Retailers are running much leaner organizations, rethinking space needs, and reexamining prototypes in the wake of a profound weakening of the retail industry, the hardest-hit sector in commercial real estate. Which new models are proving viable?
In the current recession, thousands of stores have been shuttered, new projects have been shelved, rents have been pared, property values have cratered, and retail workers have been sent packing in legions: more than a half million lost their jobs alone in 2008. But as the dust begins to settle and the rolling metal curtains are peeled back for a new sales day, retail is reemerging as a different animal, one that is leaner and keener.
“We are looking at a whole new era in this post-overstoring, post-overmalling world,” says Wendy Liebmann, CEO of New York City–based WSL Strategic Retail, a global retail consultancy. The breadth of the most recent downturn changed the dynamics of the retail proposition, perhaps permanently, she says. “There’s been a fundamental shift in the way shoppers think about consumption, a moment in time when they stepped back and asked, ‘Do I really need this stuff?’ and ‘Do I really have to make that trip to the mall?’”
Shops have winnowed their inventories and space needs, Liebmann notes, which portends even fewer in-store choices and more web browsing in the coming years. “The internet has become a legitimate channel and a place where people now shop every week,” she says.
In some ways, stores are morphing into showrooms. With less stock, many merchants are training employees to quickly find out-of-stock goods online for shoppers, who can later duck into online “fitting rooms” to try them on without mussing their hair, says Jane Lisy, marketing vice president for Cleveland-based developer Forest City Enterprises. “But I don’t think all those tactile experiences will totally disappear into cyberspace,” she adds. “People will still want to touch the merchandise and feel the fabric and see how it fits. It’s hard to replace that.”
Smartphones and mobile marketing also stand to revolutionize retail. “Guests really want all their information centralized,” Lisy observes. “With mobile technology, they can see their best route to a store, what they might want to select, what the promotions are, what the center amenities are, where they can eat; the applications are boundless.” Social media sites like Twitter continue to tempt smartphone-toting consumers by offering Twitter-only specials and the like, she reports. Motorola’s international “Motorola 2009 Retail Holiday Season Shopper Study” indicates that 51 percent of consumers with smartphones used them in stores last holiday season for such tasks as comparing prices, reading product reviews, and locating coupons, with Generation Y shoppers—those aged 18 to 34—using them most frequently, at 64 percent.
The retail real estate landscape keeps shifting underfoot as well. Those long, deep chasms left in shopping centers by the wholesale closings of Linen & Things, Circuit City, and other big-box stores continue to set the industry scrambling for creative solutions, says urban design specialist John Clifford, principal of New York City–based GreenbergFarrow’s planning group. “We’re getting calls from people who are trying to fill those holes, and the solutions are not pretty,” he says. “Those days of ‘firstleasing’—when a developer would just throw up a 500,000-square-foot [46,500-sq-m] power center and if one tenant wouldn’t take a space, he’d just go get the other—are long gone.”
There are fewer retail tenants now than at any time in the past 30 years, and store layouts and designs are being squeezed and finagled for more efficiency, Clifford points out. In many cases, mall leasing agents are ushering in nonretail uses. For example, Crestwood Court in St. Louis recruited an artists’ colony for one of its nearly vacant wings and now has sculptors, painters, a dance studio, and a small theater as occupants. New River Valley Mall in Blacksburg, Virginia, recruited a 1,000-student junior college for its space. Buffalo’s Eastern Hills Mall signed the Echoes Through Time Civil War museum, plus 60,000 square feet (5,600 sq m) of sports-related leases, including Thurman Thomas Speed Training and the New Era Park indoor baseball training facility.
Still, the fiscal future for hundreds of shopping centers remains questionable. From this year through 2013, the industry faces $350 billion in maturing debt, according to the International Council of Shopping Centers (ICSC). Challenging credit markets and a lack of liquidity make refinancing that debt next to impossible for many small owners whose property is worth significantly less now than when they first borrowed on it, notes Greg Maloney, president and CEO of Chicago-based Jones Lang LaSalle (JLL). JLL’s retail division has been taking on a number of lenders and special servicers as clients in recent months to value or stabilize retail properties for their borrowers. Many owners have extracted so much value from their centers over the years that there is not much left to refinance. “There are some really bad properties out there,” notes Maloney. “I don’t think we will see much happening with them until lenders start selling them off.” The common practice of extending or altering borrowers’ notes to delay the fiscal fate of these centers has given rise to the industry catchphrase extend and pretend,” he notes.
Large-scale retail real estate investment trusts REITs) like Simon Property Group and Westfield, on the other hand, have public capital, major lines of credit, and top-quality centers to keep them afloat. “The cost of capital today is about half of what it was a year ago for the public REITs,” analyst David Fick, managing director of St. Louis–based Stifel, Nicolaus & Company, noted in a February research report. “In early 2009, REITs were looked on as victims of the financial crisis, but virtually all survived, including the one that went into bankruptcy, General Growth Properties.” Simon has been eyeing its Chicago-based rival, first making a $10 billion unsolicited offer that General Growth dismissed as too low, and most recently offering to invest $2.5 billion in a reorganization that would match terms of a rival offer led by Miami-based Fairholme Capital Management, General Growth’s biggest debt holder.
Meanwhile, the retail development wheels have practically ground to a halt. Retail completions dropped 50 percent nationally in 2009 to 107 million square feet (9.9 million sq m) and will contract again this year to about 70 million square feet (6.5 million sq m), the lowest total on record, according to Encino, California–based Marcus & Millichap Real Estate Investment Services. Asking rental rates are expected to dip 3.4 percent to $15.96 per square foot ($171.79 per sq m) this year, but effective rents—which factor in all future rent concessions—are expected to slip 5.4 percent to $13.75 per square foot ($148.00 per sq m) after falling 7 percent last year, trends triggered by lease renegotiations and tenant cotenancy clauses kicking in. Most of the large declines were on retail properties built since 2005, where rents were often 40 percent higher than market rates, reports Marcus & Millichap.
While the lower rents are a thorn in the side of landlords, they represent the seeds of the next retail growth cycle, which will take shape over the next two to three years as merchants take advantage of cheaper space in preferred locations, Marcus & Millichap predicts in its “2010 National Retail Report.” “Developers are no longer stuck in 2007 with rent, so retailers are dipping their toes back in the water,” says Clifford.
Some headaches from the retail real estate hangover are destined to linger longer, however. Chicago-based consulting and accounting firm Grant Thornton estimates that 5,000 new-vehicle dealerships in the United States must close in the years to come to adjust to waning consumer demand. That would place about 25,000 acres (10,100 ha), or 1 billion square feet (93 million sq m) of space, on the market, based on an average dealership size of five acres (2 ha) estimated by Brady Schmidt, president of Irvine, California–based National Business Brokers, who has sold about 500 dealership parcels. Many of those properties are prime freeway-side locations with retail or special-use zoning, he reports.
Municipalities have a unique opportunity to rezone and reclaim those lands for visitor centers, public-event facilities, city and county offices, park-and-ride sites, transit hubs, or even sustainable uses such as solar power stations or wind farms, says June Williamson, architecture professor at City College of New York and coauthor of the 2008 book Retrofitting Suburbia: Urban Design Solutions for Redesigning Suburbs.
ICSC estimates that 4,763 national retail chain stores closed in 2009, 31 percent fewer than closed in 2008. However, about 240,000 stores of all varieties are estimated to have closed in that two-year window. Twenty-five to 30 percent of the nation’s retail square footage eventually will have to be repositioned for other uses, Williamson estimates.
In Marcus & Millichap’s 2010 National Retail Index, a ranking of 44 major metropolitan areas based on supply-and-demand indicators, the top three markets are Washington, D.C., which should absorb 2 million square feet (186,000 sq m) of office space this year, spurred by government-related employment growth; San Diego, which is witnessing above-average job growth and the country’s second lowest retail vacancy rate; and San Francisco, which is enjoying leasing momentum and minimal retail construction. New York City rose to No. 4 on this year’s list from No. 8 last year, but still has seen asking retail rents slide from $79.57 per square foot ($856.48 per sq m) in 2007 to a projected $62.30 ($670.59 per sq m) this year. About 850,000 square feet (79,000 sq m) of retail space will come on line citywide this year, just under 2009 tallies. Detroit, which led the nation in manufacturing job losses in 2009, is last on the list at No. 44.
The major Texas markets all rank in the top half of the index because of relative employment stability, population growth, and a comparatively small pre-bust run-up in housing prices. Dallas–Fort Worth, which is expected to lead the nation in job growth this year with 66,000 new positions, saw two of what were only a handful of major retail completions nationwide in the past few years. Opening in phases over the past year and a half were the Village at Allen and the Village at Fairview, a joint 3 million-square-foot (279,000-sq-m) mixed-use lifestyle complex on the city lines of Allen and Fairview, developed by Dallas-based M.G. Herring Group along bustling Highway 75. “Houston, Austin, and San Antonio have also held up well in the downturn, and retailers have a good opinion of Texas in general, which opened the door for us to get deals done,” notes company president Gar Herring. A little luck did not hurt either. “We were able to get all the financing secured before the markets collapsed,” he says.
Helping sell the Allen side of the 400-acre (160- ha) project to tenants such as Best Buy, SuperTarget, and Dick’s Sporting Goods was the 8,600-seat Allen Event Center, home to minor league hockey and other local events. The Fairview side, which includes multifamily residences, Macy’s, Dillard’s, and JCPenney, has also inked Gold Class Cinemas and a Whole Foods Market.
Los Angeles County, which ranks No. 6 on the 2010 National Retail Index, should start seeing a churn in investor properties again in the next year, followed by other parts of the country, predicts Lew Feldman, chair of Goodwin Procter’s Los Angeles law offices, where he is a member of the real estate, REITs, and real estate capital markets group. “But we’ll be seeing those properties changing hands at lower and lower costs,” he adds.
Mixed-use deals have performed well in select sites locally, with the retail components somewhat soft, says Feldman. While the 5.6 million-square-foot (520,000-sq-m) entertainment-themed L.A. Live complex, anchored by the Staples Center, has added the Nokia Theatre, Grammy Museum, Lucky Strike Lanes & Lounge, cinemas, ESPN Zone, Fleming’s Prime Steakhouse & Wine Bar, plus several additional restaurants and ESPN’s new West Coast Broadcast Center, its retail space additions are minimal. “Mixed-use projects require a smorgasbord of funding sources, with one stacking atop the other,” Feldman explains. “They can be challenging.” The planned $1 billion L.A. Central project, envisioned as the retail counterpart to L.A. Live, was posted for foreclosure in November. It was to include 250,000 square feet (23,000 sq m) of retail space, condominiums, restaurants, and hotel space.
Faced with lower retail tax receipts, cities are reconsidering retailers they once treated as pariahs. “They seem to be willing to look at most big boxes as a positive now,” Feldman notes. Walmart, one of many big retailers shrinking its footprint, plans one of its new “boutique” stores in south Walton County, Florida. Walmart’s plan to open a streamlined 78,290-square-foot 7,273-sq-m) store prompted some resident complaints, but as Dawn Moliterno, president of the local chamber of commerce, told the local media, “In these times, I think any commerce is a good thing.” Walmart is also pushing to secure urban store sites in inner-city Chicago, where it has just one store, and in New York City, where it has no stores.
Given the pace of recent industry gyrations, the face of American retail appears destined for a major makeover during the next decade.
One of the changes will be the addition of some shades of green. The last of the commercial real estate categories to adopt sustainable models, retail is in catch-up mode, notes Nick Shaffer, commercial real estate sector manager for the Washington, D.C.–based U.S. Green Building Council (USGBC). In shopping centers, the question of who will invest in features such as more efficient heating, venting, and air-conditioning systems—the landlord or tenant—has helped produce a stalemate, he says. While Starbucks, PNC Bank, and a few others are leading the charge to build all their new retail locations to meet Leadership in Energy and Environmental Design (LEED) certification standards, “we’re just now scratching the surface on energy efficiency, sustainable materials, and integrated systems,” says Shaffer.
Landlords Regency Centers, with its “greengenuity” initiative, and Forest City, with its triple bottomline focus on “people, planet, and profit,” are rapidly shifting emphasis to the environment, incorporating recycled building materials, more skylighting, and other resource-conserving devices in centers and creating programs to help retailers get on board. “We are on the cusp of this exploding,” points out Shaffer. “From what we’ve seen, sustainability can help retailers and shopping centers create a stronger brand and a stronger bond with their customers.”
Changes in construction codes may eventually force the issue. CALGreen, the country’s first statewide green building standards code, which requires all new buildings in California to be more environmentally responsible and energy efficient, will take effect January 1, 2011, and may be the first of many such initiatives to come, says Shaffer.
Outlet malls, once a quirky hit-or-miss shopping proposition, are in vogue and well positioned to capitalize on the new consumer value proposition. In fact, retail REIT Simon Property Group’s Premium Outlets malls are outperforming its regional malls in sales per square foot, at $500 versus $433 ($5,381 versus $4,661 per sq m), and occupancy at 97.9 percent versus 92.1 percent. A 2008 consumer shopping survey of women by the Greenberg Group real estate advisory firm, found that 40 percent of respondents did their primary apparel shopping at full-price stores, 40 percent at outlet stores, and 20 percent shopped at both venues. A year ago, a similar survey found that 35 percent shopped at full-price locales, 50 percent shopped at outlet stores, and 15 percent crossed over. Most major retailers and brands have created outlet store concepts, the latest being Bloomingdale’s.
Temporary—or pop-up shops—are filling center spaces in rising numbers. “They provide the excitement of something new and transient to draw in the crowds,” says Tamar Kasriel, founder of the Hungary-based international strategic consulting firm Futureal. “They add spice and serendipity to a shopping outing.” Pop-ups are also low-risk ways to test the market for both tenants and landlords, she adds. “They help turn malls back into destinations.”
With the open-air lifestyle center in favor in communities, only a scant few traditional enclosed regional malls have been built in recent years. Just two, the oft-delayed Xanadu Meadowlands in New Jersey and City Creek Center in Salt Lake City, are under construction. But that does not necessarily mean the mall is dead. “Malls are finding they can still capitalize on the notion that they’re the social marketplace,” says consumer psychologist Kit Yarrow, professor at San Francisco’s Golden Gate University. Despite social media and other online networking, studies show that people have fewer true friends than ever. “Malls give people the excuse to be with other people,” she maintains.
The retail sector still desperately needs to condense itself, asserts Jeff Green, president of Jeff Green Partners, a Mill Valley, California, retail research and feasibility firm. Big-box retailers, particularly electronics sellers, still reside in spaces that are too big, he notes. As leases expire and new stores are built or old ones relocated, look for Best Buy and others to shrink and start phasing back bulkier items like household appliances, he says. “We went through a whole period of bigger is better, and that was indicative of retail following the pack instead of thinking about their business,” he points out. Another factor to consider: the still-influential baby boom generation is becoming less willing to trudge through large-format stores as it faces age-related mobility issues, Green adds. “Take note of that, retail industry.”
Some of the vacant spaces are finally getting snapped up. In Las Vegas, where the recession weighed heavily on homeowners, gaming revenue, and retail business, about a third of the city’s 70 store sites of 15,000 square feet (1,400 sq m) or more that were vacant in first-quarter 2009 are now occupied, reports Kit Graski, senior vice president of Voit Real Estate Services of Las Vegas. “It was the centers on the outskirts that had the brunt of the problems,” he notes. “Even if [nearby] homes were built, most were never moved into.”
In Las Vegas and nationally, A-level retail centers should continue to hold their own, “but it’s the B and C product that’s going to get crushed,” notes Graski. Older centers that do see significant repositioning may trigger a wave of move-outs and foreclosures in neighboring centers that have not been repositioned, he says. Rents for higher-end centers are essentially being reset to late-1990s levels while lesser centers are being reset to mid-1990s levels, adds Graski.
Previously, centers that were 50 percent preleased got the nod for construction financing, points out Anthony Villasenor, senior vice president of Voit’s San Diego office. That is not the case today. As long as rents remain depressed, retailers such as Kohl’s and Burlington Coat Factory are taking over vacant big boxes at 30 percent less than what it would cost to build, he notes.
For the most part, the worst of the retail crisis has passed, says Bernard Haddigan, managing director of Marcus & Millichap’s retail real estate investment services. “Retailers are running much leaner organizations and rethinking space needs and prototypes,” he points out. However, mall department store anchors will remain challenged, predicts Haddigan. Unless they have a discount or value position, they’re going to have a tough time.”
Meanwhile, bricks-and-mortar retailers should be learning a customer-service lesson from web merchants, Liebmann says. “The internet knows who you are and what you’ve bought before the moment you start shopping. This same technology also allows stores to get to know customers in the same way and deliver their brand,” he says. The luxury retailers hard hit by changes in consumer spending need to start rebuilding relationships with their core customers and quit counting on aspirational shoppers to fill voids. In short, she says, “People are now asking: ‘What is the value proposition? Why spend hundreds on a handbag?’ It’s no longer just about demographics. It’s about consistency, about saving money, and about your passion.”
“We have to step back and ask ourselves what is relevant in this brave new world,” adds Liebmann. It’s like the old Winston Churchill quote: ‘It is not even the beginning of the end. But it is, perhaps, the end of the beginning.’”