The future of retail is, increasingly, a different use. Amazon has been snapping up dozens of struggling malls and turning them into warehouses. Private real estate giants such as Toronto-based Brookfield Asset Management and Los Angeles-headquartered CBRE Global Investors have likewise embarked on conversions of retail properties into alternative uses such as residential and office.

Repurposing has become one of the most talked-about topics in retail real estate. PERE spoke with a dozen managers, investors, advisors and lenders about what is driving conversions in the sector and what the challenges are in pulling them off.

“This is going to be a major trend going forward,” says Vince Tibone, senior analyst of retail and industrial at Green Street Advisors, a California-based commercial real estate research and advisory services firm. “We’ve really just scratched the surface with what you’re going to see.”

Tibone estimates the US has approximately 1,000 malls, roughly half of which Green Street gives a grade of B-minus or worse. Of those 1,000 struggling malls, he believes fewer than 50 have been sold over the past few years.

“In our minds, a B-minus mall is already obsolete effectively,” Tibone says. “You’re going to have a very hard time maintaining occupancy and relevant tenants going forward. You have a very large pool of malls in the US we think aren’t going to be viable retail destinations anymore.”

Retail repurposing is nothing new, says Rick Kalvoda, senior executive vice-president of advisory at Toronto-based advisory services firm Altus Group. He recalls in the 1990s valuing three malls that were written down to land value and subsequently demolished to make way for new property uses. “It’s just accelerated very much all at once because of covid,” he explains. “And it goes back to the oversupply, or as some would say, the under-demolished state of retail.”

Repurposing activity has accelerated, moreover, as distress has worsened in the sector. Even blue-chip industry names such as Blackstone and Brookfield have reportedly handed back the keys on shopping centers in recent months. Retail accounted for $471 million, or 28 percent, of the $1.7 billion in total US distressed asset sales in Q4 2020, according to data provider Real Capital Analytics. The sector represented the largest percentage of distressed sales, exceeding hotels at 25 percent and office at 15 percent.

Retail has been one of the hardest-hit property sectors during the pandemic. Indeed, retail recorded total US returns of -7.5 percent in 2020, the worst-performing sector after hotels, which recorded returns of -25.6 percent last year, according to the National Council of Real Estate Investment Fiduciaries. In contrast, industrial remained a robust performer with an 11.8 percent return, while apartments and office posted returns of 1.8 percent and 1.6 percent, respectively.

“Malls that were struggling before the pandemic, that demise really got accelerated with covid, with large retail store closures, department store closures,” Tibone says. “A lot of malls that were maybe not earmarked for repurposing two years ago, all of the sudden, today, that mall is in much worse shape.”

He adds: “Where you’re seeing investors trying to pick up attractive returns is through these fire-sale options where the lender has already taken its loss and they’re trying to get this asset off its balance sheet. You’re going to see a lot more malls defaulting and going back to the lender, and at that point, the malls will likely be sold to someone who will develop it to an alternative use.”

To put this in context, however, malls only make up part of the oversupply equation. They account for just 90 million square feet of the 1.1 billion square feet of excess retail space in the US, according to Washington, DC-based commercial real estate information provider CoStar. In the UK, meanwhile, as much as 40 percent of retail space is considered oversupply, according to London-based broker Savills.

The repurposing opportunity

Facing structural tailwinds long before covid struck, retail was shunned by many private real estate managers and investors. But significant pricing declines have led some opportunistic buyers to change their tune.

One such firm is New York-based alternative investment firm Angelo Gordon, which has generally avoided retail investments for the past seven years, after two early European deals in the sector ultimately produced mediocre returns. “But now it is getting too cheap to ignore,” says Anuj Mittal, the firm’s head of Europe real estate. “We are looking at it again. Despite retail’s challenges, if you’re buying something at these prices, you have to consider it.”

He explains: “You’re seeing everyday retail real estate shopping centers, examples where they’re selling for 10 cents, 15 cents on the last valuation. Some of these are really challenged assets and fundamentally flawed. But if something was worth $50 million, for example, but the best bid is $4 million or $5 million, you’ve got to think it’s worth looking at.”

Mittal, who has seen an uptick in retail write-offs over the past 12 months, says his firm generally has not been looking at assets where the business plan is to continue the retail use. “Instead, we’ve been looking at the opportunity as redevelopment,” he says.

The firm has two repurposing projects underway in continental Europe. One is a redevelopment of a 250,000-square-foot department store in the Netherlands into an office-led property, the other a five-story retail asset in Germany where the upper floors will be converted to office.

Ala Moana Center: Nuveen Real Estate is considering further densifying the mall site with the addition of apartments

Kalvoda has observed declines of 50 percent or more with retail property values globally. “A lot of them have either flattened or maybe slightly declined in the past five to 10 years. But most of that decline has been since early 2018, when we started seeing more changes occurring in the retail values.”

In some cases, the retail property itself has become worthless. “There’s a lot of great land that’s covered today by retail,” says Josh Zegen, co-founder and managing principal of Madison Realty Capital, a New York-based private equity real estate firm that has provided financing for retail conversion projects, which currently make up 5 percent of its $2 billion-$3 billion deal pipeline. “So, a lot of real estate investors are looking at this as covered land plays where there’s an opportunity to take something and repurpose. We’re seeing a lot of these things being sold at land value because they’re basically knockdowns.”

Retail assets that do not have new zoning and project approvals in place effectively will be assessed at land value plus the residual income on the property minus the cost to demolish the property, Kalvoda agrees: “No one is going to pay you for the upside for the profit they could get, because they’re going to have to go in and do the bulk of that themselves.”

To sell or to repurpose?

For existing retail owners, on the other hand, repurposing is often the alternative to selling.

Aware Super, for example, began reducing its exposure to retail real estate six years ago, through a combination of sales and increased investments in other property sectors. Back then, retail accounted for 50 percent of its property portfolio, compared with 40 percent for office and 10 percent for industrial. Retail now represents just 15 percent of the Australian superannuation fund’s real estate holdings, with 10 percent each in multifamily and retirement, 35 percent in industrial and 30 percent in office.

Today, it has become much harder to sell retail than it had been five to six years ago, observes Alek Misev, portfolio manager at Aware Super: “People say, ‘We don’t know where the pricing is. It’s kind of catching a falling knife.’ Our view has always been that we’re not prepared to trade because we also don’t know where the pricing is. The market is currently at a stalemate in retail.”

However, “we’re happy to wait, because it’s not hurting us any more being only 15 percent,” he says. Aware Super is looking at its remaining retail assets primarily for sale or repurposing. With the latter, suitability is based on two factors. “Location is critical with any sector, whatever you want to do,” Misev says. “Because then you look at what is around that asset. Are there hospitals? Are there schools? Are there any other things that might attract certain tenants?”

The fund also focuses on the future expected return of the asset, he explains: “If the longer-term view is that we’re never going to get out of this at a decent return, then that’s when we look into what do we do? Do we take the pain? Do we take the loss and sell? Or is there some upside through a different means?”

Capital expenditures are another consideration. “What we look at is: what if we spend the money on something else?” Misev asks. “What can we get, and how does it compare to spending money on refurbishing?”

Retail has formed the largest part of New York-based Nuveen Real Estate’s private real estate equity portfolio for the past five years, ranging from more than 43 percent in 2017 to nearly 35 percent in 2020. At the behest of its clients, the property arm of US investment manager Nuveen has been reducing its allocation to the sector. But in lieu of outright sales, the firm has been doing so by both allocating more capital to other property types and transforming existing retail assets.

With the latter approach, Nuveen is seeking to reposition 15 properties out of its 95 retail assets in the US, through re-tenanting space vacated by big-box retailers as well as bringing in new uses to existing sites. For example, with the Ala Moana Center in Hawaii, the firm is considering a project to add 580 apartment units to the mixed-use site, the centerpiece of which is the 2.7-million-square-foot mall. “We are densifying the asset,” explains Manuel Martin, global head of retail at Nuveen Real Estate.

Meanwhile, Canada Life Asset Management, the UK subsidiary of Canadian insurer Great-West Lifeco, has sold underperforming retail assets, but would not be willing to sell at a major loss. “We explore all the options and come up with the right one for a particular asset,” notes Joanna Turner, Canada Life’s head of property research. “You’re looking at location and demand, you’re looking at the local supply-demand fundamentals, and if it’s feasible to hold it as a retail asset, then that’s fair enough. But if you don’t think that it has a future as a retail asset, then you’re better off selling it.”

As for repurposing, “you have to accept for a short-term period, you’re going to probably either take a hit or you’re not going to receive some of that income while you’re refurbishing or redeveloping,” she says. “It’s not going to ever come back. But it’s going to be more suitable for what’s required in the future.”

Canada Life has been working on a number of repurposing projects in the UK, including converting a Debenhams department store in Staines-upon-Thames to 250 residential units, and is exploring various repurposing options, including hotel, co-working and residential, for the firm’s House of Fraser department stores in Guildford and Cheltenham.

“You have to think much more creatively about solutions for particular towns and areas than perhaps we did before when we were just thinking asset by asset,” Turner says. With the Debenhams store, for example, Canada Life has been working closely with the local council to ensure the project is aligned with the town’s objectives, she explains. “It’s about this idea of collaboration, which is absolutely essential between the different players.”

Aware Super has assessed the repurposing potential of a couple of its retail assets – which include regional and sub-regional malls. But it has not embarked on any projects to date. Instead, the fund will be focused on pursuing platform investments in the US and Europe with a limited window of opportunity. But it intends to keep retail repurposing on the agenda. “The view we’ve formed internally is we can probably do it in a year’s time, because this is long-term structural pain that is going through retail,” he says.

However, “if our analysis shows that it’s not worth spending the money and repurposing it, then we will eventually sell,” Misev notes. “If we already know holding it long term doesn’t make sense, then what’s left is selling the asset once the market recovers a bit.”

Easier said than done

However, a multitude of challenges can make repurposing difficult. For starters, a retail conversion project will not be successful without a strong location and a strong partner in the new property use, according to Martin.

The most challenging aspect of repurposing, however, is the rental basis, he says: “Normally, the rental basis of retail is superior to most other uses, including multifamily and industrial uses.” Although office rents often exceed those of retail in urban markets, Martin points out that most malls are in suburban locations, where it is challenging to absorb large volumes of new office space.

A retail to residential transformation, however, can be feasible given the higher density potential of a residential product at lower parking ratios. “When you can take 100,000 square feet of retail with a 5 per 1,000 parking requirement and transform it into 300,000 square feet of residential with a 1 per unit parking ratio, meaning a transition from single story to multi-story use, the income potential is much greater,” he remarks.

However, obstacles to unlocking this income include: compensating retailers for landlord termination rights, lowering development returns; a higher land basis than a new residential development may support; and the future risk of a retailer going bankrupt and resulting impact on property values, Martin notes.

Zoning can be another impediment, adds Kalvoda. Despite all the headlines about Amazon converting dead malls to fulfillment centers, “it’s still a challenge to get a change like that,” he says. Industrial, with semi-trailer trucks coming in and out, “is not exactly what people may want in their backyard.”

Another repurposing challenge is that retail owners have traditionally been focused on that property type and consequently are not able to pivot easily to an alternative use. “In some ways, over the past 20 years, the industry has been slower to start reinventing the inventory than it should have been,” says Adam Ducker, chief executive of Maryland-based consultancy RCLCO Real Estate Advisors. “There are people that own the assets who may not have the expertise, the people who have the expertise don’t necessarily own the assets, and the parties so far have been slow to partner. That’s one of the reasons why the pace of this has been slow to build. But that will change.”

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Listen to executives from Angelo Gordon, Nuveen Real Estate and Canada Life make the business case for their preferred alternative use for the property type.

Meanwhile, an owner of a retail property cannot adopt a cookie-cutter approach to repurposing. “Clearly what would work in one location absolutely would not work in another,” Turner says. “You have to do so much research, so much analysis, and also seek expert help on every single location. They always say that retail is detail. It has to be so micro, so tailored to the local catchment area.”

Financing a repurposing project can also present multiple hurdles. “It’s a lot more than taking a mall and turning it into industrial or taking a mall and turning it into residential,” Zegen observes. “It’s putting the pieces together with so many different constituents, whether that’s community constituents or it’s inline versus the boxes versus reciprocal easements. It’s not as easy as just buying and repositioning. Lenders like to come into perfect pictures, when you have all the pieces together.”

In a distressed situation, a buyer also contends with fragmentation on the debt side. “A lot of the retail, especially CMBS retail, the malls and shopping centers are in a workout or non-performing situation, which makes it even more challenging to buy the different pieces,” he adds. “And the question is: is that loan going to be sold cheap enough to be able to take the risk of putting all the pieces together?”

Mark Garmon-Jones, head of shopping center and retail investment at Savills, concurs: “It’s about building a picture of confidence to redevelop and reducing the level of uncertainty. Lenders don’t like uncertainty. They currently don’t like retail because there’s still some uncertainty in that world.”

Lenders, however, want to lend to mixed-use projects with exposure to alternative sectors, he notes: “At the end of the day, while they currently have some rear mirror issues to deal with about current retail exposures, they’re pretty excited about where they want to be in terms of the alternative space.”

The viability of repurposing

So how viable is repurposing retail? “The easy answer is it becomes more viable every day,” Kalvoda says. One reason is the growing attractiveness of retail as industrial becomes increasingly expensive, he notes. As cap rates compress in industrial, “there is a search then for higher income returns and you start to look at other things. You might look at something like retail that becomes more attractive as the value drops.”

Meanwhile, the bid-ask spread in retail – currently around 20 percent – is narrowing, which is expected to lead to more trades in the sector. “As the values continue to decline, now it becomes closer and closer to what those buyers are willing to buy at,” Kalvoda observes.

Debenhams: This department store in Staines-Upon-Thames is one of the repurposing projects Canada Life is pursuing in the UK

Misev notes it is easier to repurpose retail assets today than it had been half a decade ago because of the emergence of new alternative uses for retail during that time period, including multifamily, student housing, retirement living and co-working spaces. “There are more areas that we can explore now than we could five or six years ago, because the world has changed so rapidly,” he says.

Moreover, more existing retail owners have come to terms with reality. “There’s been a few deniers on our journey. But a lot of people get it now,” says Garmon-Jones.  Many retail owners are now focused on creating product in alternative property sectors, meaning sectors that are not retail, office, residential or last-mile industrial. “By redeveloping and repurposing their assets, they reduce their retail weighting and they create the alternative product they so crave.”

Garmon-Jones adds that the cap rates in the alternatives sectors are far superior to those in retail currently. “There’s still a lot of money for the alternatives sector,” he explains. “That’s the arbitrage that helps with the viability in terms of knowing your cap rate in the alternatives is far stronger than retail.”

Meanwhile, distressed retailers are now more willing to sell their properties than they were five years ago. “The challenging retail environment makes a buyout that much more compelling for some of these businesses today,” Zegen remarks. “That conversation is an easier conversation today than pre-covid.”

Also easier today is engaging with local jurisdictions on retail conversion projects. “If all of the sudden you have a defunct owner that can’t pay taxes and retailers are going out of business, that leads to crime, that leads to lost tax revenue,” he explains. “In some of these communities, it may be that much easier to get a rezoning or a planning approval post-covid versus pre-covid.”

The time horizon for retail repurposing opportunities is expected to span the next several years. “Shopping center retail is absolutely distressed as an asset class, and I don’t think that’s going to get better,” Mittal says. “I’ve got to think this going to be part of the opportunity set for the next three to five years. If you think about the typical five-year loan, I don’t think the majority of deals in the last couple of years have been refinanced. They’ve mostly been extended. I think you’re looking at the next few years for most of that stuff to go into the hands of the lenders.”

Tibone believes the timeframe could be even longer. “I don’t think it is a finite window of opportunity,” he says. “I think there’s going to be slew of opportunities over the next five to 10 years as more and more of these weaker malls come to market.”

In the US, the investable universe for malls is much smaller than it is for industrial, office or apartments, where there are thousands and thousands of assets spread across the country, Tibone notes. That said, “I don’t view this as something if you don’t invest in 2021, that you’ve missed the boat,” he asserts. “This is going to be a very long-term trend in my view.”


How retail repurposing is regional

The difficulty of executing conversions in the sector depends partly on where the asset is located. 

The extent of retail distress, and consequently retail conversions, varies by geography. The US and UK are considered two of the world’s most over-retailed markets. The US, for example, has a retail floorspace per capita ratio of 215 square meters of gross leaseable area per 100 people, according to the International Council of Shopping Centers. The UK, meanwhile, has a ratio of 43 square meters of GLA per 100 people, but is a much more densely populated country, having a land mass and population equal to 2.6 percent and 20 percent, respectively, that of the US, according to data from the ICSC and The World Bank.

Mittal notes that it is easier to repurpose retail in continental Europe than in the UK partly because the use class is general commercial, which makes it much less cumbersome to change from retail commercial to office commercial. By contrast, he finds zoning changes to be “very difficult” in the UK because of the number of stakeholders involved and the number of filings and reports that need to be put together. “It really costs you millions to go through that exercise, it takes six to 12 months and quite a bit of a black box,” he remarks.

Availability of retail property data is another challenge, since such information is critical to writing the business plan for the asset, Mittal adds: “Once we buy the asset, we want to be taking that cap-ex or repositioning risk and that might be shrinking the retail. The process of shrinking the retail is knowing turnover data. I think that’s essential. That’s something you don’t see as much in the UK. It makes buying retail a little bit more like shooting in the dark, where you just don’t have that turnover data to figure out if someone’s viable most of the time.”

Meanwhile, Daryl Stubbings, director of Australian investment management at QIC Global Real Estate, the property division of Brisbane-based alternative investment firm QIC, has yet to see a significant repositioning of an entire retail complex in Australia into an alternative use. This is primarily because the country has significantly lower retail floor space per capita than the UK and US, with 106 square meters of GLA per 100 people and a land mass and population approximately 84 percent and 7.7 percent, respectively, that of the US, according to ICSC and World Bank data.

“We don’t have the same level of distressed assets that you see in the UK or in the US where you have high levels of vacancy,” he says. “Our retail sector hasn’t been overdeveloped to that point.”

Instead, retail repurposing in Australia usually takes one of two forms. “We’ve all been looking at how we take space in our malls that’s unproductive, that’s trading below our benchmark levels, and how we convert that to a use that resonates better with our customers and talks more to what the consumer is looking for,” explains Stubbings. This typically includes converting apparel-based retail uses to entertainment- or lifestyle-focused retail uses.

“The other strategy is looking at land in and around our shopping centers to activate uses other than retail,” he says. This usually entails building new space for uses such as childcare, medical office and hotels. “That actually makes the retail more productive and provides resilience to the income stream by bringing more people into your trade area, into your catchment.”