Service Merchandise, once a prominent catalog showroom retailer, declared bankruptcy in 1999, shuttering its remaining stores by 2002. However, the intriguing aspect of this retail demise is the continued existence of Service Merchandise store leases, even two decades after its closure. This phenomenon underscores the inherent value residing within well-structured commercial real estate leases, particularly those negotiated strategically. The enduring presence of these leases reveals a compelling story about foresight in real estate and the unexpected afterlife of a retail brand.
Founded in 1960, Service Merchandise pioneered the catalog showroom model, operating from a single retail location in Nashville, Tennessee. The company rapidly expanded, leveraging its catalogs to reach millions of customers and establishing physical catalog showrooms across the United States. By 1995, Service Merchandise boasted over 400 locations spanning 38 states, becoming a significant player in the retail landscape.
The typical Service Merchandise store occupied a substantial 50,000 square feet. This space was strategically divided, with a portion dedicated to a retail showroom displaying sample merchandise – primarily jewelry, housewares, and consumer electronics – and the remaining area functioning as a warehouse to fulfill both in-store and catalog orders. This hybrid model allowed Service Merchandise to offer a wide selection while managing inventory efficiently.
Service Merchandise strategically chose high-traffic retail locations for its catalog showrooms, often securing spaces within large regional shopping centers and occasionally acting as anchor tenants in major malls. This prime real estate strategy was crucial to attracting customer foot traffic and ensuring visibility.
A cornerstone of Service Merchandise’s real estate approach was negotiating long-term leases at low, fixed annual rents. These leases typically spanned an initial term of 25 years, with options to extend for an additional 25 years or more. Crucially, rent increases during the initial term and option periods were often minimal or non-existent. As many Service Merchandise leases originated during the company’s aggressive expansion in the 1970s and 1980s, their annual fixed rents were locked in at favorable market rates from that era.
By the time Service Merchandise filed for bankruptcy in 1999, many of its leases retained over 30 years of remaining term and options. These leases stipulated annual rents as low as $2.00 to $5.00 per square foot, while prevailing market rents had surged to four or five times that amount. Despite the retailer’s financial woes, these long-term, below-market leases transformed into valuable assets, known as leaseholds.
In bankruptcy proceedings, a debtor’s assets are typically auctioned to satisfy creditor claims. Service Merchandise’s valuable leaseholds became assets of its bankruptcy estate and were subsequently auctioned off to a variety of buyers, including investors and other retailers. Intriguingly, some landlords even opted to repurchase their own Service Merchandise leases from the bankruptcy court to regain control of the property and capitalize on current market rental rates.
While some landlords challenged the leasehold sales, citing lease restrictions or concerns about the financial stability of the acquiring parties, the majority of Service Merchandise leasehold sales were ultimately upheld by the courts. Investors who acquired these leaseholds then subleased the spaces at market rents to thriving retailers such as Michaels Stores, DSW Designer Shoe Warehouse, and TJ Maxx & HomeGoods.
These leasehold investors profit from the difference between the market rent received from subtenants and the significantly lower fixed annual rent owed to the landlord under the original Service Merchandise lease. This “rent spread” generates income until the original lease term expires. In other instances, retailers strategically acquired leaseholds to secure prime locations and benefit from below-market rent structures.
The Service Merchandise case study is not isolated. Numerous other bankrupt retailers, including Toys R Us, Sports Authority, Kmart, and A&P, have also seen their leaseholds sold to investors and users during bankruptcy proceedings in recent years. Similar to Service Merchandise, despite these retailers ceasing operations, their strategically negotiated leases can persist for decades, continuing to hold value and shape the retail landscape long after the brands themselves have faded. This highlights the enduring and often overlooked value embedded within commercial real estate leases and the strategic foresight of companies like Service Merchandise in securing favorable long-term agreements.
