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June 20, 2024

The New Alliance Forming in CRE’s Retail Sector

As retail leasing burns hot, Class A property owners are stepping in to partner with secondary and tertiary property owners in desperate need of capital and upgrades.

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The past 15 years have been a rollercoaster ride for retail. The Great Recession (2008) squeezed wallets, then came the "retail apocalypse" (2010) fueled by eCommerce, and finally, the pandemic (2020) forced many brick-and-mortar stores to close their doors. Yet, retail has proven remarkably resilient.

Today, there's a buzz of innovation in the air. In Atlanta, landlords are curating a tenant mix that blends shopping with sports experiences. Chicago's downtown is undergoing a renaissance, with pop-up shops dotting major promenades like Michigan Avenue and retailers like Starbucks and Apple creating cutting-edge experiences to win back customers.

This vibrancy, however, is concentrated in prime locations like The Battery, Magnificent Mile, and suburban neighborhoods. Secondary and tertiary retail spaces (Class B and C) are facing a different reality—namely, vacancies and lack of funds. But there is a promising light at the end of the tunnel as Class A owners step in to formulate partnerships with the local shops that have traditionally held down the suburban shopping scene.

Highs & Lows: Market Conditions, Shopper Habits, & More

Retail has had to manage many headwinds from macroeconomics to disruptive technology. As a result, retail is in a very unique position today. There are many opportunities for growth and expansion, however, some subclasses are slow to recover.

The obsolescence of Class C shopping outlets.

Urban retail is thriving compared to its rural counterparts. Mega malls, prime destinations housing luxury brands, boast low vacancy rates of around 5% in major cities. However, strip malls and outlet centers are experiencing some occupation challenges.

Traveling outside major cities reveals a stark contrast: shopping centers with empty storefronts. Think of strip malls filled with local businesses. These are often classified as Class B or C retail, serving local needs without the allure of premium brands and years of competition from online shopping have started taking their toll.

As businesses shutter their doors, leaving available space often in need of conversions or upgrades, a lack of funding has led many of these properties to stay vacant much longer than normal. Cushman & Wakefield reports vacancy rates as high as 30% for Class C properties, a challenge further compounded by the shrinking size of brick-and-mortar stores.

The shrinking retail footprint.

In these suburban shopping centers, one might also find another vestige of retail: The big box store. Retailers like Bed Bath & Beyond, Best Buy, Barnes & Noble, Walmart, etc. known for their expansive inventories and looming presence are slowly receding from the retail landscape—and not because they are completely shutting down.

Rather, retailers like Best Buy, Home Depot, Target, and Barnes and Noble are reimagining the end-to-end shopper journey, opting for an electronic footprint to enrich the in-store experience. As a result, many of these retail behemoths are leaning heavily into omnichannel shopping and reducing their brick-and-mortar footprint when and where it makes sense.

The Perris Pavilion shopping center in southern California faced a challenge when Big Deal Outlet, a massive 25,000 square foot tenant, vacated their space. Recognizing that most retailers no longer require such large footprints, Perris Pavilion took a bold step. They divided the former Big Deal Outlet into 21 smaller units, creating a diversified mix of retail, food, and office spaces. This innovative approach proved successful, with 20 of the 21 units filled by 2022.

Emphasis on “void analyses” and finding the right tenant mix.

To revitalize their spaces, many retail property owners are partnering with developers and brokers to discover the best tenant mix for their spaces and the surrounding areas. This collaboration goes beyond simply attracting premium brands. It's a powerful tool for all classes of retail. By surveying surrounding areas, owners can identify missing services and businesses the neighborhood needs.

This data-driven approach ensures the right tenant mix, leading to increased dwell time and a more vibrant shopping experience. Ultimately, these strategies breathe new life into underperforming suburban retail spaces, transforming them back into bustling promenades.

Misconceptions about retail supply and demand.

Retail headlines might be screaming about store closures, but take a closer look and you'll see a different story. Real estate owners and operators are more concerned with the lack of available retail space than empty storefronts. In major cities like Atlanta and Boston, vacancy rates are incredibly low, hovering around just 3%. Raleigh takes the cake though, boasting the lowest vacancy rate in the country at a miniscule 1.8%.

Adding to the optimism, construction in the retail sector is booming. Currently, a whopping 51 million square feet of new retail space is under construction, with a significant 70% of that already pre-leased.

However, there's another side to the coin. Retailer closures are undeniably on the rise. By mid-2024, an estimated 3,200 restaurants and stores have shut down, a staggering 24% increase over the same period last year. What’s more, construction costs are still very high, making it difficult for Class B and C property owners to upgrade or configure available space.

These contrasting realities paint two very different pictures of the retail sector, and both are surprisingly accurate. The surge in closures suggests that many businesses are struggling, likely due to rent pressures. At the same time, the robust development activity and low vacancies point towards a potential upswing for the industry as a whole.

The Rise of the “Phoenix” Mall: How Big Investors Are Breathing New Life into Local Retail

For years, large retail investors have basked in the sunshine of seemingly endless tenant demand for their top-tier properties. Class A strip malls, boasting high-end finishes and prime locations, have consistently attracted national chains and commanded premium rents. However, the tide is turning. Unprecedented demand has left even these sprawling retail giants with limited vacancy space. This has sparked a new trend: a strategic shift by large investors towards Class C and B properties.

These properties, often strip malls and local shopping centers, are frequently owned by regional mom-and-pop outfits or family businesses. Unfortunately, many have fallen into a state of disrepair; their once-vibrant facades and dated interiors failing to attract tenants in today's competitive retail landscape. The result? A vicious cycle of declining occupancy, stagnant cash flow, and a lack of capital for modernization projects.

“What we’re running into is that when properties lack the right upgrades or infrastructure, you have challenges leasing them,” Shelby Swanson, an Associate Broker at The Econic Company spoke on a panel at ICSC Northern California earlier this year about the challenges she has witnessed in retail leasing. “When there isn’t correct loading, access, venting, all of the details needed to create a leaseable space, you could have a shell space, that was never built out, sitting empty for years.”

Here's where the opportunity for alchemy lies. Large, national investors, flush with tenant demand they can't fulfill in their own portfolios, are reaching out to these regional owners. The proposition? A mutually beneficial partnership. The big players bring the financial muscle to fund much-needed renovations and property upgrades. This could involve anything from modernizing the exterior to creating co-working spaces or revamping common areas to cater to a new generation of tenants.

The regional owners, on the other hand, contribute something equally valuable: prime locations. Many of these Class C and B properties sit in established neighborhoods, boasting a loyal customer base and strong foot traffic. They simply lack the financial resources to unlock their full potential.

This strategic alliance between national and local players creates a win-win situation. Regional owners don't have to sell their cherished properties, but instead, gain access to the capital needed to revitalize their shopping centers. Large investors, meanwhile, find a path to expand their portfolios and tap into new tenant pools. The ultimate beneficiary? The shopper. These revitalized shopping centers, once on the brink of obsolescence, are reborn as vibrant community hubs, offering a diverse mix of local businesses and national brands, all housed in a modern, welcoming environment.

This trend towards "Phoenix Malls" signifies a crucial shift in the retail landscape. It's a testament to the power of collaboration and the enduring value of local expertise paired with national resources. By joining forces, these unlikely partners are breathing new life into our communities and ensuring the continued success of physical retail for years to come.

Supporting the Future of Retail

This new dynamic isn’t the sole innovation on the horizon for the retail sector. As previously reported, retail tenants are learning to leverage technology to influence their negotiation power. This is fundamentally changing the way retail leasing is done and adding further complexity to the landscape alongside these cross-class partnerships.

To stay competitive, retailers need to become data-driven powerhouses. AI tools like Prophia empower CRE owners and operators to explore unconventional strategies for maximizing their property value.

Prophia provides operator teams and stakeholders with real-time, unencumbered access to portfolio and asset insights. Features like dynamic stacking plans and automated lease abstraction allow teams to verify massive amounts of data quickly, ensuring they enter negotiations with every crucial data point mapped and verified.

This streamlined approach keeps conversations moving swiftly and fosters transparency, which is essential when working with third-party teams or other ownership groups.

Whether your leasing strategy includes partnering with owners in another asset class, right-sizing your portfolio, or pursuing acquisitions, commercial portfolios need to harness the power of their data to access the newest paths of portfolio growth.

Hannah Overhiser

Hannah is Prophia's Content Marketing Manager and a seasoned B2B and B2C marketer. Her career began in eCommerce consulting with a focus on code testing. This technical expertise transferred seamlessly to SEO and she started working agency-side as an SEO and Content Strategist. Today, her home is Prophia, and she puts...

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