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Will New Retail Strategies Be Enough to Fill Pandemic-Induced Vacancies?

Retailers are fleeing commercial space at an alarming rate—mall space vacancies surged 83.1 percent in the first quarter of 2020, according to a recent report from commercial real estate services company JLL. The same report indicated that across all retail real estate, total net absorption—a figure that calculates the difference between the commercial spaces vacated by tenants and the spaces taken up by them in the same time period—was negative 6.4 million square feet, a 213.5 percent decline year-over-year from a positive net absorption of 5.3 million square feet. This poses a harrowing reality for shopping center operators. The one question keeping the industry up at night: how are they going to fill all this empty space?

With the Covid-19 pandemic in full swing, shopping centers have shelved more experiential projects such as higher-end restaurants, gyms and even residential complexes due to either social distancing requirements or consumer anxieties about going back to stores. This means landlords are going to have to be more creative in filling out their spaces, whether through partnerships with grocers, splitting space among younger, more agile retailers or even building out fulfillment centers.

“We know from the news that there’s a number of closing department stores coming,” said James Cook, Americas director of retail research at JLL. “In the past, the best uses for them have depended on where the mall is located. For example, you’d take what was once a Sears and part of it is now a Dick’s Sporting Goods, while part of it is another retailer like a Five Below. That’s still a great reuse.”

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Landlords are admittedly facing an uphill battle finding replacements for the department stores and apparel retailers that are exiting, particularly if they operate major shopping centers. The pool of successful retailers this year largely comes from essential categories such as mass merchants, off-price retailers, dollar and discount chains, grocers, home improvement retailers and drugstores, all of which typically fill single-tenant, freestanding, general purpose commercial buildings.

In fact, these essential-driven single-tenant spaces, categorized by JLL as “general retail,” are the only area of real estate that saw positive net absorption in the first quarter at 1.6 million square feet.

Fulfillment centers

Top shopping center operators such as Simon Property Group, Westfield Group and General Growth Properties (GGP), among, others feel the most pressure with what to do with their real estate, and with whom they should partner.

Simon in particular has been in the news for many reasons lately, including its reported discussions with Amazon to convert some of its mall anchor properties once occupied by Sears and J. C. Penney into fulfillment centers.

On the surface, the idea of an anchor location becoming a distribution center for any major retailer seems like a logical move as more consumers shop online and retailers want to move their inventory closer to the consumer.

But many hurdles stand in the way of this scenario, particularly the costs to reconfigure the space, since warehouses typically have high ceilings and have many requirements for how they’re built.

Malls are zoned for retail, they’re not zoned for things like warehouse and distribution, so now you’re dealing with the municipality,” Cook said. “There are parking issues. Are you suddenly going to have all these 18-wheel trucks coming in with e-commerce deliveries in your mall? Municipalities aren’t even going to want to allow that.”

Plus, it could open up a precedent where tenants can reconsider their lease negotiation, or may actually have a means to exit the deal entirely if they signed a contract contingent on an anchor store driving traffic.

“That means the existing tenants may have an opportunity to come and say, ‘Look, we signed up on the basis that this was an anchor store. It now isn’t an anchor store. It’s not pulling people in. We want to renegotiate the rent,’” said Neil Saunders, managing director at GlobalData Retail. “Then you would have some tenants who say, ‘Not only is this not an anchor store that’s pulling in footfall, but actually you are giving over space to one of our main rivals online and we’re not particularly happy about this.’”

The fulfillment center solution may be a better option for struggling retailers outside of malls that are operating freestanding stores. If a store isn’t profitable, a retailer could convert it into a fulfillment center rather than close it altogether to unload unsold merchandise.

“Our retailers were coming to us saying, ‘How do we unlock this merchandise, we’re backlogged and we want to do more. What are some of the things we can do?’” said Joanne Heyob, senior vice president, operations strategy and design at WD Partners. “I know that a lot of stores eventually started to think about how could they potentially open up with a form of curbside to get their employees back in the stores safely, while also abiding by whatever local jurisdictions were.”

Grocery stores and quick service restaurants

While department stores and apparel retailers have had it the worst throughout this crisis as far as creating vacancies and managing rent—in fact, apparel and accessories retailers represented 41.5 percent of the tenants that asked for rent relief in the first quarter, according to JLL—grocery has gone in the opposite direction, leading to the idea that more grocery stores would be desirable alternatives for empty retail spaces for both landlords and consumers alike.

The introduction of grocery stores within malls isn’t exactly new, Saunders said. “They are much more interested in that now because grocery has been the area that has grown very rapidly throughout this whole crisis. Grocery stores are seen as a great way of driving footfall.”

When specifically asked about opening grocery stores at Simon Property malls, CEO David Simon said in an earnings call: “Yes, I am hopeful that we can certainly do more business with that category.”

JLL’s Cook noted that quick service restaurants have been successful during the pandemic since they are convenient and don’t require indoor capacity restrictions, making them potential hotspots for filling old real estate.

“We’ve seen a lot of new chains that we’ve seen expanding right now and most people don’t even realize it,” Cook said. “Anything that’s easy to pick up for takeout or order for delivery or especially if you’ve got a drive thru, you’re doing better.”

DTC brands

Leap, a service provider that helps digitally native brands brands open, staff and manage their own stores, works with landlords of all sizes to bring its client brands to physical locations, but the rise in vacancies has given co-CEO and co-founder Amish Tolia excitement over the potential to take its brands into higher-class malls.

Tolia advised mall operators and other landlords to find retail concepts that are relevant whenever possible, but also noted the importance of keeping leases flexible and transparent.

“You’ve really got to think about the structures of how you do deals with your current and future tenants,” Tolia said. “It’s incredibly important in today’s environment that tenants and landlords together have the highest likelihood of success. When things are working they’re both succeeding. You’re seeing tenants disappear left and right and unfortunately that’s just because a lot of the cost structure and the cost of business is untenable given the new realities of brick-and-mortar retail.”

Experiential retail?

Does the pivot to newer brands and business models mean landlords should give up hope on the experiential and entertainment side of shopping forever? Not exactly, particularly if a coronavirus vaccine hits the market within the next year.

“Do any of us really believe [experiential retail models] won’t work sometime in the back half of 2021 or sometime in 2022?” Jan Rogers Kniffen, CEO of retail consultancy J Rogers Kniffen Worldwide, told Sourcing Journal. “We all believe there will be a palliative or vaccine, so do I still think that experiential retail is where the world is going despite COVID? Yeah. Do I think COVID has slowed all that down. Absolutely. Do I think that’s permanent? No. It may not grow at the rate we thought it was going to grow, but I don’t think that people are going to quit doing fun things because they’re going to be forever afraid of going any place again.”

Delaying the inevitable

As unfortunate as it sounds, the natural trend that has occurred in which physical retail market share has given way to e-commerce means that not every piece of empty space can be saved.

“While everyone is going to work very hard to minimize vacancies and I think that is the right thing to do, I think there’s a dose of reality required that vacancies are a part of the landscape,” Saunders said. “We all try to solve issues and problems, but the truth is, there will be vacancies. That’s the math.”

Kniffen said that mall traffic had been dropping at an average rate of 7 percent per year prior to the pandemic, so like many other trends, Covid-19 just accelerated the inevitable.

Since 2014, Kniffen has predicted that by 2030, 50 percent of all non-restaurant sales would be online, but due to the pandemic, he believes that number will only rise faster.

“There has not been one category—grocery, apparel, electronics, books—not one point of market share for any of those has ever gone back the other way since 1999,” said Kniffen. “It tells you how powerful selling online as been.”