'Reworking Retail' Creates Opportunities for COVID-Conscious Custom Offices

Two trends in a turbulent ocean of commercial real estate leasing and development have converged — brick-and-mortar retail is sinking, while boutique, wellness-centric office demand is swelling — and Northwood Retail is riding the resulting wave.

The retail developer’s strategy of converting idle retail spaces to boutique offices — as it did with its W4 project — has creatively catered to both supply and demand across key developing regions, from its hometown, Austin, Texas to Charlotte, North Carolina.

“Quirky, boutique offices have become a newer play on unused retail assets,” development manager Ryan Muscott told LoopNet. And the W4 is just one example of the type of creative office space that has become a prominent part of its current and planned national portfolio. “It’s incredible what you can do with a bit of strategy and creativity,” he said.

“What we’ve seen in retail as a whole is that the big-box retailers aren’t out there anymore, and the smaller regional players aren’t leasing as much, with everything having gone the way of Amazon and online shopping,” Muscott said. “But our primary market has been retail development, so we’ve had to get creative with our leasing, with how we position our assets and what kind of user might utilize certain assets … and where we can, we’re creating opportunities for creative office users.” Examples include the firm's assets in Prestonwood Place shopping center in Addison, Texas, and at The Shops at Park Lane in Dallas, where retail-to-office conversion are currently under construction.

The concept of “chopping up” retail spaces that are too large, especially in shopping malls and other retail-anchored environments, has been gaining popularity, and Northwood Retail is capitalizing on that trend.

Although both sectors thrive in open floorplans, retail requires different footprints compared to offices, particularly when it comes to lease depth — the distance from the building’s windows to its core. “We lean on our design partners to come up with an initial scheme, knowing what the fundamentals are,” Muscott continued.

A typical office would need to have a certain lease depth to make sure that office desks lay out efficiently and there’s adequate light to all desks, he said, “so we walk through with a design team to envision what a space could look like.”

At Domain Northside, Muscott’s team has implemented several successful iterations of this process, and the Mark Odom Studio-designed W4 model was the second such endeavor. Its Z Block development, also designed by Mark Odom Studio, is under construction as well. “With a former creative partner, we did the same thing — installed creative office space above retail — and it was very successful, so we thought we’d do it again, and we knocked it out of the park in terms of the leasing and the demand for it. We inherited [what’s now the W4 space] in early 2019 and by the time we finished the build-out of the space, we had leased it already.”

Another stretch of retail at Domain Northside had been sitting vacant since it was built around four years ago, he said, “and it was due to the size and depth of that retail space. There just weren’t tenants out there that were in the market for such large spaces and it wasn’t easy to chop up.” The company ended up splitting the unit in two in terms of depth from street, with a street side and a backside, and then built a creative office in the back of the retail space. “It’s a really unusual situation, but we already have interest … and have already leased three of the four suites that had sat for years.”

Northwood has been positioning its portfolio to cater to these opportunities in every market it serves. In the Raleigh, North Carolina suburb of Cary, for example, Northwood was able to lease a “cold, dark shell — a hard-to-lease, no-retailer-would-go-there kind of space that had been vacant for 30 years," Muscott said of the firm's Waverly Place asset. "We added a mezzanine level inside ... and were able to lease it to creative office users."

In another space of the same asset, he said, the firm also took an old jazz club that had a mezzanine and converted it to an office as well. The new office developments have not only served up space for office users, but has created "additive" and "synergistic" opportunities for other businesses such as restaurants who have set up shop adjacently to supply the office users, he said.

It’s not just the developer that benefits from leasing vacant shell space that would otherwise never work for office tenants. The conversions are helping fill a demand for a new class of office users, especially in the age of coronavirus. As a bonus, he said, these types of retail-to-office retrofits provide what the current market is demanding from a health and wellness standpoint.

Pre-pandemic, the main draw was location, relating to the property’s immediate environment. “The Domain market was developed to be a walkable, mixed-use environment that is truly a live-work-play ecosystem that attracts the younger crowds and tech companies with millennials looking for that kind of amenity,” he said.

However, the process of finding creative ways to plug private offices into a very public environment and the creative design that goes into the renovations often mandates unique access points and private outdoor spaces, which align well with newfound sensibilities about distancing and the division of public and private spaces, he continued. Offices in this environment require a sequestered access point for staff and dedicated stairways and elevator bays, along with decks and patios from which the user can interact with the community around them without the public being able to do the same with the office space.

“These spaces can support a more focused user group with more limited interaction with other users, and as a result of COVID-19, more tenants are drawn to dedicated space and feel at ease in the current pandemic,” Muscott pointed out. “So, we’ve positioned a lot of our assets this way, because I think that is something the next generation of tenants are going to be looking for.”

A melding of indoor and outdoor space is a big component of that, he went on. “We have several of these creative office concepts across our portfolio in every region we serve — Southeast, Texas and out East, too. We have a focus on the Sunbelt, where weather is nice year-round, but balconies are very popular everywhere.”

For instance, he continued, “We’re about to build a 60,000-square-foot, four-story boutique office unit at Domain Northside that has balconies on each corner of the building on all four floors and designated garage access to three floors.”

In one of its properties at Domain Northside, a focus on outdoor elements came in the form of creating a 9,000-square-foot space with a private courtyard. In another, it was turning a utility roof into a useable roof deck.

“For tenants that are looking for that differentiator between the conventional office and creative office environments — asking themselves why they would choose this creative office that might not work as efficiently as it could over a standard layout, that creativity is paramount.”

There’s demand for darker spaces, he said, as some in Austin’s tech sector are holed up in front of computers all day and might prefer that type of environment. But in those cases, access to private outdoor space for breaks becomes even more key. Many other tenants demand more natural light in their workspace. Boutique office spaces converted from retail allow for renovations such as skylights, which wouldn’t be possible on an anonymous floor of an office tower.

These renovations are not easy, he explained, but they do have some draws for developers. “From a landlord prospective, we can control when a tenant can get in, so you can look internally and control the schedule and timing to accommodate any delays that may occur. You can also control the costs to the extent you can.”

These types of one-off concepts also involve building restrooms and break rooms for one space, rather than creating common, shared boilerplate cores, he added. That provides room for creativity and additional amenities, but building that extra infrastructure can increase costs, Muscott said.

Developers typically give retail users a tenant allowance to build out the space, he said, but boutique office users traditionally don’t have a defined space program and are unfamiliar with the development process. “Without the experience or ability to manage that process successfully, we’ve had to take that on, from cradle to grave,” he said. “The majority of it is on the landlord to build out the entire space, turnkey, so there is a bit more capital-intensive burden, but the benefit for us is knowing we’re going to spend that money upfront.” You may have to factor those costs into the rent, but the basic structure doesn’t change, he said. “You still have to make sure it pencils.”

Landlords of creative offices spaces situated in what is otherwise a retail environment must also take on operational responsibilities. “In a typical office lease, the landlord or property owner provides janitorial services. But for the other surrounding assets, we aren’t responsible for the cleaning of retail storefronts, so we might have to hire janitorial service on a one-off basis. It’s still a landlord’s responsibility to maintain and service the elevator as well, for instance, so it adds a little nuance. For an investor or property owner that doesn’t have that in its portfolio, it’s something new that you haven’t had to manage before.”

There can be a bit more risk in this type of project as well, he said, and you still have to make sure it’s a viable arrangement. But retailers in today’s climate — particularly digitally native entities that are establishing a physical presence for the first time — face a more inherent risk of going out of business compared to office tenants who are not as dependent on sales and traffic volume.

“For now, people are taking pause, as you can imagine. It’s hard for a tenant to sign a 10-year lease when they don’t know what next year is going to look like, and what COVID-19 inflection points might be on work-life balance, so we are working with tenants on getting creative with deal structuring, lease terms and lengths,” he said.

But even without a clear picture of what COVID-19 is going to do to the economy, “people are really going to be looking for creative office assets that allow for individualization, customization and health and wellness aspects, such as having dedicated lobby access, and across our portfolio we have positioned ourselves with these opportunities and these concepts for users to take,” Muscott said.

“It’s an interesting time. What I’m most surprised about is the leasing interest out there. We have active leasing deals in the works for both office and retail, and people are still excited about the opportunities that are available, especially on the office front.”