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When Retail Won't Work: Alternative Uses for Converting Former Ghost Malls Back Into Income-Producing Property

Major Mall Makeover, Downsizing and Debt Reset Often Only Way to Reclaim Property's Highest And Best Use
October 17, 2012
Rackspace occupied the dead Windsor Park Mall in 2007 after demolishing the structure and converting it to Class B office space.
Rackspace occupied the dead Windsor Park Mall in 2007 after demolishing the structure and converting it to Class B office space.
Like hundreds of aging and obsolete shopping malls scattered across suburban America, Windsor Park Mall, located in a gritty area northeast of San Antonio, was a property on life support waiting for someone to pull the plug.

The neighborhood's demographics had deteriorated and the classic graybox built by Simon Property Group forerunner Melvin Simon & Associates during the regional mall heyday of the mid-1970s had slowly declined, losing anchors one by one, followed by nearly all the center's 116 shops. The last department store, Mervyn's, closed in 2005. The same year, the 1 million-square-foot mall's best use became a temporary refuge for hundreds of victims of Hurricanes Katrina and Rita.

Rackspace Hosting, a fast-growing cloud-computing and web hosting company, was looking at options for housing its rapidly expanding operations by 2007. It was considering putting a new headquarters in the San Antonio area, or relocating into larger space in Raleigh, N.C.

One option available in the San Antonio area was working with economic development officials in Windcrest, a small city about 12 miles northeast of San Antonio. Their main goal was to find a taker for the abandoned mall on Interstate 35 and Walzem Road, a major eyesore in a suburb of barely 5,300 people.

"It was a mall. It went downhill and now it’s an office building," said Graham Weston, co-founder and chairman of Rackspace Hosting in San Antonio told local media. Weston is fond of calling the mall conversion "a recycling job."

Communities all over America that are rethinking the 'burbs" face similar challenges as Windcrest: whether to rehabilitate, re-tenant, refinance and reposition left-for-dead mall properties, or tear them down and start over again.

As younger workers increasingly favor moving back to the urban core to work and live, a growing number of regional malls and obsolete suburban office buildings face either repurposing or death by demolition, according to Wednesday's newly released Emerging Trends 2013 forecast and survey by the Urban Land Institute (ULI) and PwC.

But therein lies good news. Visonary local planners and developers have a target-rich environment for reconsidering how ghost mall sites can reconnect with future growth in communities, ULI said. Urban theorists are revisiting the whole concept of piecemeal development of malls, strip centers, housing and office campuses as compact mixed-use projects near transit hubs gain traction.

Blighted properties that cannot be re-tenanted with department stores or shops are being converted into churches, office buildings, light-industrial, government buildings, town centers, parks and transit centers, said Jonathan Miller, author of the Emerging Trends study, during a presentation Wednesday.

ULI Chief Executive Officer Patrick Phillips said local governments are beginning to show more flexibility in zoning and development standards combined with public-private tools like tax-increment financing, to encourage redevelopment of old malls for such uses.

"The regulatory and financing structures are evolving in a way that should allow more of these properties to be repurposed in a productive way," Phillips said.

Rackspace and the city of Windcrest admittedly captured lightning in a bottle with the unlikely adaptive reuse of its mall property. The tech company moved its headquarters into the vacant Mervyn's space and has been renovating and expanding ever since, converting the mall to a tech campus, despite the initial reluctance of many employees.

Rackspace now boasts more than 3,000 employees at the site, sparking a revitalization. A Starbuck's opened across the street, and the YMCA moved into an abandoned Target store.

Editor's Note: This is the third in a three-part CoStar series on dying or abandoned enclosed malls. Part One: The De-Malling of America: What's Next for Hundreds of Outmoded Malls?
Part Two: Elements Needed for a Turnaround Include Lower Debt, Deep Pockets

Unfortunately, the Rackspace experience remains an exception to the rule for troubled B or C mall properties. Most malls struggle in a kind of retail limbo, limping along as as their owners try to find whatever local tenants or seasonal or interim use they can to pay the bills and debt and stave off foreclosure.

Others face the bulldozer and wrecking ball for light-rail stations, parks, or even distribution space to serve the e-commerce needs of more thriving retail centers. CoStar talked to a number of owners, lenders and special servicers who have worked with their real estate service providers to come up with creative, albeit sometimes unorthodox, strategies for revitalizing and re-tenenting troubled malls around the country.

This week, we profile several of these former obsolete traditional malls that have once again become major nodes of commerce within communities.

Downtown Scottsdale: High-Tech Persistence Pays Off

Over the last decade, the Phoenix suburb of Scottsdale has rescued two failed malls in its downtown area.

Even when it was built in the 1980s,the Scottsdale Galleria was a mall without anchors, fashioned as "the Rodeo Drive" of the Phoenix area, with specialty shops, a food court and restaurants along with a multiplex theater. However, the mall was plagued by poor timing, coming online in the early 1990s recession. It never exceeded 30% occupancy and closed within three years.

The Galleria, meanwhile, had the misfortune of being located about a half-mile from Camelview Plaza and Scottsdale Fashion Square, the latter now Arizona's largest indoor mall.

After acquiring the mall in the mid-1990s, former shopping REIT Excel Legacy sold it to Scottsdale Associates, now New York City-based JEMB Realty, in 2000 for $28.8 million. City officials and the new owners, hoping to capitalize on the first Internet tech boom, first tried to reposition it as a data center. But the dot-com bubble had already burst.

After the mall dragged on for several years, JEMB renamed it Galleria Corporate Centre and began a focused leasing effort to bring office tenants in. Throughout the 2000s, downtown Scottsdale had become very successful attracting a combination of restaurants, entertainment and residential lcoations. Eventually, high-tech companies found they could lure highly educated young workers interested in living near their jobs. It turned out the Galleria had the largest amount of vacant office space in the area.

"It wasn't really considered successful until about two years ago, " Bob Tunis, Scottsdale economic development director, tells CoStar.

JEMB attracted SAP, with about 80 employees. Yelp moved in about two to three years ago and now has 500 employees, the business social networking and rating site's largest office in the country. McKesson, a medical fulfillment company, and Islandia, NY-based CA Technologies moved its sales office to the Galleria about six months ago.

"We have a major crunch. There are companies lined up around the block trying to get into downtown Scottsdale," Tunis said.

In another Scottsdale mall conversion, the Los Arcos Shopping Mall, once the largest regional mall in Arizona, was torn down less than a decade ago to make way for the 300,000-square-foot Skysong, a facility for Arizona State University.

"It just happened that this was one of the most desirable spots in downtown Scottsdale, which doesn't have much space available for new development," Tunis said. "It was really a stroke of luck they made the decision to convert this to office a number of years before the market turned.

"It really has to do with timing, that downtown Scottsdale became the place to be in the last five years."

Malls Get Schooled

Another key strategy for reviving other vacancy challenged enclosed malls is adding non-retail users such as colleges and higher education to augment the remaining anchors and shop tenants. In two recent examples, colleges have become mall owners.

In Austin, TX, Austin Community Colleges (ACC) acquired the ground lease to the 1 million-square-foot Highland Mall in August from special servicer LNR Property for just $1.5 million, a loss severity to its lenders of 120%. The mall had lost several anchors, most recently Macy’s in 2011, and was on the verge of failing.

The colleges acquired the anchor boxes one at a time and most recently closed on the acquisition of the small shop space and common areas, said Kristin Mueller, executive vice president and director of retail business development with Jones Lang LaSalle in Atlanta, which worked with LNR to execute the sale.

In Martinsberg, WV, private college Mountain State University acquired the 552,212-square-foot mall Martinsberg Mall in 2010 from The Lightstone Group for $11 million, rescuing it from bankruptcy. Mountain State has announced redevelopment of anchor stores , most recently the former Sears location.

The renovation, approved Oct. 3 by the city Planning Commission, will include demolishing the existing store and building out new restaurant and shop space. Such new ownership can pull a dying mall from the brink because not enough department stores exist to fill them, Mueller said.

"We're focusing on the distressed properties and making them better in place, and that does often mean changing out the type of retail on the properties," Mueller said. "They may go from four fashion department stores to two and some big box tenants. Or, there may be a very different offering in terms of retail, and/or converting them to other uses such as these colleges."

Aging Malls Find Religion

Ten years ago, if a Department of Motor Vehicles or a church went into a mall property, it was considered the death knell for the property as retail. Today, those types of non-retail uses are embraced because they bring traffic and are often complimentary to the remaining retail.

An act of God literally resulted in the World Overcomers Outreach Ministry purchasing the Hickory Ridge Mall in Memphis in 2008. That year, a tornado hit the mall built in 1981 and renovated in 1997 to help stay competitive with the Wolfchase Galleria which opened the same year.

The February 2008 twister heavily damaged the front entrance the Sear and Macy's anchors. Quick work allowed Sears to reopen within days. The church ministry spent $5 million renovating the mall, including $1.4 million to buy it.

The renovation opened to great public fanfare in August 2010. The church retained a retail component but is converting some of the space for use by the church, JLL's Mueller said.

Trump Card For a Dying Mall: Deleverage and Downsize

For years, retail analysts have predicted the widespread razing of dying or dead malls around the country. But total demolitions of regional malls have been remarkably rare to date, observes Mueller.

"For the most part, owners recognize that these properties are on excellent real estate, and reworking assets that have outlived their format or usefulness to better serves modern needs is a better solution for bondholders than tearing them down," Mueller said.

The obvious solution for some is simply to downsize to meet current market demand and decreasing space requirements of retailers. A case in point is Macon Mall, a super regional mall in Macon GA. The two-level mall had been renovated several times since its 1975 opening, including a major expansion in 1997 that increased its size from 1.1 million square feet to about 1.5 million square feet.

But by the late 2000s, the mall was in severe decline. After a new lifestyle center, the Shoppes at River Crossing, opened in the region and lured Dillard’s away. Saddled with $140 million in debt, the mall entered foreclosure and Jones Lang LaSalle was assigned to work with the special servicer as operator.

"The mall was overbuilt and a portion had to be taken down," Mueller said. "We achieved the objective of the bondholders, which was to get the mall sold to maximize proceeds." The mall sold out of foreclosure for a mere $6 million, lowering the cost basis sufficiently for the new owner, Augusta, GA-based Hull Storey Gibson, to demolish the east wing of the mall and right-sized it to current market needs.

"That is a rational response," Mueller said. "They took down what we identified as excess space for the market and they’ve renovated the remaining mall. It's a very different property today, and they’re well positioned to lease it up."

Capital markets may be ready to go out on a limb for such ventures. The 2013 Emerging Trends report forecasts that investors will take greater risks in their portfolios as they chase greater yields in riskier secondary markets and product types -- including aging suburban malls, said Stephen Blank, chief ULI fellow, capital markets and finance.

"Private equity investors are looking at smaller deals as opposed to the mega deals, and these repurposed retail assets are those smaller deals," Blank said. "They have a high return opportunity and there is financing available through a variety of nontraditional channels.

"There may be some breakout in certain markets where capital flows into these assets. And there are funds to repurpose them, rather than watching them sit and wither away."
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