When the coronavirus pandemic seized the U.S., Allen Morris had a plan for Maitland City Centre, a 220-apartment community with a 35,000-square-foot commercial space that claims a whole city block in Maitland, near Orlando, Florida. Mr. Morris, who helms the eponymous development company, would not seek rent from the Centre’s restaurants, which included a gelato shop and several concept eateries, if they stayed operational during Covid-19.
“We took the initiative to go to our restaurant tenants on the ground floor,” Mr. Morris said. “And we said, ‘Look, don’t worry about paying your rent. Just, you must stay open, you must promise us to stay in business because it’s so beneficial to the leasing of our apartments.”
In a time when urban developments across the U.S. are bleeding renters to the suburbs, Maitland City Centre boasts a 94% residential occupancy rate, Mr. Morris said. To a large extent, he attributes that to the presence of commercial tenants, especially food and beverage establishments that have provided convenient dining and takeout options for residents amid the pandemic.
More: As Winter Approaches, Caribbean Islands May Be a Lure for Both Investors and Second Home Seekers
“I believe that the commercial elements and the residential elements in a mixed-use project are entirely symbiotic,” Mr. Morris said. “They benefit one another and create a synergism in a mixed-use project that you don’t get in a standalone building.”
That mutual advantage, however, seems to have somewhat eroded during the pandemic, which has triggered the bankruptcies of major retailers in the caliber of Neiman Marcus, which was to have occupied New York City’s Hudson Yards on Manhattan’s far West Side. The volatile economy is also threatening numerous small businesses and experiential retail, which struggled to stay afloat during the nationwide shutdowns this spring.
According to commercial real estate data provider CoStar, about 130 million square feet of stores will shutter this year in the U.S., a record driven by the disruption of foot traffic and the acceleration of e-commerce caused by coronavirus. Most commercial closures will affect malls, CoStar said, but residential buildings that also house retail are not immune. The typical commercial occupants— think restaurants and gyms that help foster a community for renters and homeowners—are in industries battered by the pandemic.
More: The Pied-à-Terre Could Make a Comeback With Buyers Who Want to Maintain Connections to Cities
Not all major cities, however, are seeing these woes play out equally. While big retailers are closing stores across the nation, some cities like Seattle—which has a relatively low unemployment rate and was able to get the virus under control early on—have been recovering faster than others, propping up small businesses that rely on foot traffic. Moreover, not all metros attract mixed-use developments, which tend to favor dense urban pockets, where residents both work and live.
“Commercial tenancies have a much larger impact on residential buildings in real urban centers like San Francisco or New York or Washington DC or Chicago,” said Scott Gordon, senior vice president for Kennedy Wilson’s property services division in Los Angeles. “There, a very significant retail and dining presence on the lower floors has a much greater economic impact than perhaps in Los Angeles, which is obviously a lot more spread out.”
Renter Woes
Commercial troubles in mixed-use developments usually undermine residential rent prices.
“If you have failed retail tenants in your mixed-use building, it makes the other components of the mixed-use building less desirable because those previous amenities are not there anymore,” Mr. Morris said. “That would tend to put downward pressure on the residential rents or the concessions or the terms that the landlord is getting to the multifamily apartments.”
More: Why You Might Want a Jumbo Mortgage Right Now—Even if You Don’t ‘Need’ It
That pressure can erode the residential rent premium that mixed-use developments often carry compared to the overall market. Depending on the location and the mixture of retail, the premium can be as high as 20%, studies show.
For instance, a Whole Foods supermarket alone can pump up rents by as much as 8.4%, according to a 2019 report by Newmark Knight Frank that analyzed the rent effects of seven grocers in Washington, D.C., Virginia and Maryland. And, this is for apartments located within a mile of the grocer. Units directly above a Whole Foods see even more pronounced prices, the report authors say. For mixed-use developments, retail-anchoring grocers contribute the highest rent premiums.
“Some people just like the convenience of being able to go to the grocery store and not have to step out or being able to run down if they forgot something for dinner,” said Lindsey Senn, executive vice president of finance and development with Chicago-headquartered real estate company Fifield. “Because of that, the loss of a grocer makes much more of an impact than, say, a restaurant closing when there’s another restaurant that’s down the block.”
Taking it a step further, the absence of a business, signaled by dark and boarded-up windows, might give scores of potential residential tenants a pause.
“When you are leasing an apartment, you are selling an experience,” said Mr. Gordon. “When you have an empty commercial space, it is about perception.”
Because of this, developers are now more scrupulous about the commercial tenants they sign on. Before the coronavirus outbreak, developer Joseph Kavana, chairman and CEO of Sunrise, Florida-based K Group Holdings, had been in talks with multiple restaurants he considered bringing to Metropica, a $1.5 billion, 65-acre community under construction in Broward County near Fort Lauderdale. The pandemic has changed the conversations.
“We have had discussions with a lot of different restaurant groups,” Mr. Kavana said. During the pandemic, “some of them have done better than others. Frankly, at this point, we believe that the best approach is to take a breathing moment and wait and see what develops after this.”
Despite the pandemic, Mr. Kavana hasn’t scrapped his intention to have eateries as well as offices in Metropica, banking on the idea that people will eventually return to both.
NYC Co-ops Can See a Direct Hit
One segment where shuttered retail has easy-to-measure financial implications for residential occupants is the New York City co-op market. When co-op buildings lease their ground floors to businesses, the generated revenue helps defray the monthly fees for the residential owners.
Earlier this year, Warburg real estate agent Christopher Totaro worked with the buyer of a 2,500-square-foot home in an eight-unit co-op in downtown Manhattan. The monthly co-op fee was about $1,000. Then, in April, before Totaro’s client purchased the unit, the business downstairs, an upscale furniture design shop that paid roughly $1 million in annual rent, moved out for a reason unrelated to the coronavirus. The departure pushed the co-op fee to $3,000, Mr. Totaro said.
More: Low Mortgage Rates, Limited Inventory, and Pent-Up Demand Could Make This Fall a Busy Season
“If you’ve got a business such as a restaurant that is shut down because of Covid or is not paying rent, the people that live upstairs may be paying to carry that restaurant through these times,” Mr. Totaro said.
Co-ops without hefty reserves to continue paying their mortgage and maintenance in the absence of commercial rent might have little choice but to increase their owners’ fees. After some consideration, Mr. Totaro’s client went through with the purchase.
“People, I think, don’t understand the magnitude of the ripple effect” of underperforming retail, Mr. Totaro said.