Gap stores, over 20 Banana Republic locations and six Old Navy stores.

After racking up $2 billion of debt, the once-mighty Gap is reassessing its future, refinancing and putting further development on hold. More serious, while Gap has not announced any store closings as yet, analysts believe that it’s only a matter of time. Following February’s reduction of the retailer’s credit rating to junk status, some are even speculating that the chain will file for bankruptcy protection.

“That downgrading is a clear signal to developers that Gap is a high-risk tenant — it’s a signal to beware,” said Howard Davidowitz, chairman of Davidowitz & Associates, a Manhattan-based national retail consulting chain.

Developers are closely watching Gap’s dramatic reduction in capital spending, from about $1 billion in 2001 to roughly $400 million in 2002. Company executives have said that they will not seek any new locations this year, opening only those stores to which the retailer has already committed. The chain, which traditionally holds court in a store-size booth at ICSC’s annual Spring Convention in Las Vegas, won’t be exhibiting at all this year. The company expects total store growth for all three brands to be less than 5 percent for 2002.

“What we need to do is better understand what direction Gap wants to take their retail formats and react accordingly,” Hecht said. “Right now I don’t know that they’ve given a clear statement of where they’re taking their retail formats.”

Gap’s hard bargaining with developers obtained it virtual anchor status in many centers, with breaks on rent and CAM charges. But now the bargain must seem particularly hard.

Old Navy: Too many, too big and too near Gap locations, critics say.

“Gap is still doing well in our stores, although not as well as they were, so our percentage rent from them has decreased,” said Terry McEwen, president of Memphis, Tenn.-based Poag & McEwen, which has 24 Gap company stores at its six lifestyle centers.

“We have Gap in virtually all of our centers,” said Robert Michaels, president of General Growth Properties, Chicago. “In many of them they’ve got three or four concepts.” General Growth has 48 Gap stores, 42 Old Navy stores and 25 Banana Republic locations. But looking on the bright side, at least that doesn’t mean General Growth executives are scratching their heads wondering what to do with space they’d hoped to fill with Gap. “They’re already there, so we’re not counting on a bunch of new stores coming in.”

Other developers are not so fortunate, and one segment of the industry that is likely to feel the pinch more than most is smaller lifestyle centers. Poag & McEwen, for example, was planning to open a Banana Republic at its new Shops at Briargate in Colorado Springs, Colo., in spring 2003. That store is now on hold.

“It’s not stopping the center from opening,” explained McEwen. “It’s just that at this time, we don’t have a commitment from Gap.”

He added that Gap’s nonexpansion plans could be putting new center development on hold for some lifestyle companies. “In a lifestyle center, the Gap could easily have 10 percent or more of the shopping center, and losing that much square footage could be a real detriment to the financing of the project,” McEwen said. He noted that at his firm’s last two centers, Gap had taken about 30,000 square feet, or about 10 percent of the gross leasable area in each.

As for Briargate, McEwen said, the center will stay in close touch with Gap, but “we’re going to look for other people for their space. Ideally, their sales will recover, and they will be able to move forward and come back in. But we won’t indefinitely hold the space.”

But when it comes to the industry as a whole, some say that even a decision by Gap to close some stores will have only a minimal impact.

“Gap operates over 4,000 units, so if they close a couple of hundred stores, in the big scheme of things, what is that?” asked Deborah Jackson, executive managing director at Landauer Associates, a New York City-based consulting company for commercial assets, owned by Grubb & Ellis. “I don’t believe they’ll close Banana and GapKids, because I think the fix on those is easier. I’d be more concerned with Gap adult stores and, to a lesser degree, Old Navy. If I were an owner, that’s where I’d be looking. Gap adult has to compete with everybody, and a lot of other guys are doing it better.”

Though Jackson noted that A malls are less likely to be affected by any Gap closings (stores in those centers tend to be the last to close, and new tenants are often readily available anyway), she said that owners of underperforming centers do have reason to worry.

“If you’re going to lose Gap, and you already have vacancy issues, how are you going to fill space?” Jackson said.

Other observers note that the company might not choose to close any mall stores at all.

“I’m not sure I’d leap to the fact that they’ll close stores in shopping centers, because there are a lot of Gap stores on Main Street and off Main Street,” noted Candace Corlett, a partner at WSL Strategic Retail, a Manhattan-based consulting firm. “As the downtown areas in communities have come back, every downtown that looks like it’s on the verge of revival has gotten a Gap.”

One thing’s for sure: With Gap on increasingly shaky ground, it’s doubtful the retailer will be able to command the same perks in lease negotiations that it did when centers were clamoring for its business. Gap’s cachet afforded it extra bargaining power on prime locations, high tenant allowances, a free pass on common area fees and much besides.

“Those extras, over time, could equal the rent,” observed Davidowitz. “Gap was producing so much business and was so critical to have, it was a signature store in the mall. So they negotiated their brains out.”

One executive at a regional developer, who asked not to be identified, noted that even in top centers, Gap was able to negotiate lease agreements that excluded certain recovery items. “Receiving rights to terminate the lease in shorter periods of time if sales didn’t hit expectations, getting below-market rents — there’s not a thing that they weren’t getting,” he said. “A lot of people look at them now and say that it’s payback time: ‘You beat us up a little bit, and now it’s your turn to take the lumps.’”

Meanwhile, analysts are even beating up the chain for its comparatively modest store growth projections. Expanding its three main brands by less than 5 percent this year still translates to new openings of between 240 and 280 stores, and many analysts believe that’s too much. In February, for example, the retailer opened flagship locations for its Gap, Banana Republic and Old Navy brands in a 127,639-square-foot anchor venue at the Dallas Galleria.

“It’s hard for me to look at almost two years of negative results, and see them opening up any new locations,” said Liz Pierce, senior vice president at Wedbush Morgan Securities, a Los Angeles-based investment banking firm. “I’d like to see them focusing on the right merchandise, working on their real estate, figuring out their target audience, and then two or three years from now, if they need to open a store, OK. It’s a question of diverting their resources to better and higher use.”

Indeed, many observers blame Gap’s slide not solely on merchandising mistakes, but also on its aggressive store expansion. In 2000, with the economy in decline, the retailer increased its square footage by 31 percent. During the third quarter of 2001, it added 198 stores and expanded 44, for an increase in square footage of 5 percent in the quarter. Overall, the chain’s square footage is 20 percent above 2001. Currently, Gap has 4,171 stores, a 13 percent increase over its 3,676 stores a year ago.

Equally damaging to the retailer, note observers, has been the explosive expansion of Old Navy. Once considered the jewel in Gap’s crown, with its cool, campy approach to value-priced apparel for the whole family, Old Navy was originally envisioned as a 10,000-square-foot strip center store. But Gap ran away with the concept, placing it on street corners and in malls — often right next to Gap locations — with increasingly larger-format stores.

“To me, it’s Old Navy that’s causing them the worst pain,” said Pierce, adding that the stores are too big and the merchandise selection flawed.

Analysts have also recognized that the placement of Old Navy stores close to Gap’s other concepts has resulted in some sales cannibalism.

Gap maintains that it is taking prudent steps to fix its problems.

“Our focus for this year is on restoring company store performance,” said Alan Marks, a Gap spokesman. “Looking ahead to 2003, we are not committing to new deals at this time, and we will make a decision on square-footage growth in the first half of 2002.”

That medicine might be good for Gap, but for developers, it is nevertheless bitter to swallow.

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