Outside the Box: Brick-and-mortar retail gets a new lease on life as entrepreneurs move into empty spaces

A strange thing is happening in Chicago’s northern suburbs — fine-dining restaurants that previously wouldn’t set foot outside of downtown are rushing to open up there.

Le Colonial, for years a downtown fixture and one of Chicago’s most stylish restaurants, this yearannounced a new location in Lake Forest. Nearby Winnetka recentlywelcomed a French bistro and a high-end steak restaurant, owned by a hospitality group that had previously focused on the downtown area.

The immediate reason for this shift, of course, is that the pandemic and resultant remote working has reduced foot-traffic in many city centers and created a new market of well-off consumers who are spending far more time at and around their homes than before.

But that’s just one part of a bigger picture in brick-and mortar retail that runs counter to the dominant narrative that has predicted the demise of brick-and-mortar retailing. Retail real estate is proving resilient and is even poised for a rebound, despite pressures caused by Covid and growing online channels.

Startups galore

A big reason for my relative optimism about retail real estate is the surge in U.S. entrepreneurial activity sparked by the pandemic. After a steady decline for more than a decade, the average number of business startup applications soared 58% between April 2020 and November 2021, according to Census Bureau data. These entrepreneurs often (or eventually) need physical retail space.

The pandemic has forced millions of people to rearrange their lives and reconsider their priorities, turning away from the 9-to-5 template. At the same time, the influx of government support has slightly de-risked the entrepreneurial economy and, helped by lower-than-usual retail lease rates, given people the courage and opportunity to pursue their startup ideas.

That means more retail spaces will be occupied by incoming businesses. And as these business start up, they will often require an overhaul and repurpose of the physical footprint; Whether that’s a run-down old building being repurposed as a new restaurant, or a hair salon redesigned as a doggie day-care center, these spaces will recycle.

Does this mean physical retail activity will start to claw back share from online? Likely not. But it does mean that the outlook for a big chunk of the $426 billion commercial construction industry will be significantly brighter than currently experienced.

Trickle-down benefits

Commercial construction activity slipped slightly last year, but we forecast it will pick up again in 2022 and beyond. Over the next four years, we expect retail construction to rise at an annual pace of around 3.3%-3.5% — net of inflation — narrowly outpacing broader commercial construction activity.

The trickle-down benefits are substantial. Demand for refitting and repurposing retail spaces stands to strengthen the whole ecosystem, from construction firms to building products to architects and interior designers. Property owners too will gain, even if they are leasing at lower rental rates than before. After all, that’s much better than having unoccupied space.

Significant spending on retail construction occurs when a lease turns. It can be pretty sizeable, even for relatively small projects. 

There are some risks and headwinds to this scenario. Inflation could push renovation costs higher, crimping entrepreneurs’ risk appetites. In an inflationary environment, variable new fixed mortgage payments would also rise, though existing fixed mortgages would be unaffected. A major stock market correction could deflate some entrepreneurs’ investment capacities.

Overall, though, the coming years are likely to show that the demise of physical retail activity has been greatly exaggerated. Chicagoans, who are now enjoying Loop-quality dining options in the northern suburbs, likely agree. The rest of us, too, can expect a slew of new businesses to repurpose old, empty spaces. 

Rob Rourke is vice chairman, Global Industrials, at L.E.K. Consulting.

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