Real-estate developers are betting on a risky strategy to reimagine retail space as apartments or last-mile logistics in hopes of rescuing struggling shopping centers

  • With the retail apocalypse seeing acceleration from the pandemic, developers, and landlords are increasingly looking to redevelop retail into residential or industrial spaces. 
  • The strategy has been around for over 15 years, but commercial real-estate experts told Business Insider that the pandemic has increased interest. 
  • The fiscal restraints imposed by the pandemic has also impacted the redevelopment play. Simon Property Group has put its projects on pause, while Brookfield Property Partners has sold one mall it was planning to redevelop.
  • Visit Business Insider's homepage for more stories.

The retail apocalypse was already in full swing before the coronavirus hit. After weeks of total shutdown, and now months of uncertainty, it's become clear that the pandemic has only made the downward slope that much steeper. 

Major retailers like Neiman Marcus, JC Penney, and J Crew have filed for bankruptcy, and Yelp data shows that of the almost 16,000 restaurants that have closed since the start of the pandemic, 60% of them could stay shut permanently. 

With so much closing and downsizing, and e-commerce continuing to gobble up more retail sales, owners of underperforming retail assets have to ask, what should they do with their space? The United States has the most retail space per person of any country, with 23.5 square feet per person versus 4.6 square feet in the UK. 

Over the last 20 or so years, conversions of retail space into other asset types, such as apartments or light industrial, has been one way landlords deal with underperforming retail assets. This redevelopment can be mixed-use, keeping some retail in place, or can totally repurpose an asset from the ground up.

"Redevelopment has been something that has been on the table and on people's minds since the term retail apocalypse or death of retail was first spoken about," Omar Eltorai, a market analyst at CRE data firm Reonomy, told Business Insider.

Business Insider spoke with two CRE experts who have seen an uptick in landlord and developer interest in converting retail space into residential, industrial, and healthcare properties since the start of the pandemic. They told us why the trend is getting hotter, where we may see more properties converted, and why conversions can be tricky to pull off.  

How retail owners can convert property

For retail owners, converting a property type is no small decision. It usually requires renegotiating with the lenders and investors who have put their money into a retail property, long fights to rezone the space, and expensive construction.

"It's never anybody's first choice to convert retail to another asset class," Chris Wilson, an EVP at JLL and the firm's national agency retail lead, told Business Insider. 

"Retail folks are not saying to themselves 'I sure wish I had a last-mile operator on my property,'" Wilson said.

Instead, the decision is often made for the developer by the performance of the site.  High-end, or Class A retail, has continued to see increased revenue over the last decade, while underperforming retail, further from population centers and tourist destinations, has taken the brunt of the negative outcomes.

These trends could change, as the coronavirus pandemic threatens to rearrange what assets are doing well and which are struggling.

Read more: From warehouses to office space, real-estate markets are getting turned upside down. These are the must-know deals and key trends.

About 15 years ago, according to Wilson, redeveloping retail properties became a major tool in developers' toolkits — as it helped them find a way to fill spaces that were struggling or squeeze more revenue out of their property. The trend coincided with a move towards mixed-use developments that partnered apartments with retail space that ranged from restaurants to grocery stores, and encompassed both redevelopment and conversion of old buildings as well as the development of new-mixed use properties. 

It has continued apace through the 2008 crisis and until the present day, as a new rash of retail vacancies is already making conversions more attractive. 

"I do think that COVID has accelerated those conversations, not from conversation to action, but by bringing more properties on the table to be discussed," Reonomy's Eltorai said.

Fresh targets and new assets 

Christopher Sowers, senior vice president for the multi-family advisory group at Colliers, told Business Insider that these sorts of conversions will accelerate thanks to the pandemic. He also sees more hotel properties, which have been slammed by the global downturn in travel, being discussed as possible redevelopment targets as well.

Retail, which had previously seen conversion into apartment properties or industrial, is also being eyed for healthcare and life sciences uses, as that asset has been a recent high performer. 

An aging population, requiring more medical office space, and advances in biotechnology that have created a boom in the healthcare tech markets, have led to a boom in the real estate submarket.  CBRE's 2020 US Real Estate Market Outlook noted that the sector has seen an average of $12.2 billion in investment each year from 2014-2019.

Wilson told Business Insider that JLL is working on with a major portfolio of 140 big box stores that will look to convert a third of the stores into medical space. 

The conversion idea has also been picking up steam for other types of space that has seen demand stall during the pandemic. 

Early-stage startup Bluelofts, based in Dallas, Texas, has developed a way to turn vacant floors in office buildings into modular apartments. With remote work and the collapse of oil and gas markets landing two major blows to the Dallas market, this strategy seems to have a lot of tailwinds.

Read more: Logistics startup Bond has teamed up with SoftBank-backed REEF Technology to bring nano-warehouses to parking lots across the US. Here's how they're building the distribution hubs of the future.

Redevelopment doesn't always mean distress

While the coronavirus has accelerated conversations about converting struggling retail, conversions aren't always a sign of a distressed asset.

In the Allston neighborhood of Boston, New Balance is in the midst of redeveloping 15 acres of industrial land into a mixed-use property that includes offices, sports facilities, a concert venue, ground floor retail, and apartment complexes. The development has already opened up New Balance's headquarters, and the practice facilities for both the Boston Bruins and Celtics. 

Just across the street, there's a Stop & Shop that serves local Allston residents and the swarms of college students who live in the area. Colliers' Sowers advised Stop & Shop, who owns the property their store sits on, on its redevelopment of that location which was proposed in 2018. 

The store is successful, but Sowers said that the New Balance development indicated that there was a "higher and better use than a single-level grocery store." Their solution is the biggest development the neighborhood has ever seen, a mix of 868 new housing units, a newly redeveloped grocery store with additional retail and some office space. 

It will be challenging to keep the grocery store operating during much of the development, according to Sowers, but the strategy shows how mixed-use retail development can actually boost the performance of the original asset. The grocery store will have a thousand-plus person strong built-in customer base, and the additional apartments will be part of a convenient, mixed-use neighborhood, a "win-win" for the clients.

This grocery-anchored redevelopment is an example of class of redevelopment that upgrades already high-performing assets.

Brookfield's big redevelopment bets

Brookfield Property Partners has embarked on redevelopment projects like in the A-class Alderwood Mall in Lynwood, a Seattle suburb. The company will continue to operate the shopping center, but is also building a 300-unit apartment complex on-site with help from real estate investment trust AvalonBay. 

In another huge undertaking, Brookfield acquired major mall operator GGP in 2018, taking on 125 properties and announced its intention to redevelop about 100 of those properties on November 2018 earnings call. 

The complexity of redevelopment means that Brookfield needs to find the best use for every property in the portfolio, finding the correct mix of retail and residential or other asset classes, apply to rezone each property individually, and then take on the challenge of actually redeveloping the location. 

Read more: Simon Property is at the center of 3 big legal battles as stores finally begin to reopen. Here's what the future holds for the biggest US mall REIT.

To be sure, if a redevelopment project doesn't make demographic and financial sense, firms are unlikely to go through with them.  

Brookfield recently scrapped plans to redevelop a mall in Burlington, VT that it had acquired in 2017, The Wall Street Journal reported Tuesday. The company had originally planned to build apartments and a 10-story office tower on the site of a demolished shopping mall, but has now sold the site to a local partner, Devonwood Investors.

Brookfield confirmed the reports to Business Insider. A spokesperson from the firm added that after "extensive analysis and significant investment of time and money" Brookfield found that continuing with the development would not meet the firm's economic goals or its investors' best interests. 

Fiscal concerns have halted other redevelopments: Simon Property Group announced that it had suspended or eliminated more than $1 billion of capital it had set aside for mall development and redevelopment on its first-quarter earnings call. The group did not return to requests to comment further.

Read more: 

  • Real estate developers are building costly cold storage space before they even have tenants. They're betting the risky move could be a winning investment as grocery delivery booms.
  • Neiman Marcus' shocking exit from glitzy Hudson Yards strikes a huge blow to the $25 billion project. The departure could unravel one of the most expensive mega-malls in US history.
  • Amazon just signed a lease on a huge NYC warehouse used by one-time rival Jet.com. It shows just how hot the market for industrial real estate has gotten.

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