Spate of Tenant Bankruptcies Has Malls on Edge.

The economy might be as strong as ever, but a recent flurry of Chapter 11 bankruptcy filings by niche retailers and theater chains is threatening to slam L.A.-area shopping mall owners.

It remains to be seen how many store locations will ultimately be closed, but Strouds Inc., United Artists Theatres, Edwards Theatres, Frederick's of Hollywood, and several other chains have filed for bankruptcy protection recently. And others, including Restoration Hardware Inc., are experiencing serious problems.

The situation is threatening mall owners not just with a loss of lease payments as troubled chains pull out, but also with a loss of the customer traffic that these chains generate.

"In a lot of the Chapter 11 filings, the company reorganizes and the landlord still has a tenant," said Michael Kogan, head of the bankruptcy department at law firm Arter & Hadden. "But if they close the store, the landlord has an empty space and maybe can't fill it up. That is how the cycle starts. Then the landlord has problems and files Chapter 11. People rely on other people in the business world."

Several real estate industry observers agreed that many L.A.-area mall owners will likely hit stormy seas in the months ahead. The survivors will be those that were conservative about financing their centers and that have enough money in reserve to weather the storm.

"Real estate is cyclical," said Rick Caruso, a developer of upscale shopping malls. "You have to be prepared for the downside."

Caruso believes the recent Chapter 11 filings may be an indication that consumers are not spending as wildly as before, creating major problems for chains that leveraged themselves heavily in the hope that last year's spending spree would continue indefinitely.

"I think people are getting a little more conservative with their spending dollars, but the economy is still strong," Caruso said. "We're seeing a bit of a shakeout. The retailers and companies that are stretched too far are going to be feeling the effect."

Robert White, head of the bankruptcy department at downtown law firm O'Melveny & Myers, acknowledged there has been a real "ramp-up" of Chapter 11 filings in California this year, but was hesitant to attribute them to any single trend.

"Not all the filings are the same. If you look at the theater chains, there are basically too many screens. All the companies invested large amounts of money in constructing multi-screen-complexes so they have a huge requirement for cash to build out all this construction," White said.

The Chapter 11 filings, he noted, do help troubled retailers and theater chains get out of their leases, enabling them to close unprofitable theaters and under-performing stores.

Now and then

In the late 1980s and early 1990s, many bankruptcies were filed because a flurry of leveraged buyout deals left companies over-burdened with huge debt. At the same time, the economy was lurching toward a near standstill.

But this time, retailers and theater chains were either overly optimistic about their product lines and the economy, or were unable to compete against big-box stores that can sell goods for less while providing a better selection.

One of the latest Southern California retailers to enter the Chapter 11 club is Strouds, which operates 61 stores that sell linens, sheets and other home furnishings. The company, based in the City of Industry, filed for bankruptcy protection this month as part of a restructuring planned to improve its competitiveness and profitability.

To that end, it plans to close nine under-performing stores in the next two to three months. Three of them are in California: in Santa Barbara, Fresno and Rowland Heights. The rest are in Illinois, Minnesota and Nevada.

With Strouds closing some of its stores, and other chains reevaluating their leases and locations, shopping malls are taking a cautious attitude toward selecting tenants. "When we do a shopping center, we try to get credit-worthy people and we have been pretty successful in doing that," said Jerry Snyder, a partner in J.H. Snyder Co., a commercial real estate developer currently building the Howard Hughes Center in West L.A. "This is a major consideration."

But what may be a successful retail venture one day can turn south the next, as consumers alter their tastes. "The nature of the retail business is that it is always changing," said Tom Mizo, a managing director with Chadwick, Saylor & Co. Inc., a Los Angeles real estate investment banking firm. "The strong survive, but there are always new retailers with new themes to replace the old ones. If you don't change and keep up with the current trends, you disintegrate."

Other chains on ropes

To prevent that from happening, Frederick's of Hollywood and Restoration Hardware are changing their merchandise mix. Frederick's filed for Chapter 11 this summer and is figuring out what kind of lingerie it must stock to compete with Victoria's Secret.

Restoration Hardware, a home furnishings and hardware retailer based in Corte Madera, Calif., has hired an investment bank to provide advice on strategic alternatives. If it begins closing stores, several upscale shopping centers will be affected.