The Evolution of Retail Part II: Power Centers
Jeff Green and Jason Baker/Shopping Center Business

In our first article of this series, we talked about the ever-changing world of retail real estate. From the impact of e-commerce on brick-and-mortar stores to the lack of new development and the growth of non-retail uses. In this article, we take a closer look at the evolution of the power center and how it must adapt to stay relevant as retail continues to change.

The power center entered the American retail scene in the 1980s as a haven for large “category killer” retailers that wanted to set up shop in conspicuous warehouse-sized complexes of 250,000 square feet or more. Typically built near regional malls and other high-traffic areas, power centers fared reasonably well— until the recent recession. When retailers began rethinking their store prototypes and questioning if they could be equally relevant in smaller spaces, the power center became less desirable.

Some power center retailers such as Mervyns were already starting to implode before the downturn, which eventually claimed other such prominent retailers as Linens ’n Things, Steve & Barry’s, Shoe Pavilion and Circuit City. More recently, the Borders bankruptcy returned an additional 12 million square feet of space to the market, nine million of which was located in power/regional centers, according to Terranomics Research.

Such real estate changes have combined to create harder-to-fill power center vacancies, many with relatively narrow storefronts and long, deep spaces that aren’t always practical for modern merchant footprints. Some of the better-located power centers are signing replacement tenants, but there’s still far too much inventory on the market despite recent economic improvements. After all, for every major regional mall that was constructed in a 15-year period ending in the early 2000s, there were up to six or seven power centers built. That’s a lot of space to maintain.

Power center retailers continue to re-assess their space needs. For example, after dropping its weaker-performing categories such as recorded music, Best Buy has found it doesn’t need its copious 30,000- to 50,000-square-foot space. It’s already started moving to smaller digs to sell today’s sleeker electronics line. Many traditional power center retailers have started gravitating to more compact spaces in open-air lifestyle centers, in part because studies have shown that shoppers spend more time and money at centers that offer a greater variety of tenants.

As retail leases at power centers continue to expire, many tenants are either choosing to shrink their box sizes or not renew at all. There are some instances when a big-box tenant can shrink in place, though the odd-shaped power center spaces often make that impractical. Sometimes the space a retailer is willing to give up is not always the most re-usable because it’s located at the back of the center. Moreover, regional malls are taking big-box power anchors such as Dick’s Sporting Goods and Bed Bath & Beyond to fill their own vacancies.

All of these departures have created a ripple effect: Many power center anchor leases have very restrictive co-tenancy provisions built into them. That is, if centers lose key anchors and can’t replace them, the other anchors become entitled to penalty-free exits or much cheaper rents.  If center owners try to bring in non-retail uses to fill the gap, co-anchors are often able to cite any one of dozens of “use exclusions” built into their contracts, giving them similar exit or rent-rate latitude.

Additionally, the largest remaining big-box tenants, including Costco, Walmart, Sam’s Club, Target, Lowe’s and The Home Depot aren’t usually interested in second-generation power center vacancies. In the few spaces they can fit, parking usually isn’t adequate enough, so they opt to build most of their locations instead.

So what’s the solution? We’re seeing some viable tenants surfacing, most notably expanding national retailers such as Nordstrom Rack, TJ Maxx, Home Goods, Sprouts, Marshall’s, Ross Dress for Less and Stein Mart. Larger value retailers like Big Lots and other regional players are also expanding; however, as we mentioned in our last article, many of these users are hitting a growth saturation point. The home furnishings arena, which has been expanding aggressively over the past few years, is especially in danger of this.

The positive side here is that there is clearly a retail recovery happening. It just doesn’t include any new construction. In the third quarter of 2011, 1.75 million square feet of power centers were under construction, compared to 17.75 million square feet in the third quarter of 2008. And, while power center vacancies improved slightly to 7 percent in the third quarter of 2011 from 7.6 percent in mid 2010, the rates are still markedly higher than the mid-four percent levels of early 2008, according to CoStar.

Some power center retailers are starting to rethink their “poison-pill” posturing and are realizing that, in order to thrive, they must recognize their centers have changed. They will need to grow more flexible about their co-tenancy demands if we’re going to see some relief. If this happens, we think the market will start to see more power centers adopting a mix of non-retail uses such as medical, education, gyms, day cares, museums and even civic uses like sub-courthouses and motor vehicle departments. To overcome the over-supply of power center space, the industry will have to think creatively and remain open to these alternative uses.

The lack of new supply is already putting more of a premium on vacant space in the better-quality power centers as the retail economy is slowly expanding again. But don’t look for any new construction of the power center space like we saw prior to the downturn. Those power centers will likely become functionally obsolete in the next real estate cycle. At least, that’s what history has taught us.

In the third part of our series, we will look at the evolution of the American icon, the regional shopping mall. We’ll show how the mall has fallen out of favor in development circles and been forced to re-engineer itself to adapt to new market realities.

Jeff Green is president and CEO of Phoenix-based Jeff Green Partners, a leading consultant in retail real estate feasibility, retail expansion planning, medical retail planning, location analysis and commercial land use. He can be reached by email at jgreen@jeffgreenpartners.com.

Jason S. Baker is an X Team International partner and co-founder and principal of Houston-based Baker Katz, a full-service commercial real estate brokerage firm specializing in first-class retail tenant representation, project development and leasing, and investment sales. He can be reached by email at jbaker@bakerkatz.com.