Declining Rents And Investor Concern Forcing Mixed-Use Developers To Rethink Retail
The twin crises of e-commerce’s rise and the coronavirus pandemic hit retailers hard, diminishing their reputation among investors and lenders. But mixed-use developers say whatever its current troubles, retail will always be needed to create properties appealing to the widest possible range of tenants, and it still plays a key role in their work.
“While retail is not directly driving value in the near term, we still strongly believe retail indirectly drives value by setting a tone for the building, generating traffic and providing a unique building amenity,” said Lindsey Senn, executive vice president of finance and development at Fifield Cos.
That doesn’t mean it isn’t being looked at differently now. Institutional partners are more skeptical of using retail and can cite data on its declining rental income, Senn added. Assembling the puzzle pieces of a mixed-use development won’t be as easy as it was even one year ago.
“As a result, we are reconsidering the amount of retail in new developments but not excluding it completely,” she said.
Fifield Cos. developed a number of significant Chicago rental properties in the past decade, including The Sinclair, a 390-unit Gold Coast tower at 1201 North LaSalle St.; the 492-unit 727 West Madison in the West Loop; and Logan, a recently finished 220-unit development in Logan Square, which includes 64K SF of retail space.
Senn does not recommend any hard and fast rules for signing up retailers at new mixed-use buildings. Some neighborhoods already attract high levels of traffic, and not withstanding retail’s recent troubles, few if any changes in strategy may be needed when recruiting tenants that will bring in life and activity, she said.
Optima Inc. Senior Vice President Mark Segal said his firm won’t change its retail strategy. It just broke ground on Optima Lakeview, a 198-unit luxury apartment complex at 3460 North Broadway St. in Chicago’s Lakeview neighborhood near Wrigley Field. It will also have 14K SF of commercial space.
“While obviously dealing with COVID-19 presents challenges, we believe that over time, some normalcy will return, along with the ability of people to resume activities they have done in the past,” he said.
The company populated its Optima Signature tower, which opened in 2017 in affluent Streeterville, with an eclectic mix of retailers, including many service providers that residents see as amenities. Streeterville retail tenants include a restaurant, a full-service veterinarian, a fitness studio and a nail salon. Segal said the firm has a similar vision for Lakeview.
And although the company also made room for nontraditional users such as Guidepost Montessori at Magnificent Mile, a new elementary school that now occupies 14K SF, Segal said he still has great confidence in traditional retail. He points to recent stats that show brick-and-mortar retail is stronger than many realize.
At the pandemic’s height, e-commerce accounted for 16.1% of all retail spending, not much higher than pre-pandemic times, Linneman Associates principal and former Wharton School professor Peter Linneman said during Walker & Dunlop's Oct. 21 Walker Webcast. E-commerce accounted for 11.8% of retail sales in Q1 2020 before the pandemic began.
“This was the perfect storm to test if e-commerce could overtake brick-and-mortar for good, and e-commerce failed miserably,” Linneman said.
Of course, that doesn’t mean brick-and-mortar retail will smoothly sail through the crisis. Well-known retail chains such as JCPenney, J. Crew, Pier 1 and Art Van Furniture filed for bankruptcy this year, and more shutdowns are expected. And although August sales at grocery stores and home furnishing stores were up compared to the previous August, clothing saw a 20% decline, and revenue at restaurants and bars was down 15%, according to the U.S. Commerce Department. The damage may be permanent. Moody’s Analytics estimates effective retail rental rates will sink 11.1% this year.
The overall conditions mean curating retail for mixed-use developments will be more challenging from now on and warrant a cautious approach, especially in less-established trade areas, Senn said.
Placing retail outlets on the second level of a project could be risky, she added. Instead, keeping even the high-quality retailers on the ground floor and in the sightlines of casual shoppers and passersby is the better option. Sticking with retailers considered essential in a pandemic, or ones that provide services to residents, may also be necessary, as will limiting the size of retail suites.
Fifield is leasing up Logan and has found that filling up a development’s retail spaces in the midst of the pandemic is far from impossible. A small-format Target store occupies 27K SF. Other spaces were taken by a Verizon store, an ice cream shop and casual restaurants including a Korean-style barbecue. The retail space is 70% leased and the company is close to signing a deal with a dentist.
“We’re still getting great traction from potential tenants,” Senn said.
But in the future, many mixed-use developers may still have to get more creative with their first-floor retail spaces, she added. The good news is that space is flexible. Developers could choose to ramp up parking or expand other services such as bike storage.
“There are a lot of options or puzzle pieces which you can fit in,” she said.
One option Fifield is considering for future projects is a blending of retail and residential spaces. It is looking at options like finding a coffee shop or doughnut shop owner willing to use the seating space of a building lobby for its customers, sharing it with residents and bringing in foot traffic and life.
“It’s challenging to find operators that want to share space, but I think we will start to see more of that in some markets,” she said.
No one knows how long this troubled period for retail will last, but Senn said it won’t be short.
“I think all of this is going to impact retail going forward beyond the next 12 to 24 months.”