Mixed Use in an Overretailed Landscape

Thousands of retail complexes across the United States, from small strip centers to megamalls, stand vacant or suffer from double-digit vacancy rates. Sears, JCPenney, and RadioShack, for decades among the most profitable retailers in America, may need to close a combined 1,000 or more stores over the next year or two, say some independent researchers. And several publications, as well as many Wall Street analysts, have declared that rising internet sales on websites such as Amazon.com and eBay will bring the demise of thousands more bricks-and-mortar stores and hundreds of malls sooner rather than later.

But, to paraphrase Mark Twain, the death of the retail real estate market has been greatly exaggerated. Many older centers are getting facelifts, particularly those in urban areas where residents have above-average incomes. Development in suburban markets, stagnant over the past decade, is expected to pick up in the years ahead as rebounding home sales and values help fuel slow but steady growth in consumer spending.

And while sales over the internet will continue to chip away at those in traditional retail centers, the rate of that incursion is slowing—in part because more savvy retailers are launching aggressive online marketing efforts of their own.

“Retail developers, owners, and retailers themselves are not going to roll over and play dead,” says Matt Kircher, executive managing director of Cassidy Turley’s Terranomics retail services unit in Burlingame, California. “They’re altering their marketing strategies, floor plans, tenant mix, and the like to ready themselves for the future.”

Housing, Spending, and Retail

Retail real estate development is as cyclical as homebuilding—perhaps even more so. Builders of retail centers, whether they specialize in big malls or smaller complexes, not only have to consider interest rates, the health of the overall economy, and local supply and demand trends, but also must factor in such dynamics as changes in disposable income and evolving consumer spending habits as they plan projects and decide whether to move forward with them.

“People always need a place to live, but they can always delay or even cancel their plans to buy a new plasma TV or bracelet,” Kircher says. “That’s one reason why retail development can be a little riskier than homebuilding. And besides, you can’t really buy a new house over the internet as easily as you can a new pair of jeans.”

New suburban development closely tracks local homebuilding trends, experts say, primarily because it brings new people—and potential retail customers—to the area where the shopping center would be located. Even a medium-sized new housing tract or an increase in home resales can have a dramatic impact on profits: buyers of new homes often need new appliances and other costly items, while those who purchase an existing home may quickly want to replace carpets or drapes, or buy supplies for painting or remodeling.

When the housing market is strengthening, retail sales rise. That is good for the center’s owner and/or developer, especially if they share in their tenants’ gross revenue, and often leads to an upswing in new retail construction.

“New retail construction almost always follows the path of new rooftops,” summed up Jesse Tron, a spokesman for the International Council of Shopping Centers (ICSC). That “path,” though, can have a lot of potholes. When the housing market began to tank around 2006, homebuilding dropped sharply and new retail development—which was already on a downslide—went into freefall. Most plans for new retail projects were postponed or canceled, while owners of existing centers found themselves dealing with tenants who wanted to downsize or slash their rent payments, or who had vacated their space altogether.

Infill Retail

The downturn prompted many retail real estate companies to focus or refocus on high-density urban projects, whether the deal involved rehabbing an older building in a good location in the city’s core or demolishing the structure and building a new one. It is a trend expected to continue for at least the next year or two, most experts say.

“There are a lot of infill properties out there that have ‘good bones’ and are in highly trafficked areas with solid demographics,” Kircher says. “Those are the properties that are ripe for rehabbing. But we’ve also seen a steady increase in the number of developers who are buying those infill properties, knocking the existing structure down, and rebuilding from the ground up. That’s a trend that’s going to stay with us for at least a few more years, too.”

Los Angeles–based Caruso Affiliated, for example, about ten years ago purchased a small orchard and nursery in the densely populated Fairfax District of its hometown, bulldozed them, and replaced them with the Grove, an open-air, 600,000-square-foot (56,000 sq m) retail/entertainment center whose 18 million annual visitors now surpass the number of people who go to Disneyland. And just this spring, the privately held firm announced a $60 million makeover of its similarly sized Americana at Brand shopping complex on Brand Boulevard in nearby Glendale that will connect it to the Glendale Galleria shopping center about 900 feet (275 m) away. Caruso Affiliated owns the Galleria with General Growth Properties, a Chicago-based real estate investment trust.

Americana at Brand, which opened in 2008 (project profile, Urban Land, September/October 2011) represents two other growing trends in the retail real estate industry: the addition of residential property inside, atop, or adjacent to the retail center, and the inclusion of ample community meeting space and government-related offices. These two elements attract visitors who may shop after attending a neighborhood confab or transacting business with city or county agencies.

Americana’s 600,000 square feet (56,000 sq m) of retail space is topped by 100 upscale condominiums, plus 242 luxury rental apartments that are 98 percent leased. There is ample meeting space that community groups can use at no charge, and free public events are held regularly—including three-times-a-week yoga classes at the development’s two-acre (0.8 ha) park, which features a “dancing fountain” by WET Design of Sun Valley, California, the same design firm that created the famed waterworks show in front of the Bellagio Hotel and Casino in Las Vegas. The development includes a police substation that not only helps make visitors and residents feel safe, but also helps generate foot traffic from people who venture to the mall to resolve minor issues with local law enforcement. Thus traffic tickets can turn into retail traffic.

Caruso Affiliated has similar public-oriented events and services at most of its other southern California properties. “We don’t want to build town centers,” says Rick J. Caruso, company founder and chief executive officer. “We want to build the center of town.”

A growing number of retail developers and owners are adopting similar strategies to bolster their chances of success at new projects or to breathe fresh air into old ones. “We will definitely see the inclusion of more residential space and even offices at many retail projects in the future,” says Ian F. Thomas, chairman of Vancouver, Canada–based Thomas Consultants, who has worked with owners around the world to design or redesign their projects and formulate the right tenant mix.

“Residential and office components, as well as all those recreational and amusement attractions that have popped up at centers across North America, ramp up the ‘body heat’ of a property by making it busier and more exciting to go to,” says Thomas. “Residents and office workers are sort of a captive audience of the owner. If you want to buy a handbag or go out to dine, you can do so by taking a short walk to the center rather than jumping into your car and driving several miles.”

Retail centers large and small are also getting a boost from a growing number of tenants who want to establish relatively small franchise operations—a trend recently fueled by the struggling economy.

“The true mom-and-pop stores are leaving, but they’re being replaced with some familiar names,” says Michael V. Pappagallo, chief operating officer of Kimco Realty, based in New Hyde Park, New York.

Among the fastest-growing groups of new tenants at Kimco’s nearly 900 neighborhood and community centers in the United States are such franchise operations as Dunkin’ Donuts, Subway, and Chipotle Mexican Grill, he says. “Small entrepreneurs who want to start a business are still out there, but the tough economy we’ve had has pushed them toward the franchises so they can work with proven concepts and a proven playbook,” he says. “A startup today would rather have a Supercuts sign over their front door rather than one that says Joe’s Barber Shop.”

Rusting Anchors

Still, there are not enough startups today to take the place of the myriad department stores and other large-scale retailers that have announced—or are expected to announce—plans to shutter more of their outlets in the years ahead. The parent company of Borders bookstores closed the last of its roughly 625 U.S. stores in late 2011, leaving large amounts of vacant space at many centers; some of the 567 stores closed by bankrupt big-box consumer electronics giant Circuit City remain unoccupied long after its final outlets were padlocked in 2009.

The mixed-use City Creek Center in Salt Lake City is the only enclosed mall built since 2006. It has a retractable roof.

More bad news may lie ahead, especially for owners of power centers and big suburban malls that depend on the financially weakest retailers as their anchor tenants. A comprehensive study based on financial data and other information from retail chains was compiled earlier this year by 24/7 Wall St., an online financial news service based in New York City. It predicted that big-box electronics retailer Best Buy likely would have to close 200 to 250 of its outlets this year alone if it wants “to sharply increase its prospects financially.” Sears Holding Corporation, which last year announced plans last to shut 172 stores, may have to close another 100 to 125 to get healthy, while its Kmart unit would have to shutter between 175 and 225 stores, the study says.

JCPenney, which reported a net loss of $985 million in 2012, would have to close 300 to 350 of its stores to significantly improve its financials, the 24/7 study says, and RadioShack, which has a much smaller space footprint than the others, would need to shut as many as 550.

It is important to note that none of those retailers has announced store-closing plans as drastic as those suggested by 24/7 Wall St., but the report suggests the magnitude of closings that might be on the way. “All of these retailers have a common enemy—the growth in sales over the internet,” Thomas says.

Online retail sales in the United States totaled $231 billion last year, according to a recent report by Cambridge, Massachusetts–based research and advisory firm Forrester Research. Online sales are expected to grow at a 10 percent compounded annual rate through 2017, when they will reach an expected $370 billion.

Adding salt to the wound inflicted by rising internet sales is the growing trend of “showrooming,” in which consumers visit stores to look at a new TV or outfit they would like to buy, but then go home and hunt for the identical item online for less.

Counterstrategies

Savvy retailers are fighting back. Many have spruced up their own online presence and are more aggressively marketing in-store sales through their websites and e-mails. A few will even allow consumers to purchase an item online, but insist that it be picked up or returned at the nearest store. The reasoning is that if, for instance, a customer buys a new grill on the retailer’s website but has to take delivery at the store itself, there is a good chance that the customer might also decide to purchase a new set of barbecue utensils or other items as well.

“We’re also seeing more stores and even entire shopping centers offering free [software] applications that customers can put on their home computer, cellphone, or other handheld device,” Thomas says. The apps “can let shoppers know what’s on sale, get coupons for discounts, and find out about new products as they walk through the center or enter a particular store. It’s a powerful marketing tool for retailers and mall owners.”

Federal lawmakers may also help. In early May, the U.S. Senate approved the Marketplace Fairness Act, a measure that would give all 50 states the power to tax most internet sales. The proposal, which most traditional retailers and the ICSC say would go a long way toward leveling the playing field with online competitors, was sent to the House of Representatives on May 7 for consideration.

Even if Congress strips away some of the advantages that pure online retailers such as Amazon enjoy today, experts say it will not be enough to save many older suburban malls unless their owners are willing to launch massive modernization programs or simply raze their buildings and start from scratch. “It’s not that malls are overbuilt,” says Gar Herring, president and chief executive of Dallas-based developer MGHerring Group. “The problem is that they are under-demolished.”

That is a phrase many retail property owners and developers are now using, from East Coast to West. Remarkably, the ICSC reports that only one traditional enclosed mall—City Creek Center in Salt Lake City, a mixed-use project with about 700,000 square feet (65,000 sq m) of retail space—has been built in either urban or suburban markets since 2006. And while ShoppingCenters.com’s latest Directory of Major Malls found 15 proposed projects across the United States that would each have 1.2 million square feet (111,500 sq m) or more of retail space, nearly all languish on the drawing board or are just beginning to have dirt moved around.

Hipness on Display

Most of the malls and smaller centers that will be built in coming years will look different than the ones shoppers see today, experts say.

Exterior design and signs will be enhanced to advertise the hippest or most popular stores and restaurants inside, Thomas says. Showroom and promotional space will take up a greater percentage of individual store space, but overall square footage will probably shrink as retailers seek to keep rents down and need less storage space as they continue to “morph their in-store and online marketing schemes together,” says Charles J. DiRocco, Jr., managing director at Real Capital Analytics.

Shoppers will also see even more movie theaters, eclectic eateries, and cutting-edge attractions at larger centers in the years ahead, Thomas says, as developers and owners seek to woo consumers away from their online shopping habits and return them to local malls—or at least blend the two experiences through new “clicks and bricks” strategies.

“Owners have to give shoppers a reason to come to their centers,” Thomas says. “Otherwise, people will just stay home and buy things on their computer.”

Those interested in mixed-use best practices may wish to purchase ULI’s

Mixed-Use Development Handbook
.