Back to the future in commercial real estate

Newsweek economics columnist Robert J. Samuelson declared in his December 29, 2008 column that 2008 was “the end of an era.” He wrote, “We know 2008, much like 1932 or 1980[?], marks a dividing line for the American economy and society.” The economic trends in the commercial real estate market bear out Samuelson’s claim.

On Friday, December 26, an opinion piece on Slate’s “The Big Money” declared, “Shopping malls are a thing of the past. It’s time we closed them all down. The author, Chadwick Martin, pointed out some current facts:

Already, malls are in a considerable amount of trouble. Shopping centers on the block are selling for 25 percent to 35 percent less than they did just a year ago. Retail vacancies are on the rise; nationally, 6.6 percent of stores were empty in the third quarter of 2008, a 20 percent increase from the same quarter last year and the highest mark since 2002. Much of the pain is interwoven with the retail sector, where analysts estimate 148,000 stores will have been closed in 2008.

The changes in these malls are the very opposite of the revitalization of walkable urban places such as in Silver Spring, North Arlington, and Logan Circle:

At the risk of getting Gladwellian, every store that closes has an impact on the shops left behind. Walking through a half-empty mall is an unsettling experience; it feels as dreadful as Dawn of the Dead, just without the zombies.

Many mall management firms are also in financial trouble because of losses from many bubble-era real estate deals. What truly surprised me was the author’s conclusion about what to do next:

But why just consolidate? Let’s close them all. I’m not saying that all of their tenants should close. Instead, the stores that once filled the malls should go and fill other empty storefronts dispersed across the city. Call it the great chain-store diaspora.

Even writers from the urbanist community don’t advocate wholesale closing of malls, acknowledging that malls are private property. While economic commentator Mike “Mish” Shedlock declared that the “Shopping Center Economic Model is History” back in April 2008, he made no comment about where to go from here; as a libertarian-leaning economics and finance writer, urban planning and infrastructure are outside the scope of Mish’s blog. As far as I know, no one outside the urbanist community has previously concluded that it would be okay or even positive for malls to go out of business, and for the stores to relocate to Main Streets. What a year it’s been.

Of course, it’s possible that an even more auto-dependent form could succeed the malls, if such a form even exists. However, the nationwide trend is moving toward faux town-center-like “lifestyle centers.” In a “lifestyle center,” it’s not as big of a jump to add a little housing, remove some surface parking, and maybe add a few offices. It’d be even better to simply redevelop the land into a true walkable urban place.

However, hoping for the wholesale replacement of malls with either of these more walkable forms is unlikely. The fact remains that there is more commercial space than existing demand. We know there was enormous and mostly car-dependent commercial real estate overbuilding during the bubble years. At the time, chain retailers engaged in bidding wars to rent space in a shopping malls and strip mall in the latest piece of sprawl. Even more amazingly, the space was often 80 to 100 miles from the nearest non-retail jobs. Now that euphoria has turned to panic, we’re finding the true value of far-flung malls (and exurban McMansions). It’s an awful bind.

There is a potential silver lining in the current panic-filled commercial real estate environment. As Mr. Martin mentioned in his piece, those stores have to go somewhere. Many of those stores will want to own or lease their own buildings. Some might try the single use building on the suburban arterial behind acres of parking. But this could be problematic for stores that aren’t all-in-one retail big boxes such as Target. After all, who wants to fight traffic while driving to a sprawl-mart that only sells one category of product? Wasn’t the all-in-one format one of the most appealing aspects of a suburban shopping mall? More importantly, how many of those mall-based retailers will want to operate in a building that is large enough to be practical in single-use suburban form? Will higher-end boutique-format chain clothing retailers like Banana Republic, Anne Taylor, Express, Guess, Kenneth Cole, etc. be able to operate out of a stand-alone single-story building set back behind acres of parking on the side of some suburban arterial?

If that would work, some of the national higher-end retail brands would already be trying it. But these stores have found success opening stores in walkable urban places. In the District of Columbia, there are four shopping districts that support clusters of national retail chains that are usually mall-based: Downtown (Old Downtown clustered around Metro Center), Connecticut Avenue between Farragut Square and Dupont Circle, Friendship Heights, and Georgetown. Columbia Heights is emerging and has a different mix of retailers. Additionally, some clothing stores that usually locate in malls have opened shop in the Fenton Street development in Silver Spring.

These are successful shopping districts for similar reasons that private car-dependent shopping malls were successful. There is a large cluster of different stores that serve different tastes, but similar socioeconomic demographics. Within a similar distance as spanned by a typical mall, a shopper can reach a similar selection of stores. Furthermore, no shopping mall in the region can offer the extra added bonus of the historic Downtown’s flagship stores. The Macy’s is five floors tall, bigger than any other Macy’s in the region. The H+M offers the chain’s entire product line, like their stores in Manhattan. The Zara spans two floors. And so on.

The walkable urban shopping district is a much better arrangement for society. The stores don’t all rent from the same landlord. Because they are in a district that has more uses than just retail, one business failure has less effect on all the other stores. There are still restaurants, offices, other stores, and residences to generate foot traffic. It takes years for a mixed-use walkable urban district to decline, rather than months like shopping malls did during 2008.

Retailers will start to encounter similar problems as those who currently prefer to live in a walkable urban place: lack of affordable rents. Because we as a nation have spent 60 years building almost exclusively car-dependent environments, there will be more retailers interested in walkable urban places than vacancies. Rents for retail space in walkable urban places will increase, just like it has for residential space because of its relative scarcity.

One likely outcome is for the chains to just keep bidding up the rents, making it impossible for legacy small businesses to keep their doors open. Alternately, the chains could stop bidding against each other and instead set up shop in another section of the metropolitan region, thus beginning a cycle of revitalization in another walkable urban place. However, we know from practical experience that the latter mode is not how chains operate. If they did, Apple would be in discussions with the Shaw Historic District rather than in Georgetown over the design of their new store. Chains look at income levels, rents and other quantifiable factors from afar when choosing where to set up shop. That’s why Apple is opening another store in the Favored Quarter rather than going where the rents are lower. They’re a big corporation. Even though they make really cool products, they don’t know and don’t care about Washingtonian development economics. It’s not their business.

Still, it’s quite possible that Apple would make even more money in Columbia Heights or Logan Circle or Shaw or College Park because of those locations’ cheaper rents and better Metro accessibility. But Apple, located in Cupertino, California, really doesn’t know about how Metro access affects local businesses in our region. It’s not in their computer model. I’m not specifically criticizing Apple; this is simply how national chains conduct their business.

As a result, all these stores that are getting displaced from dying malls are in for a rough ride. In the big picture, most players in the commercial real estate game have no idea what consumers want right now. Most consumers don’t either. However, consumers are voting with their dollars that they don’t want the suburban mall anymore. In other words, strap in because we’re in for a really rough ride in retail, as our nation enters a period of cognitive dissonance that will mark the historic boundary between the post World War II oil-and-corn-syrup economy, and whatever emerges next. Based on the trends in commercial real estate, a more urban future looks bright on the other side.