Looking back over the last half-century, possibly more than any other real estate classification, the retail development prototype has shown resiliency, yet distinction, almost by decade. In this article, we’ll explore those prototypes and their respective time periods, briefly touch on how e-commerce and COVID-19 affected tenant and developer perspectives, discuss current trends and prognosticate on what the next decade’s configuration will look like.
NewMark Merrill
In the 1970s and 1980s, the super regional mall was the prototype of choice. Think Buckingham Square, Town Center at Aurora and the Westminster Mall {two of which are gone now). During the 1990s, developers focused on service-oriented businesses surrounding a neighborhood grocery store. In the 2000s, with highly leveraged loans and the rapid expansion of big-box stores, power centers became the format du jour, with the square footage of some of these outdoor centers rivaling those of the enclosed mall. Think Aurora City Center, Larkspur, Comerstar and the Shoppes at Northglenn. Thereafter, consumers wanted experiences and developers pivoted creating lifestyle and mixed-use developments with ground-floor retail, apartments above and a central gathering place for events, which helped fuel the rapid growth of infill high-rises and four- and five-story wrap apartments. Think McGregor Square, Streets of SouthGlenn, Belmar, and Cherry Creek North.
All the while, as prototypes morphed and were incorporated into the mainstream, the e-commerce revolution gained momentum and fueled concern about the death of bricks-and-mortar retail stores. Throw in the pandemic, resulting in store closures and the American consumer’s requirement – and now penchant – for shopping from home, and the demand for large-scale shopping destinations diminished and continues to do the same. The U.S. Census Bureau reports that from 2018 through 2022, with total store and non-store sales growing from about $1.22 trillion to about $1.62 trillion, e-commerce sales have grown from $111 billion {9.2% share) to $231 billion {14.3% share). So although e-commerce sales do now equate to a meaningful share, the death of retail was highly exaggerated as consumers still like to touch and feel before making a purchase.
So what are we developing today and into the near-term future?
A retail real estate development model revolves purely on tenant sales projections. The more sales tenants generate, the higher rents they can pay, and we, therefore, see an increase in delivered square footage. But challenges and mitigating factors in today’s environment cause minimal development.
Other than higher land prices, higher construction costs, higher loan rates, tenant bankruptcies and tenant consolidation, developers have smooth sailing.
With higher land prices, you have to go vertical. With verticality and higher construction costs and higher loan rates, you have to be more economical in design of finished product and size. With tenant bankruptcies and consolidation, demand for new space is less. Use Bed, Bath & Beyond as an example. It closed 475 stores covering its various brands, and it barely made headlines. In fact, most landlords were happy to take their space back because it was accretive with the lack of available space, allowing them to relet those former stores at higher rates. Think about it this way: If you are a retailer and can lease a second-generation space now {versus a year or two from now when a project is actually delivered) at a lower rent, typically in a desirable location with good co-tenancy, why would you seek brand-new construction? So current market conditions are a win-win for tenants and owners of existing product, but not for developers.
accretive with the lack of available space, allowing them to relet those former stores at higher rates. Think about it this way: If you are a retailer and can lease a second-generation space now {versus a year or two from now when a project is actually delivered) at a lower rent, typically in a desirable location with good co-tenancy, why would you seek brand-new construction? So current market conditions are a win-win for tenants and owners of existing product, but not for developers.
Now, the news is not all bad, but the good news list is much shorter for the risk tolerant. The proliferation of multifamily construction has multifamily developers demolishing obsolete retail and with that total inventory reduced, demand has outpaced supply and rents rise. Good news. Quantitatively, Costar data delineates how headwinds outpace tailwinds in stark reality. For the 10-year period ending in 2002, approximately 36 million square feet of retail was delivered here in the Denver area. For the 10-year period ending in 2012, approximately 34 million sf of retail was delivered. And to illustrate the overarching theme of this article, for the 10-year period ending 2022, only 9.14 million sf of new retail was delivered.
The second piece of good news revolves around Colorado’s continued population growth. Historically, the Denver population has increased 165% since 1992, from approximately 1.8 million people to 3 million at the end of 2022. With the increase in people and continued projected future increases, consumers will demand retail close to their residences and that will dictate further expansion, but the equilibrium does not exist today.
Where do we go from here?
For today’s retail developer, efficient and economical development yields accretive results. With a 5- to 10-acre land parcel where a strip retail building of 15,000 sf with several pad sites can be developed, the pad site sales, ground leases or build-to-suits provide enough proceeds to lower the basis of the remaining strip retail, which allows rental rates that can be justified based on the aforementioned generated sales, to yield positive results.
In summary, large is out, and smaller, more economic developments rule the day. Right now we’re back to grocery and service-oriented business. Will the circle come full? Only time will tell.
Article by Lance Taylor, Vice President of Acquisitions and Development, NewMark Merrill
For the Colorado Real Estate Journal, November 15, 2023
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