The hole that Target left

When Target launched a store in Smiths Falls, Ont., in 2013, it was a beacon of hope.

The town of 9,000 just outside of Ottawa had suffered a slew of setbacks, including the closing of the Hershey chocolate factory, the Stanley Tools plant and a hospital. It was counting on the outsized Target outlet, which employed about 100 people, to help revive the local economy.

But today, more than two years after its U.S. parent failed in Canada and abruptly shut all of its 133 outlets here, the Target store sits empty – a stark sign of the challenges facing landlords who were left with a flood of abandoned retail space as Target and other chains faltered.

By last fall, the landlord of the Smith Falls Target, RioCan Real Estate Investment Trust, was ready to tear down the outlet along with the entire mall it was in, until a local developer snatched up the County Fair Mall in December in an eleventh-hour bargain: less than $2-million.

"We were never going to be able to re-lease it," Edward Sonshine, chief executive officer of RioCan, said about that Target outlet. "You get outside of the big cities and it gets tougher."

The Smiths Falls store is far from alone among Target outlets that remain vacant, many of which appear doomed to stay empty for a while, underlining the uncertainties of a fast-shifting retail market.

Retailers are rushing to reinvent their businesses amid a rise in online shopping that is squeezing incumbents and forcing them to invest in their own digital initiatives. A growing array of merchants is closing or shrinking stores while interest among big U.S. retailers to set up shop in Canada has waned following the Target disaster and their own troubles at home. Landlords are feeling anxious.

The complex task of finding new tenants for the almost 16 million square feet of former Target space has dragged on longer than many mall owners had expected, straining their operations. The process has been complicated by the large size of the stores, often requiring them to be divided up for smaller retailers. And while landlords now have commitments from new tenants for much of the abandoned Target space, many will not have it filled and generating rental income for months or years – some not until 2020.

"This is an enormous amount of disruption and upheaval in retail," said Michael Turner, executive vice-president at landlord Oxford Properties Group Inc., whose malls include top performing Yorkdale Shopping Centre in Toronto and Square One Shopping Centre in Mississauga. Oxford had five Target stores and has five Sears stores. "We're seeing a consolidation in retailers as well as new formats of retail and new business models."

Of the 140 former Target stores – seven of which never opened – 46 are still vacant and, of those, 26 have "no prospects" for replacement tenants, according to a February analysis of the sites by retail real estate brokerage Northwest Atlantic (Canada) Inc. It also found that Target landlords have "done deals" with new tenants for 94 of the former stores and expressions of interest for 20 more.

Northwest had advised Target on picking locations and, more recently, helped other retailers decide on leasing the vacated space.

In addition, about 20 former Zellers outlets remain empty, industry insiders say. Target's U.S. parent had bought most, but not all, of the Zellers leases from Hudson's Bay Co. for about $1.8-billion in 2011.

Beyond the problem of Target looms more uncertainty for landlords – and the fear that many more millions of square footage of retail space could be added to the market.

"There's the whole Sears question out there and that will be addressed next," Mr. Turner said.

Sears Canada Inc. has been struggling, raising concerns about its long-term fate. Sears has almost 170 stores in all, including 95 full department stores and 26 home stores (the latter are mostly in open-air power centres). It has shuttered dozens of stores in recent years.

The retailer has suffered from declining financial results for years. Under new leadership, it is trying to transform its business with smaller stores, discounted designer-brand fashions, and grocery sections to draw customers more often. But its U.S. parent, which also owns Kmart and is closing even more stores, triggered alarm bells in March when it warned in its annual report there is "substantial doubt" that it will be able to continue as a going concern after years of losses and sagging sales. The company insists it made the reference simply to comply with regulatory disclosure requirements and, in any case, Sears Canada operates separately from its U.S. parent.

But landlords are on alert.

Too big to fill

The large size of the Target (and Zellers) stores has added to the challenge of re-leasing them. They are too big for many would-be tenants and often have to be subdivided, which takes investment and time.

"You have to become a lot more creative at how you look at retailing and how you backfill that space," said Sylvain Cossette, president of landlord Cominar Real Estate Investment Trust, which has made part of one of its seven former Target stores into a call centre.

Some of the Target space will simply be knocked down or converted to storage or call centres, which can generate lower rents. Other Target sites, however, are being repurposed for potentially more lucrative uses, such as residential or commercial space.

The Northwest survey this year is an improvement from the findings of another study done by Ryerson University's Centre for the Study of Commercial Activity (CSCA), which concluded that as of last October almost 45 per cent of the Target space was still empty.

"Given the sheer scale of the absorption challenge and associated legal issues, currently we remain in a leasing and redevelopment (subdividing space) phase," says the CSCA study. "Going forward, concerns regarding structural vacancy will increase and the pressures for adoptive reuse will be heightened."

Insolvent Target Canada got court protection from its creditors in January, 2015, after less than two years of operating here, shutting all stores by April, 2015. And while other failing stores are closing in Canada, including BCBG Max Azria, Express, HMV, Jean Machine, Tip Top Tailors, Future Shop, Danier and Lululemon's Ivivva, the pace of closures south of the border is even more intense, among them big outlets such as many Macy's and Sears. Then again, Americans have more mall space per capita than Canadians: 23.6 square feet of retail space exists per person south of the border compared with 16.5 square feet here, according to the International Council of Shopping Centres.

In Canada, to prepare Target stores for new uses, landlords are pouring hundreds of millions of dollars into overhauling the outlets, often splitting them up for multiple tenants and losing up to a fifth of a Target store's retail space to corridors, common areas and loading docks.

"It just takes time," said Scott MacDonald, executive vice-president at landlord Morguard Corp.'s investments division. It had nine Target stores, which it doesn't expect to have completely filled and bringing in rent until 2020. Morguard also owns nine Sears stores, having agreed to take back the lease of a 10th one in January to convert the Edmonton location into other uses, including possibly residential, which is what could happen to some of the Target space in the same Bonnie Doon mall. "It takes an awful lot of money."

Mr. Sonshine of RioCan – the largest single Target landlord with 26 of its stores – said much of the space will be filled by the end of this year. He estimated it could spend about $140-million to revamp the outlets for new tenants. And it will cede about 20 per cent of the space to common and other areas, he said.

Still, executives at RioCan (which collected roughly $90-million from Target in a settlement tied to its retreat) and other major landlords say they will emerge stronger from the Target debacle, bringing in more rent from the new tenants than they did from Target. It had inherited long-term, low-paying leases from Zellers as an "anchor" tenant that technically draws more shoppers to malls – although Target failed to lure many consumers, Mr. Sonshine said. He said RioCan will end up with 140 to 145 per cent more rent from replacement tenants than from Target. Still, the entire process "has taken longer than I would have thought."

Another challenge for landlords is that, in a departure from the past couple of decades, they can no longer bet on a major U.S. retailer expanding into this country in the near term, Mr. Sonshine said. "We're not looking for any other big American tenant to come up here in the next few years."

And while smaller foreign players are arriving, they have relatively moderate expansion plans, industry insiders say. Those chains include e-commerce merchants such as U.S. eyewear specialist Warby Parker that are branching out into brick-and-mortar stores. "I don't think you're going to see retailers saturate markets the way they used to," said Patrick Sullivan, chief operating officer of landlord Primaris Management Inc.

Some major landlords moved quickly in 2015 to buy back their Target leases and gain control over choosing future tenants rather than possibly leaving the process to Target's court insolvency proceedings. Oxford and Ivanhoe Cambridge bought back 11 leases for $138-million while Cadillac Fairview Corp. (whose malls include Toronto Eaton Centre) acquired five leases plus an owned store for about $45-million. Meanwhile, Wal-Mart Canada Corp., Canadian Tire Corp. and Lowe's Canada picked up almost 40 Target store leases. But ultimately, Target was forced to hand back 75 leases to their landlords, unable to find suitable buyers for them.

Among chains that are taking portions of Target stores are U.S. discounter TJX Cos.'s Winners, Marshalls and HomeSense; PetSmart; Sport Chek; Designer Shoe Warehouse; H&M; Zara; GoodLife Fitness; Dollarama; Giant Tiger; Cineplex (and its expanded entertainment concept RecRoom); and Cara Operations Ltd.'s restaurants, such as East Side Mario's.

Landlords are pouring hundreds of millions of dollars into overhauling many former Target outlets, often splitting them up for multiple tenants and losing up to a fifth of a store's retail space to corridors, common areas and loading docks. RioCan's work at the Burlington Mall offers an example of such changes.

'Plan B'

In Smiths Falls, County Fair Mall, which was bought by Guy Saumure & Sons Construction Ltd. from RioCan, is struggling; less than one-third of its space is occupied. The former Target store – still with its signature big red ball still outside the entrance – could remain empty for years, said vice-president Chris Saumure.

The mall "loses money every month right now until we can get enough tenants back in," Mr. Saumure said. "It will just take time and money and luck." He will look at a range of replacement tenants, including offices, call centres and self-storage services.

During a weekend last month], Mr. Saumure donated the Target space to a local home show to help get people back in the mall, he said. Enclosed shopping centres in small cities and towns are suffering "a painful death" because they can't attract major tenants and are saddled with high maintenance costs, he said.

The farther away the malls are from large centres and populations, the tougher it is for them to draw enough shoppers to ensure they're viable, landlords say. Mr. Saumure's firm plans to convert County Fair Mall into an open-air plaza instead, cutting expenses such as heating in common areas.

At Five Points Mall in Oshawa, Ont., RioCan is selling the Target store property to a self-storage company and demolishing the enclosed centre to turn the mall into an open-air centre, which is cheaper to run, Mr. Sonshine said.

"Those traditional malls that are there just aren't very successful these days," added Steve Creighton, senior vice-president of self-storage firm Dymon Group of Cos., which is building the storage operation.

At two abandoned Target stores in each of Hamilton, Ont., and Whitby, Ont., property manager Triovest Realty Advisors is working on splitting up the space for other retailers and possibly office and storage uses, said John Crombie, senior vice-president of retail leasing at Triovest. The problem with divvying up the space for different tenants is "you end up with space that's unusable," he said. "You're not able to lease out the whole space – that's the downside." Landlords can struggle to find retail tenants for the back section of a store because passersby don't see it, he said.

Still, executives at major landlords say they've turned the Target fiasco into an opportunity by investing in and improving their malls, luring more shoppers after having divested underperforming centres. "There are going to be fewer retailers operating in fewer and better shopping centres," Oxford's Mr. Turner predicted. He suggested as many as one quarter of today's shopping centres could eventually find new uses or fall by the wayside. "The better centres are going to steal more wallet share at the expense of the weaker ones. Target has accelerated that process."

And while landlords were caught by surprise by the Target closings, they are drawing up contingency plans for Sears stores in a worst-case scenario.

They are pencilling in potential Sears replacements, such as Quebec-based fashion chain La Maison Simons, which is still expanding; and they're tapping into many of the same strategies they are using to fill the Target space, including adding restaurants and entertainment venues to get more people into malls. But it won't be easy as consumers increasingly embrace e-commerce.

"The elephant in the room, as we all know, is Sears," said Alan Marcovitz, president of landlord Westcliff Group. The Montreal-based company owns five former Target outlets – which are partly or fully leased or occupied – seven Sears stores and one vacant Zellers.

"You never want to see a brand go under," added Roman Drohomirecki, chief operating officer at Ivanhoe Cambridge. "But it's our business to make sure we have Plan B in case it does happen."