Perhaps more than any other modern company, e-commerce behemoth Amazon.com Inc. has disrupted the retail landscape. Within that territory, Amazon is now poised to shake up the retail real estate sector.
The Wall Street Journal reported on Aug. 9 that Amazon is exploring a partnership with Simon Property Group Inc., the country’s largest mall owner, to convert empty Sears and J.C. Penney spaces into Amazon distribution centers. Two days later, CNBC reported that Amazon might open some of its new large-format grocery stores—not Amazon-owned Whole Foods locations or Amazon Go no-cashier convenience stores—at Simon properties.
To be sure, both concepts are innovative. But what might block the door to these opportunities? Experts say zoning regulations and co-tenancy clauses could trip up these plans. However, these potential obstacles would likely come into play more with Amazon-run distribution centers than with grocery stores.
Retail vs. industrial
According to CNBC, Floris van Dijkuma, managing director of Washington, D.C.-based investment bank Compass Point Research & Trading LLC, says that since a grocery store is considered to fit a retail use, it could be “much easier” to place one within an old anchor store than it would be to backfill it with a distribution center.
It’s unlikely that an Amazon distribution center would qualify as a retail use, according to Larry Silvestri, a commercial real estate attorney in St. Petersburg, Fla. Therefore, a retail-to-industrial transformation might be restricted under zoning rules that have been on the books for decades. In addition, such a conversion might violate a reciprocal easement agreement between a mall developer and the remaining anchor tenants, says Silvestri, who has extensive experience in retail real estate.
Co-tenancy clauses might also stand in the way of an Amazon distribution center occupying an anchor space at a mall. A co-tenancy provision in a lease requires a landlord to maintain a certain share of operating space within a retail center or to keep certain anchor tenants open. If a percentage of space or a specific store stays empty, a co-tenancy clause might let an in-line tenant insist on rent concessions or even back out of a lease.
But a retail giant like Indianapolis-based Simon, the owner of the largest retail real estate portfolio in the country, wields negotiating power over tenants that a smaller landlord might not hold, Silvestri points out. So, Simon might be able to overcome tenants’ objections to an Amazon distribution center, particularly since a lot of retail tenants are seeking rent relief during the coronavirus pandemic, according to Silvestri.
“I suspect that Simon has the ability, in some of its malls, to do this now without a lot of heavy lifting,” he says. “But at others, there might be some heavy lifting needed to deal with these issues.”
On top of that, Silvestri suspects that most co-tenancy clauses at Simon properties still favor Simon.
Another advantage for Simon, according to Silvestri: It contributes a pile of property tax and sales tax revenue to the communities where it owns and operates retail centers. That could buy it some goodwill with local officials who control zoning.
“I have a great respect for the vision and the ability of Simon executives to plan this out and not go off half-cocked, and Amazon also has a certain degree of political clout at the national level,” he says.
Shopping for groceries
Experts say Amazon might also be able to conquer concerns by folding a true retail component—like a grocery store or a showroom—into a mall-based distribution center.
“I find it very interesting and encouraging,” Silvestri says of Amazon’s grocery-at-the-mall concept. “I would mourn the death of the mall. I do not mourn the evolution of the mall.”
Grocery stores at malls certainly aren’t a new phenomenon. For instance, Rochester, N.Y.-based Wegmans Food Markets Inc. in 2018 opened a two-story location in an empty 146,500-sq.-ft. J.C. Penney store at Natick Mall in Natick, Mass. Brookfield Property Partners LP owns the mall.
Silvestri describes Wegmans’ execution of the Natick location as “superb.”
“It’s not just a mall owner filling space, and that makes a big difference,” he says. “A lot of it is in the execution. If you just take a dying suburban mall and put a grocery store in it, it’s not going to lift all the boats with the tide. You have to execute properly.”
Embracing industrial
As for industrial uses at malls, Silvestri says the “knee-jerk reaction” would be to reject Amazon warehouses. But what, he asks, are the alternatives for reinvigorating a sagging mall?
In fact, Amazon signage and Amazon trucks at a mall—along with Amazon employees working inside and their vehicles parked outside—would make the property look busier and could help attract shoppers, says Tom Donovan, partner and vice chairman at New York City-based commercial real estate brokerage firm B6 Real Estate Advisors LLC, says.
“Perception becomes reality,” Donovan says. “Initially, tenants may not love the idea. But I think, bigger picture, it’s healthy for the industry to have these spaces not boarded up.”
Regardless of whether Seattle-based Amazon occupies space there, retailers will still be eager to lease space at class-A malls, according to Donovan. “I don’t think larger retailers are going to boycott the malls just because of Amazon,” he says.
A “natural evolution”
The idea of opening Amazon warehouses within Simon properties is “brilliant,” according to Ami Ziff, director of national retail at New York City-based real estate investor, developer and manager Time Equities Inc.
Last-mile distribution represents a “natural evolution” of old big-box spaces, he says.
“I think it’s possible. And I think it was bound to happen,” Ziff says. “There’s a supply-and-demand imbalance. There [are] fewer retailers looking for space, and we’re overbuilt.”
In 2018, the U.S. had more retail space per capita—23.5 sq. ft.—than any other country, according to Statista. In second place was Canada, at 16.8 sq. ft.
By contrast, demand for warehouse space in support of e-commerce is rising. In July, commercial real estate services company JLL predicted U.S. e-commerce sales could soar to $1.5 trillion by 2025, triggering the need for an additional 1 billion sq. ft. of industrial space across the country. Craig Meyer, Americas president for JLL’s industrial segment, calls the industrial sector “the darling of the commercial real estate industry.”
Eliminating “eyesores”
One of the knocks against carving out mall space for distribution centers is a potential drag on foot traffic. But real estate observers say some foot traffic generated by an Amazon warehouse would be better than no foot traffic generated by an empty anchor.
“Smart retailers will leverage their current stores and their footprint to support those [fulfillment] operations, and folks like Amazon will continue to absorb more space that’s close to the customers they’re trying to deliver to,” Ziff says.
To accommodate industrial uses at malls, Ziff expects more retail co-tenancy clauses to include language allowing distribution and fulfillment centers. Ziff says that with any industrial outfit occupying a Time Equities property, it would be critical for a retail operation to be part of the mix. Across the board, though, the ability of Amazon and similar companies to open industrial facilities at retail centers remains a gray area.
Ziff says most “reasonable” retailers would welcome an Amazon warehouse as an industrial occupant at a mall, since a vacant store is an albatross. Retailers “can see that vacancies are eyesores, and vacancies don’t add any sales or any traffic or any co-tenancy,” he notes.
