• Shifting Retail Landscape Reshapes Live-Work-Play Investment Strategies

    “Live-work-play” was a favored pre-pandemic buzz phrase among commercial real estate investors who touted the synergistic appeal of its mix of uses in attracting tenants. But as the “work” aspect shifted away from physical offices, and as social distancing brought “play” to a grinding halt, investment in these areas fell out of favor.

    However, promising retail trends suggest live-work-play neighborhoods could offer investors upside going forward, especially those with the right set of characteristics. Specifically, those areas able to maintain foot traffic levels throughout the workweek and on weekends have demonstrated more resilience at the onset of the pandemic and have recovered faster than other areas.

    Inherent in a live-work-play neighborhood is an ability to work, which requires a significant office presence. However, as office nodes emptied out during the pandemic as employees shifted to remote work arrangements, areas such as downtown Manhattan saw their streets nearly empty during the workweek. This resulted in a significant loss of business for stores reliant on spending from office workers and was reflected in the recent performance of urban retail rent growth and occupancy, which have under-performed suburban retail by a significant margin.

    As the effects of the pandemic continue to dissipate, retail foot traffic is recovering, but new patterns are emerging. Retail and recreation visits tracked by Google show that consumers still desire a brick-and-mortar shopping experience, but retail sales are becoming more reliant on weekend visitors, who are more likely to be in the area for leisure as opposed to weekday visitors, who are likely in the area for work.

    As of May 2022, weekend foot traffic is now within 4% of its 2019 baseline, while retail traffic on weekdays remains 6.7% below pre-pandemic levels. The disparity in recovery of weekend and weekday foot traffic is even more prominent in certain major markets such as New York City and Los Angeles, where weekend visits are more than 50% higher than weekday visits.

    The recovery in retail foot traffic is just one of a handful of trends that should have investors giving live-work-play neighborhoods a second look. From a retail, or “play,” perspective, monthly leasing activity has exceeded its historical average for 14 of the past 15 months, in-store retail sales in April 2022 were 23.6% above the same period in 2019, and real consumer spending on services has now returned to pre-pandemic levels.

    From the “work,” or office, perspective, the slow and steady return to the workplace is expected to continue to benefit these neighborhoods, although the best-positioned live-work-play neighborhoods will be relatively insulated from very high remote working rates. After all, security tech provider Kastle Systems estimates average office occupancy is still only at 43% of its pre-pandemic baseline, meaning urban retail continues to miss out on this important revenue stream. And in terms of the “live,” or multifamily, aspect, the pre-pandemic trend of people seeking the amenity-rich lifestyles available in urban areas is staging a surprisingly strong recovery.

    From an investment perspective, not all live-work-play neighborhoods are on equal footing. Those with limited exposure to reduced foot traffic from remote working are more favorable. Also, those with stronger demographics and those that are further along in their recoveries from the pandemic are also better positioned to outperform in the near term.

    CoStar examined more than 300 urban neighborhoods to evaluate the live-work-play dynamics for urban office nodes. Forecast and historical buying power growth, workplace and retail visits, walkability ratings, young professional population growth and its share of population, and property type composition were analyzed to produce a Live-Work-Play, or LWP investment score on a scale from 0 to 100.

    This analysis found that retail in neighborhoods with high scores, those in the top 50th percentile, were more resilient at the onset of the pandemic and recovered faster. The drivers of this LWP scoring system favor growth markets, which generally have structurally higher vacancies and more active construction pipelines than gateway markets. As a result, office nodes with high LWP investment scores historically had higher retail vacancy rates than those with low scores.

    However, that dynamic reversed in 2020 as high-rated neighborhoods were better able to weather pandemic-induced challenges and have experienced increased retail leasing activity. Over the past 12 months, neighborhoods with high LWP investment scores have seen retail vacancies compress by 66 basis points compared to a compression of 32 basis points for those with low scores. The vacancy spread between the two neighborhood cohorts has now widened to 30 basis points, with this trend expected to continue moving forward.

    The difference in retail vacancy rates between areas with high and low LWP investment scores is driven in large part by demand outperformance. From the third quarter of 2015 to the first quarter of 2022, neighborhoods with high scores have average annual net absorption equal to 0.36% of existing retail inventory, quadruple that of neighborhoods with low scores. This trend in absorption, the net change in the amount of space occupied and vacated in a specific period, is expected to continue in the future as dynamic neighborhoods offer a favorable environment for retail demand and rent growth.

    Most highly rated live-work-play neighborhoods experienced strong retail rent growth in recent years as well. For example, Nashville, Tennessee’s downtown and West End neighborhoods, which each had an LWP investment score of 70, led the way with 15.9% and 15.1% cumulative retail rent growth since the pandemic, followed closely by West Raleigh in North Carolina, with a score of 75, and Northwest Las Vegas, with a score of 80.

    The Nashville districts benefit from strong migration trends and high percentages of young professionals in the local population, along with a robust pipeline of high-end apartment construction. West Raleigh’s retail rent growth is fueled by 6.1% cumulative demand growth since the first quarter of 2020, resulting in its current 98.7% occupancy level. Tivoli Village, a large mixed-use development in Northwest Las Vegas, is currently under contract as the region’s highest-value mixed-use deal since 2017. The asset is selling at a significant premium to other properties in the area, signaling investor confidence in live-work-play opportunities in dynamic neighborhoods.

    Although rent growth has not quite caught up with demand in Boston’s Midtown neighborhood, which had an LWP investment score of 77, the node’s retail leasing velocity since 2020 is more than 10 times its historical average, indicating the area may become a prime target for investors in the near future.

    Conversely, neighborhoods with lower LWP investment scores such as San Francisco's Financial District (18) and Santa Monica in the Los Angeles area (56) have struggled since the pandemic. These nodes experienced an outsize impact from COVID closures and remote working, resulting in significant declines in retail rents and leasing volume. Retail demand losses in other dense urban areas such as the Grand Central Station area and the World Trade Center in New York, which posted LWP investment scores of 22 and 25, respectively, continue to face headwinds to growth in their respective retail sectors, along with various other urban central business districts with scores below 50.

    Urban retail and office nodes have been struggling through the challenges brought about by the COVID pandemic, and many have lower property valuations as a result, but live-work-play neighborhoods that were an investor darling before the pandemic have the chance to reinvent themselves to accommodate recent consumer trends and present a new opportunity to investors, particularly as companies continue to determine long-term remote-working policies.

    Within urban and prime urban areas most affected by this trend, retail property investors should look to neighborhoods that are better situated to maintain foot traffic levels throughout the workweek and on weekends. Walkable, dynamic, live-work-play neighborhoods with the right set of characteristics can offer retail investors favorable returns as shopping and working trends continue to evolve.

    Peter Ferramosca is a commercial real estate consultant with CoStar Advisory Services.

    Source: www.CoStar.com