CREJ - Retail Properties Quarterly - February 2015
Retail in central Denver neighborhoods is booming with strong job growth, new millennials arriving daily and a limited supply of real estate. This creates not only opportunities, but also several challenges for the central retail markets. All the new, young people downtown is driving demand for housing as well as places for these folks to eat, shop, socialize and recreate. Central Denver retailers are now defined as hip, progressive, artisan, foodie and trendy, which is what its young, rapidly growing population is looking for. The growing demographic is just what retailers are looking for as well – young, employed and without kids, which means, unlike me, they have time and money to spare. The challenge for landlords, developers and investors is how to balance the need for predictable, stable and creditworthy tenants with a track record that banks and investors desire, with the demand for hip and progressive entrepreneurs. Something new and exciting could be great for a property, but which cool new restaurant or retailer is going to have the long-term success that makes the bank and investors happy? The other prevalent market dynamic in central Denver has been the new ground-floor retail opportunities that have come with the boom in multifamily developments. Though it has been great to have new product provided in mixed-use developments, it also has been a challenge for retailers to get comfortable with this product type. Retailers are used to single-story buildings with visibility, access and ease of parking as top priorities when choosing locations, and many of these fundamentals are tested in a mixed-use project. My company is spending more time than ever helping landlords and tenants navigate these trends. Our experience with urban properties, as well as with retailers and landlords in traditional shopping centers, has given us an opportunity to help bring these two together. The landlords of urban properties take advantage of the hot market, and the owners of traditional shopping centers are able to attract new active tenants. Mixed-use retail. Millennials are driving demand for urban housing and thus creating the multifamily construction boom we are currently seeing. The good news for retail tenants looking for space is that almost all of the new large multifamily developments include ground-floor retail, which is helping to balance some of the demand for new space. The challenge is that many mixeduse projects are built with the residential units as the primary focus, leaving ground-floor retail spaces struggling because they are not traditional real estate assessment models. Access, visibility, parking and other key aspects that retailers typically are looking for are different in an urban setting than in a traditional shopping center, which makes it difficult for retailers to assess these sites. Since retail is only a small portion of the overall project, there is not a consistency in retail dynamics that one would find in more traditional retail settings, making it more difficult to prelease some of these projects. Because retailers have difficulty applying traditional formulas (traffic counts, ingress, egress, parking stalls) and their spaces can be less visible because they are a part of a large vertical building, they prefer to wait until projects are substantially complete, and physically walk the site to feel comfortable with it. These projects tend to lease up later into the development process than single-story retail, and a retailer who is not local has to be really interested in order to make a trip to walk the site. Working with landlords to help gain perspective on what retailers are looking for at these sites, and tenants to help them assess which opportunities are right for them, is key throughout this process. From the developer perspective, it is important to know that not all ground-floor space has to be retail. There are other ways to use the ground-floor space if the correct retail dynamics are not there. However, it is enticing because it boosts the pro forma and activates the front door of the project, while empty ground-floor retail does nothing to help the bottom line or the appearance of a new development. For retail in mixed-use buildings to be successful, there has to be strong pedestrian traffic and a surrounding cluster of active retailers creating enough activity to overcome a retailer’s traditional dependence on auto traffic, easy access and parking. Restaurants. The central Denver restaurant market is hot, but beware of the revolving door. 2014 was a record year for restaurant openings in Denver, as Westword tracked over 300 restaurant openings throughout the year. (Almost one per day!) Compare that with 2013, when there were 200 restaurant openings. Hip, new restaurants tend to open with great fanfare and are quick to be touted as a smashing success, while restaurant closings seem to get lost in the noise created by all the grand-opening celebrations. Westword also reported 100 restaurant closings in 2014. This is still a very healthy restaurant market for landlords, with a net gain of 200 restaurants. The challenge is how to avoid being in the situation where your space becomes a revolving door of openings and closings, a trend that never seems to work out for anyone. With demand high and a limited supply of restaurant space, the law of supply and demand says rents will keep pushing higher. With higher lease rates and new entrepreneurial restaurateurs who either overlook their occupancy costs due to the desire to get a space, or are inclined to inflate their potential sales, many restaurants are in trouble the day they sign their lease. Restaurants generally look to keep their rent plus triple-net expenses in the range of 6 to 8 percent of their total sales. It is important for landlords to understand that the longterm success of their tenants is dependent on keeping rents in line with a restaurant’s potential sales. Collecting the highest potential rent requires finding tenants that will achieve the highest sales in a particular location. This can be challenging because much of the current activity for restaurant space is coming from new one-off concepts. A look at the sales-persquare-foot numbers of national brands can help landlords understand what the rent-tosales ratio looks like, since most are familiar with these concepts and the average unit sales are made public. Restaurant chains like Chipotle are attractive to developers not only because of their credit rating (or because their burritos are so tasty), but also because they have some of the strongest sales-per-sf numbers of any restaurant concept out there. A Chipotle store will average $2.17 million in sales out of a regular size space of 2,580 sf. This breaks down to $840.69 per sf at 6 to 8 percent, meaning this store can be profitable with gross lease rates in the $50 to $65 per-sf range for base rent plus triple-net expenses. With rents plus triple net expenses in central Denver reaching record numbers, developers need to look at whether the tenants they choose can sustain high enough sales to stay in business and avoid the costs of the revolving door.