Kohl's, Macy's turn landlords in bid to unlock real estate value

Department store operators Kohl's Corp and rival Macy's Inc are betting on a potential money-spinner - carving out prime space within their sprawling stores and leasing them to other retailers.

The move underscores the pressing need for the two chains to better monetize their real estate assets at a time when fewer people are visiting malls and instead shopping online for everything from clothes to home decor items.

Kohl's said on Thursday it would operate 500 of its nearly 1,150 stores with much lower square footage and would look to lease out the remaining space to other retailers.

Macy's, whose flagship locations include Herald Square in Manhattan and Union Square in San Francisco, is also planning to carve out storefront space for high-end retailers and lease or sell that space, Chief Executive Terry Lundgren said on Tuesday.

The companies, whose stores are located in prime shopping districts, are hoping that leasing out store space to popular brands will not only generate a steady rental income but also attract more shoppers to its own stores.

"We are looking for opportunities to bring in other retailers to take that square footage that we are able to carve out to drive some additional traffic," Kohl's Chief Executive Kevin Mansell said on a conference call with analysts.

Between the two of them, Kohl's and Macy's have about 225 million square feet of real estate space - roughly equivalent to a third of Manhattan.

Leasing out stores could also be a safer strategy compared with an outright sale or shuttering them, which would result in loss of sales.

For Macy's particularly, the move could give it more leverage as it deals with activist investor Starboard, which has been pushing the company to squeeze more money out of its real estate assets.

Nearly 1 billion square feet, or more than 10 percent of current retail space, will be "rationalized" in the coming years in the form of store closures, conversions to other uses, or rent roll-downs, according to real estate data and analytics firm CoStar Group.

"We will achieve a rationalization of square footage over time, not necessarily fewer stores but probably less square footage," Mansell said on the call.

Retailers are generating lower sales per square foot than they did in the decade leading up to the 2008 recession. In early 2000's, companies produced sales of over $350 per square foot, while now it is less than $330 per square foot.

Having fewer stores is economically viable and therefore retailers are closing or seeking rent relief, CoStar Group said.

However, executives of the two chains still believe in the need for brick-and-mortar stores.

"At the end of the day, we need physical stores," Lundgren said in a CNBC interview on Tuesday. "A very very large percent of our business is done for us in the physical environment."