Simon shares jump on reported talks with Amazon. But converting stores to warehouses may face hurdles
Shoppers ascend and descend escalators at the King of Prussia Mall, owned by Simon Property Group, United State's largest retail shopping space, in King of Prussia, Pennsylvania.

Shares of Simon Property Group jumped Monday following a report that said the biggest U.S. mall owner is in talks with Amazon to turn shuttered Sears and J.C. Penney stores into warehouses, as it looks to fill vacant space and collect more rent.

Simon's stock was up more than 10% in trading ahead of its earnings report after the market's close Monday.

Amazon's discussions with Simon are focused on turning some ailing department store spaces into last-mile fulfillment centers, The Wall Street Journal reported Sunday, citing people familiar with the situation. Both Sears and Penney have filed for bankruptcy protection — Sears in October 2018 and Penney in May — as department stores have largely fallen out of favor with shoppers. The two companies have been looking to close underperforming stores, as they try to mount a turnaround.

Simon declined to comment on the report. Amazon has a policy of not commenting on rumors or speculation, according to a statement emailed to CNBC.

According to the Journal report, it is unclear how many spaces inside of Simon's malls are being considered by Amazon. The company operates 63 Penney locations and 11 Sears stores, according to the company's most recent public filing in May.

Real estate analysts view the potential move as a positive one, at least in the near term, considering how hard the retail landscape has been hit by the coronavirus pandemic. Already, more than 40 retailers have filed for bankruptcy in 2020, and permanent store closures announced by retailers this year have topped 4,000 and are on pace to break a new record, according to a tracking by Coresight Research.

Mall owners such as Simon, in turn, are scrambling to find new uses for retail space when few retailers are still growing. The Covid-19 pandemic has only exacerbated challenges, by hurting movie theaters, entertainment venues, gyms, co-working facilities and restaurants. These types of businesses had, up until recently, been considered alternative uses for retail space, by Simon and other mall operators.

"In this environment, it will be difficult to fill boxes of that size in the short-term," said Joseph Malfitano, founder of turnaround and restructuring firm Malfitano Partners. "A deal with Amazon provides a quick fix as these locations would likely need to be subdivided, which would take time and money."

Another potential obstacle would be how a mall property is zoned by local governments.

Warehousing is considered an industrial use, not a commercial one. This means the former department stores may need to be rezoned, and the surrounding community and other retailers and restaurants at the mall might not welcome the change. Another factor would be the number of trucks and traffic in and out of mall parking lots, especially overnight, analysts said.

An Amazon warehouse could also bring in less rent per square foot than a typical department store tenant would. Warehouses typically pay between $5 to $10 per square foot in rent, whereas department stores can pay closer to $20, Sandler O'Neill + Partners real estate investment trust analyst Alexander Goldfarb said.

But right now, "any community wants tax revenues ... malls are huge tax drivers to the community," Goldfarb said.

The dire situation that the coronavirus pandemic has inflicted might make a community more willing to accept an industrial tenant moving into the local shopping mall, he said.

Another hurdle for Simon would be co-tenancy clauses, which can be triggered when one or a number of anchor tenants at a mall leave the property. This legal provision essentially gives tenants within the mall power to renegotiate their leases, potentially paying less in rent, when a major department store chain goes dark and traffic drops off.

"A tenant like Amazon ... could trip co-tenancy provisions for other tenants, which will also cost landlords money," Malfitano said.

Regardless, the need for e-commerce fulfillment hubs is clearly spiking across the country, often outweighing supply in markets, as consumers are buying more and more online.

Demand for industrial real estate could reach an additional 1 billion square feet by 2025, according to a July report from the commercial real estate services firm JLL. Prior to the Covid-19 crisis, about 35% of its industrial leasing activity was related to e-commerce, JLL said. But now, as much as 50% of that leasing activity has already been tied to the online retail industry in 2020.

Simon has partnered with rival mall owner Brookfield Property Partners as one of three bidders looking to salvage Penney from bankruptcy, CNBC previously reported. Penney's lenders have until midnight Tuesday to select a winning bidder, according to court documents.

It is unclear whether Simon Chief Executive David Simon will mention the Penney deal or other potential transactions, including one with Brooks Brothers, during Monday's earnings conference call. Analysts also are eager to hear how mall rent collections are trending since stores have reopened, and how the real estate company is faring in trying to get out of its deal to buy high-end mall owner Taubman . It terminated the $3.6 billion transaction in June. But Taubman is still pushing ahead with it.

Simon shares have fallen about 54% this year. The company has a market cap of nearly $21 billion.