Malls Can Benefit From Shift to Mixed-Use, and Developers Are Catching On

Mixed-Use Strategy Allows Owners To Increase Rents Across Property Types

By Robin Trantham
CoStar Advisory Services April 28, 2021 | 10:46 AM

In recent years, a number of major U.S. mall owners have touted a strategy of pursuing mixed-use development to offset declining store revenue. Many mall owners have added residential units, office space or hotels to bolster the performance of their properties. One mall owner in suburban Washington, D.C., even announced a deal to add subgrade self-storage space to gain a new source of non-retail revenue.

Taking a closer look at recent mall performance, it does appear that this mixed-use strategy is helping mall owners to right the ship and ultimately should aid these assets in navigating today’s challenging retail landscape. Based on a sample of mixed-use centers across the country, we found that each property type on a mixed-use site typically commands higher average rent levels than those in non-mixed-use sites in comparable markets. In the case of apartments, the difference in average rent levels was nearly 14%.

Among all retail property types, malls have been particularly hit hard during the pandemic because the average tenant roster composition of a mall varies significantly from that of the smaller center types such as community, neighborhood or power centers. These smaller shopping centers typically have a much higher percentage of space dedicated to necessity-based tenants like grocers and discount stores, which were deemed essential during the pandemic and were allowed to remain open.

Malls, on the other hand, tend to be more exposed to nonessential retailers such as apparel and department stores that were ordered to close during the pandemic, and suffered massive sales declines.

This outsized exposure to distressed tenants made malls particularly vulnerable to the effects of the pandemic. In 2020, the average mall vacancy rate increased by 150 basis points, at least 20 basis points more than any other center type. In 2021, mall vacancies are projected to increase by another 170 basis points. In addition, regional mall REIT returns fell by 37% in 2020, according to NAREIT, the Washington, D.C.-based trade group for real estate investment trusts. That’s more than any other retail subtype and vastly underperformed free-standing retail REITs, whose returns fell by only 10%.

So far through 2021, malls have staged a remarkable recovery. Regional mall REIT returns have rallied amid a relatively rapid vaccine rollout, increased stimulus and growing consumer confidence. Total returns in the mall sector have climbed by 32% year to date, exceeding the growth experienced in any of the other retail subtypes. However, even after the sector’s strong recovery this year, regional mall REIT returns still have a long way to climb back.

A Growing Strategy Shift

Given the continued challenges facing the mall market, many owners have begun to redevelop or repurpose their mall space with the hopes of revitalizing the retail on-site or transitioning to an entirely new property type that may be a better locational fit.

Examining a sample of 37 malls across the country that are either in redevelopment or in the planning stages of being redeveloped, it showed that malls of all quality types are being repurposed.

Class B malls account for the largest share of redevelopment targets at 54%, while Class A and C malls represented 32% and 14%, respectively. The relatively low share of Class C malls within this sample is likely the result of our exclusion of malls from this analysis that were demolished with no plan for redevelopment.

Most mall redevelopment plans call for at least a portion of the site to remain dedicated to retail, while looking to add complementary property types to create a symbiotic relationship between uses. Outside of retail, multifamily is the second-most common property type found within these redevelopment plans. Adding resident density on-site creates extra foot traffic and increases the surrounding buying power for a retail asset. Furthermore, apartment renters may view having access to nearby retail space as an attractive amenity.

Office and hotel additions are somewhat less common, with these two uses being included in 65% and 51% of mall redevelopment plans, respectively.

While Class B malls make up the largest share of redevelopment plans across the country, Class A malls still account for roughly one-third of mall redevelopment plans. The Marketplace at Factoria mall in Bellevue, Washington, is a prime example of a well-located Class A mall that will become a mixed-use site over the next few years.

Even though it is located in the second-wealthiest ZIP code in the state of Washington, the mall’s owner, Kimco, is adding 685 apartment units, 150 hotel rooms and 175,000 square feet of office space, with the hopes of driving more foot traffic to the existing retail. In addition, Kimco is not planning on reducing the amount of retail, but rather is contemplating increasing the retail square footage by 30%.

On the other end of the spectrum, Century Plaza mall in Birmingham, Alabama, is an example of a Class C mall in a lower-quality location that will be completely redeveloped into an Amazon distribution center.

The once-thriving center, which was at one point the state’s largest mall, closed its doors in 2009 after being hit hard by the 2008 recession and the rapid growth in e-commerce. More than a decade later, Lumpkin Development decided to repurpose it into a distribution center, an effort that could eventually create around 1,300 new full- and part-time jobs.

While the conversion to industrial space of former mall sites remains a relatively small trend today due in large part to zoning and cost hurdles, it is one that is expected to increase in the years to come, as e-commerce growth has rapidly accelerated over the past few years. These types of redevelopments will likely be isolated to low-quality and poorly located malls.

There have been some notable differences in performance within the three classes of malls over the last few years. Class A malls have been significantly more resilient in terms of both occupancy rates and rent growth given the relative strength of their trade areas and their general adaptability. Going forward, given the advantages of their favorable location and tenant base, Class A malls are likely positioned to experience the strongest recovery from the effects of the pandemic. As a result, owners of high-quality or well-located retail should consider conversion to mixed-use before deciding to demolish or completely remove an existing center.

Mixed-Use Outperformance

The symbiotic relationship forged through mixed-use construction or redevelopment allows for rents to be pushed higher regardless of property type. Apartments on mixed-use sites typically command an average rent level that is 13.9% higher than what is collected in non-mixed-use sites in comparable markets, and the premiums for office and retail properties sit not too far behind at 8.6% and 7.3%, respectively.

Given the challenges in the retail market today, owners and investors are actively looking for creative strategies to position their sites to thrive. For select low-quality malls, demolition or adaptive reuse may be the only option. However, for malls in viable trade areas, fortification of the retail space through the addition of other property types has been proven to create rent premiums across all property types in the mixed-use site.

Many malls are in prime locations from a demographic perspective, and the addition of complementary property types may be just what they need to succeed in the years to come.

Robin Trantham is a consultant with CoStar Advisory Services in Boston.

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