Repurpose, Rezone or Replace

The overbuilt US market for retail space was one crisis away from a major correction. That correction is now upon us.

The COVID-19 pandemic has brought into sharp relief the costs and consequences of the overbuilt nature of US retail real estate.  Pre-COVID the US already had double the amount of retail space per capita of Canada, and quadruple the amount of Germany.  The US inventory of retail space was historically over-developed, yet national occupancy levels remained steady for the past several years, supported primarily by a buoyant national economy that enjoyed an unprecedented bull run.

However, the relentless rise of e-commerce has been systematically dismantling scores of once proven retail brands while stunting the brick & mortar growth of others.  The lethal combination of this retail paradigm shift to e-commerce with the COVID-19 pandemic’s shuttering of non-essential businesses is leaving in its wake a large and fast-growing inventory of vacated retail boxes.  What was initially seen as a siloed infection to Department Stores and Regional Malls, has methodically spread to the Power Center arena, as sporting goods, home improvement, consumer electronics and other categories of large format retail stores shutter.

The COVID-19 pandemic has accelerated a growing national inventory of vacant big box space (JC Penney, Neiman Marcus, Stage Stores, etc) that has an increasingly bleak outlook for re-leasing, as the tenant pool of high-credit, active users seeking to grow brick & mortar locations continues to shrink.  Forward thinking retail brands are largely pivoting instead to seeking their growth through online platforms.

This rapid and unfolding change will inevitably confront owners, investors and municipalities with vacant retail boxes for whom there is no strong retail replacement.  Like it or not, an era of Retail Pruning is likely upon us, in which the path forward for big box assets will be to Repurpose, Rezone or Replace.

Let us remember that the most foolproof way to increase Demand…is to reduce Supply.  Extracting boxes, or in some cases entire failed shopping centers, from the retail inventory is a sobering but pragmatic course to re-balance supply & demand, keep rents firm, discourage the re-use of vacated boxes by worst-in-class uses, and move our national ratio of retail space per capita to a healthier and crisis-resistant level.  No doubt many owners will resist the need for this change, preferring to re-lease a vacated box with a down-market replacement, rather than spend the capital needed to reposition the asset.  Likewise, many municipalities will cling to an unrealistic old-paradigm model for sales tax revenue based on an inventory of retail space that was only expected to grow over time.  Yet as John Adams famously observed, facts are stubborn things, and the fact is that swelling vacancy will cause Supply to swamp Demand, bringing myriad blights in its wake.  A community cannot ignore a retail vacancy problem indefinitely.

While skeptics may scoff at the notion of retail centers exiting the landscape, our firm has already been approached by savvy investors and developers that have asked us to target broken retail centers as target opportunities for mixed-use redevelopment.  Re-imagined retail centers can still include retail uses, but on a right-sized scale that is perhaps 50% or less of the original retail footprint in size.  The opportunity to densify these projects with vertical housing product, hotels, or office, medical and civic uses will enable developers to take advantage of the great fundamentals that good retail real estate provides for alternate non-retail users (location, proximity to transit and employees, etc).

Sometimes less is more.  As we look ahead to what will become a national big box vacancy problem of unprecedented scale, the answer is extremely unlikely to be found in the form of expanding big box users that will absorb the supply.  The answer instead is far more likely to be found in pruning existing inventory back to healthy and sustainable levels.  Repurpose, Rezone or Replace.