Retail Development – Weathering Choppy Seas While Staying Afloat

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As 2021 came to an end and the calendars flipped to 2022, many in the retail development industry were hopeful that better times were ahead.  The country was climbing out of a crippling global pandemic, but many retailers who had been forced to close in 2020 and 2021 had re-opened, customers slowly got back to shopping and eating out, and life returned to what would pass for “normal,” at least in terms of shopping preferences.  However, as we look toward 2023, uncertainty still exists in the retail development industry, this time in the form of supply chain issues, rising inflation, a labor shortage in retail, and general doubts about the economy, all of which will likely affect the retail sector in 2023.  Despite all of these pressures and uncertainties, many in the industry remain cautiously optimistic about the coming year, while acknowledging that being able to adapt to changing times will remain key to survival.

Any consideration of what might occur in 2023 requires us to revisit the impact of the pandemic to date.  As the effects of COVID­19 continued to linger in early 2022, millions of retailers were forced to close their businesses, and some of the smaller retailers (especially “mom-and-pop” restaurants and sundry shops) were unable to re-open and turned their keys back over to their landlords.  Others reopened briefly, only to close again.  As a result, despite the efforts of many retail developers (and the Federal Government) to provide financial assistance, the pandemic resulted in the shuttering of millions of square feet of retail space.  However, some might argue that COVID­19 only accelerated the inevitable for some retailers, who were struggling before the pandemic.  This may actually result in a net positive for some landlords, who will be able to replace non-rent-paying tenants with new retailers to try to jump start their projects.

During calendar year 2022, many retail developers have been proactive in dealing with struggling tenants by negotiating early lease terminations.  These developers are seeking to strategically take back certain spaces prior to the natural expiration of the applicable leases in order to remerchandise with better tenants and higher rents.  Some “mid-box” or “junior anchor” tenants like PetSmart and Staples, who are looking to downsize their footprints, may be willing to give space back early, allowing landlords to aggregate enough square footage to attract certain “hot” retailers in an effort to revitalize their shopping centers.  For example, discount and dollar stores such as Dollar General, Family Dollar, Dollar Tree, and Five Below are in the market for residual space, often in the 5,000- to 10,000-square-foot range.  Dollar General, alone, recently announced plans to open more than 1,000 new stores in 2023, while Five Below is hoping to open 200 new stores.  In addition, many retailers in other sectors, such as convenience stores, cosmetics, hobby stores, home furnishings, pet concepts, and shoe stores have accelerated expansion plans for 2023.

Other retail developers spent much of 2022 trying to support their tenants to help keep them open and paying rent.  Some retail developers continued to organize curbside pickup programs at their properties to assist smaller retailers who lack the resources to establish their own programs.  In addition, many developers are being forced to get creative with their parking lots to provide their tenants with the ability to offer buy-online-pick-up-in-store (BOPIS) capabilities, a trend that started during the pandemic, but appears to be here to stay.  Since statistics show that over 80% of BOPIS consumers will shop for additional items while picking up their orders, it is no surprise that retailers are interested in offering this service, which may continue to be viable even when the pandemic subsides.  Also, many retailers are requesting the right to reduce operating hours to accommodate for limited employee availability, despite contrary language in their leases.  This results in instances where landlords are trying to be flexible by agreeing to allow certain stores to be open, while others are not (which is generally a situation landlords try to avoid).  The common thread is landlords working with tenants to keep businesses open (and somewhat profitable) and making retail establishments feel as safe as possible to consumers, in order to keep them coming back.

In terms of what is occurring with different types of retail projects, grocery-anchored neighborhood centers appear to have weathered the storm and generally continue to provide a good return for their owners.  Recent data indicates that, by mid-2022, national vacancy for neighborhood centers had fallen to 6.6%, well below the reading of 6.9% recorded in the fourth quarter of 2019.  Newer market entrants like Aldi and Lidl have helped bolster the sector.  In addition, specialty grocers, such as Whole Foods, Trader Joe’s, Erewhon, and Sprouts continue to open stores and provide some security to their landlords.  Moreover, data indicates that fewer consumers are buying groceries online, in many cases because they think that the fees and other extra charges make it more expensive than shopping in-store.  According to recent reports, e-commerce sales across the United States declined by 10% year over year in November, resulting in more trips to the local grocery store and, consequently, more foot traffic in the neighborhood center.

Another sector that seems to have rebounded is the luxury brands sector.  While data indicates that luxury sales in the U.S. decreased by 14.3% in 2020, likely due in large part to the pandemic, customers in 2022 appear to have resumed spending on pricier items, and luxury good sales for 2022 are expected to be on par with 2019.  Some attribute this to customers’ desire to “touch and feel” a product before spending $3,000 on a handbag or $5,000 on a sport coat, something that was much more difficult to do during the pandemic.  Luxury brands are also getting creative with pop-ups and Instagram activation to test concepts, while simultaneously attempting to appeal to a younger audience.  Of course, the ability to lease to a luxury brand provider is market driven and is not a viable option to all retail property owners.  However, those developers with the right real estate are finding willing partners with luxury brands like Hermes, Gucci, Channel, and Dior.

Not surprisingly, traditional enclosed regional malls have struggled, likely because shoppers have been unwilling, or unable, to brave the enclosed spaces that make up most indoor malls.  As a result, owners of regional malls in non-affluent areas (mainly Class B and C malls) have had to adopt non-retail uses to stay relevant.  Such uses include offices (ranging from call centers to high-tech spaces), distribution and industrial centers, movie stages, and data centers.  Other “experiential” uses like pickleball courts, golf-themed spaces such as Puttshack, Puttery, and Popstroke, and bowling alleys like Stars and Strikes and Main Event are becoming viable options for retail developers with large spaces to fill.  Whether such uses will still fall in the “retail” category after conversion remains to be seen, but there does seem to be an appetite for developers to repurpose underperforming enclosed malls.  In addition, the ability to add such non-traditional tenants needs to be balanced against the rights of other existing tenants that may have the ability to keep certain uses out of a given project.  A non-traditional use may allow a retail developer to temporarily re-lease space and get some rent in return.  But adding such uses may upset major or anchor tenants at a project, who may decide to aggressively fight the new uses or to leave the project when their current term expires, rather than renew or exercise available options.

Meanwhile, many retail developers continue to be affected by the closures of department stores, such as Sears, Macy’s, and JC Penney.  Even before COVID­19, the deconstruction of the department stores, or “right-sizing,” was seen by some as the natural progression of retail; those department stores that have elected to stay open have generally reduced product offerings to three primary product categories—apparel, housewares, and cosmetics/fragrances.  At the same time, some larger retailers are looking at less popular malls for their next store.  These retailers, who may have struggled to stand out at a crowded top-tier mall, may determine that their position at a lower-class mall is actually elevated, giving them a stronger position within the market and an increase in sales.  While this trend is not a given in 2023, it is certainly something to keep an eye on, especially for owners of Class B and C malls.

As has been the case in recent years, retailers will need to continue to adapt to the changes in their customers in order to continue to be successful.  For example, the importance of being able to offer “omnichannel” marketing has been magnified by the pandemic.  Recent data indicates that business that adopt omnichannel strategies achieve 91% greater year-over-year customer retention rates than business that don’t, and that consumers now use an average of almost six touchpoints when buying an item.  In addition, customers are becoming increasing cognizant of “sustainable shopping,” where shoppers express curiosity about what a product is made out of, where it is made, and what they can do with it when they have finished.  As a result, many retailers have been forced to improve their corporate social responsibility initiatives by selling ethically-sourced products, implementing green business practices, and being transparent with that information with their customers.

When it comes to the world of retail development, many believe that the pandemic accelerated the evolution of retail, perhaps for the better.  The good news is that brick-and-mortal retail has survived, exhibiting the resilience that many in the industry feel will allow it to weather new challenges in 2023 like supply chain issues, rising inflation, and a labor shortage.  To do so, retail developers will continue to be forced to adapt by working with their tenants to keep them open and transforming their projects to deal with whatever the immediate future brings.

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