Are outlet malls doomed by their own success?

They're a rare bright spot in retail now, but are facing rising rents and more competition as a result.

By MSN Money Partner Apr 2, 2014 6:03PM
Image: File photo of shoppers reflected in a window at the Premium Outlets at Woodbury Common in Central Valley, New York (© Emile Wamsteker/Bloomberg via Getty Images)By Krystina Gustafson, CNBC

For the past few years, outlet centers have been the yin to retailers' yang, a perfect pairing as they look to attract thrifty consumers while still maintaining their brand equity.

But as more brands flock to the off-price model, they have been driving up rents and increasing competition within outlet malls, prompting one analyst to caution that these centers could be losing a bit of their luster.

"As we reflect on the past year, we believe there is further evidence that the economics of factory outlets are under pressure," Wells Fargo analyst Paul Lejuez said.

Although, broadly speaking, new retail center construction is expected to hit an all-time low in 2014, increased demand for outlet locations has caused these centers to consistently increase their square footage over the past few years, according to data from CB Richard Ellis.

But another side effect of this demand is that in the past five to 10 years, rents for factory stores have also shot up, Lejuez said. Citing disclosures from Simon Property Group (SPG), Wells Fargo estimated that average rents at premium outlet centers last year were nearly twice what they were in 2004, and are nearing the rents seen at traditional malls. While in 2004, the average rent at an outlet mall was closer to $22 per square foot, it's now closer to $40 per square foot -- less than $5 cheaper than what is seen at a traditional mall, according to the data.

"Even with the increase in rents, many retailers still say it is a highly profitable channel. And we don't doubt that," Lejuez said. "Our concern is it could get less profitable."

It's not just higher rents that are pressuring the outlet model. Whereas a few years ago there were only a few brand names taking up tenancy in these centers, retailers are now heading to the outlets in droves -- meaning shoppers can choose from Coach (COH) to Michael Kors (KORS), and from Gucci to Prada.

So while in the past, consumers' dollars went to perhaps only one brand, that wallet share is now being spread out among multiple brands, Lejuez said.

What's more, with retailers heavily discounting at traditional malls -- and with the growth of off-price retailers such as TJX (TJX), Burlington and Ross, as well as flash sale sites such as Gilt Groupe -- it stands to reason that fewer shoppers will feel the need to trek all the way to an outlet, which are typically built outside of city centers, he said.

"Of course the rise of the e-commerce channel has taken significant traffic from many bricks-and-mortar retailers, but it is the most significant threat to factory outlets, in our view," Lejuez said.

Outlet center developers Simon Property Group and Tanger Factory Outlet Centers did not respond to a request for comment.

Forrester analyst Sucharita Mulpuru said that while she thinks outlets could come under pressure in five to 10 years, they are still a relatively young channel with growth ahead. She said that outlet shoppers differ from those visiting flash-sale sites, as they are more interested in the experience of going to a physical store and browsing what's on sale, versus flash-sale shoppers, who are more like spearfishers.

"Ultimately I think that the outlet store visitor still goes infrequently enough and for special enough occasions that the Web isn't totally cannibalizing that," Mulpuru said.

Craig Johnson, president of Customer Growth Partners, agreed that while there is some overlap between outlet shoppers and those seeking discounts elsewhere, "they're looking for a different kind of a deal, and they like the environment of all these stores selling . . . the good brands."

Johnson added that although there are deep discounts at traditional retailers such as Macy's (M), which carry some of the same labels seen at factory stores, shoppers for the most part cannot get items there for the same prices they would at an outlet. This is particularly true when it comes to true luxury brands, such as Gucci and Louis Vuitton.

Johnson also said that even though retailers such as Ann and Chico's reported traffic levels had fallen during the holidays, the weakness was more symptomatic of a bad season for the entire sector, including online shopping.

"Although the traffic in general at the outlet malls is not quite what it was a year or two ago when they were at their height of popularity, people still like going there," he said.

What's more, the low costs associated with buying land in these typically suburban areas -- along with the low costs of building the centers themselves -- continue to make them a "win-win" proposition for both retailers and developers, Johnson said.

But the challenge becomes harder for those brands that are still in their infancy in terms of developing an outlet strategy, such as American Eagle Outfitters (AEO), Lejuez said. Outlet centers' new tenants in 2013 paid 38 percent more than what were being paid by prior tenants under their previous lease, he said, citing data from Wells Fargo and Tanger Outlets.

It's also more of a challenge for the less popular brands to get space in the premium outlet centers due to such high demand, Johnson said.

"We are more cautious on retailers that are late to focus on growth in the channel, as they face the triple whammy of more competition, much higher rents and less favorable traffic trends," Lejuez said.

More from CNBC

Apr 2, 2014 6:58PM
I'm of the mind that "outlet stores" are a scam.  So, I'm obviously mistaking the concept for overstocked merchandise with slashed prices.  The prices I find are essentially regular mall pricing when on sale. 
Apr 2, 2014 8:49PM
I never see where the prices at outlet malls are any better than any 25-40% off sale at a regular mall or store.
Apr 2, 2014 7:47PM
Many outlet stores sell seconds and out dated merchandise.  What good is a new pair of jeans if they don't fit properly?
Apr 2, 2014 8:41PM
To those people that shop outlet malls, you're being ripped off.  A friend's daughter works at one of the more popular brand store, she's told me every dirty little secret about the merchandise.  It's such a scam, she doesn't buy the stores merchandise.  
Apr 2, 2014 9:45PM
Discounts like most of you have said are not there but the big issue is just like the basic malls in America.  all these retailers are being screwed by extreme rents along with a percentage of sales that go to the owners.
Apr 3, 2014 12:57AM
True outlet malls that sold dirt cheap, discontinued name brand merchandise have been dead for a long, long time.

I saw an expose over 5 years ago (probably closer to 10 years ago) that showed what these places sell now. Most companies manufacture or purchase cheap knock-offs that get passed off as legitimate discontinued top-of-the-line merchandise at these types of "outlet" stores.
Apr 2, 2014 10:42PM
While there are some deals at outlet stores... some of the stores are just a gimmick to purchase multiple items in order to get a good price.
Apr 2, 2014 9:30PM
I live in a town that has an outlet mall.  Most locals avoid the place, as there is so much traffic and it has the highest incident of crime in the area.  Whoever set the place up managed to make a deal to pay lower property tax than homeowners, which is unfair as the mall requires town services such as police, fire and road repairs.  Wages paid by these stores are low as well.
Apr 3, 2014 6:39AM
Just returned from an outlet Mall we used to go to in Florida....It was a mob scene at March break and frankly, the prices were double what they used to be. We ended up leaving empty handed and bought  our clothing at the old style Mall in the heart of Daytona.  Dillard's had far better prices than anyone at the outlet mall . And no police directing traffic, no fighting to get to the checkout...Going the way of the dodo dodo bird.. Priced themselves out of the market.
Apr 3, 2014 12:28AM
We are not close to any malls. Any savings we might get there are eaten up in gasoline and travel time to get there.  Some around here have very recently been the targets for out-of-state scammers with fake ID, stolen credit cards and bogus "gift cards".  With all the crime, I don't know how they make enough to stay in business anyway. Last week guards trying to stop shoplifters in a mall saw guns fall out the of shoplifters pockets as they ran.  Glad we rarely need to get to a store at all !
Apr 3, 2014 1:04AM
Scam. Especially for the Asians. They always have to stop at the outlet.
Apr 3, 2014 1:51AM
I bought three pairs of jeans at a outlet store and one pair was defective so i took the defective pair back and exchanged them.
Apr 3, 2014 1:47AM
I like outlet stores any time i can save some money i do it.
Apr 2, 2014 7:55PM
LOL... you go to outlet malls and no one there speaks American. They are giant tourist traps. Since everything in them is imported- they won't be closing down soon.
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