If failing department stores are a problem for the shopping mall, are apartments the solution?

A growing number of mall owners are betting they will be. At Northbrook Court, plans are in the works to tear down a Macy's store and build restaurants, a grocery store and 300 apartments in its place. In Vernon Hills, the owner of Hawthorn Mall is exploring plans to add as many as 600 apartments and a hotel to the 1.3 million-square-foot property, which has lost Sears and Carson's. With demand for retail space shrinking, landlords are trying to reinvent themselves by looking beyond stores.

"I talk about this 24 hours a day," says Steven Levin, founder and CEO of Centennial Real Estate, the Dallas-based owner of Hawthorn Mall. "It's a very creative time in our business. It's very innovative, very challenging."

Apartments have become an increasingly popular choice for landlords, offering them a chance to diversify into a hot property sector and inject some new energy that doesn't just revolve around buying stuff and eating. With more consumers, especially millennials, avoiding stores and shopping online, shopping center owners have to create other reasons for people to visit their properties.

Building apartments "creates an 18-hour environment, rather than a 12-hour environment, and adds some life" to a property, says Adam Tritt, senior vice president at Brookfield Properties, the owner of Northbrook Court. "In the old model, it was far more about function and utility: I want to get my goods and get out. Today, it's more experiential."

Still, Tritt and others acknowledge they aren't quite sure how the experiment will work out. What kind of people will want to live at a shopping mall? Will the apartment boom last long enough to support a big wave of mall-based projects? Adding uses to shopping centers isn't a new idea, but so many retail landlords are embracing apartments these days that some are bound to fail.

But they need to do something. The amount of available retail anchor space—the biggest stores in shopping centers—hit an all-time high in the Chicago area of 12.3 million square feet this year, up from 10.8 million in 2017, the prior record, according to real estate services firm CBRE.

Mall owners have long relied on department stores to draw shoppers to their properties, but the stores have lost so many customers that they have become more of a liability than an asset. The Carson's department store chain went out of business this year, closing all 40 or so of its stores in Illinois. Sears, which filed for Chapter 11 bankruptcy protection in October, is fighting for its life. The demise of big-box chains like Toys R Us also has created some big vacancies.

"Retail allowed itself to become very boring," Levin says. "It's shrinking, and that's healthy. It needs to shrink because we have too much retail."

Many investors, worried about the future of brick-and-mortar real estate in the Amazon era, are steering clear of retail property. An index of U.S. shopping mall values has dropped 7 percent over the past year, while an index of strip centers has fallen 2 percent, according to Green Street Advisors, a Newport Beach, Calif.-based real estate research firm. All other property sectors are flat or up.

NEW MIX OF TENANTS

Some landlords are trying to strengthen their properties by adding "e-commerce-resistant" tenants like restaurants, fitness clubs or entertainment chains. After Sears shrunk its store at Oakbrook Center, GGP, now owned by Brookfield Properties, leased part of the space to KidZania, a children's entertainment concept. A Life Time Fitness club is replacing a former Sears Auto Center.

But apartment proposals are starting to pile up, and not just at large suburban malls. In October, New York-based RPT Realty unveiled plans for two big residential towers next to Webster Place Shopping Center in Lincoln Park. The owner of Deerbrook Shopping Center in Deerfield is seeking village approval for an addition that would include 246 rental apartments and townhomes.

In downtown Naperville, the owner of Main Street Promenade, Retail Properties of America, wants to add a 74-unit apartment building next door. RPAI plans to target empty nesters for the apartments, says Shane Garrison, president and chief operating officer of the Oak Brook-based real estate investment trust.

Investors like RPAI are betting people will pay up to live in an apartment building connected to a shopping center because of the restaurants, shopping and other amenities at the property. Apartments at other RPAI mixed-use centers rent for about 15 percent more than comparable properties a few blocks away, Garrison says.

On the other hand, renters who want to be close to commuter trains that will whisk them to downtown Chicago probably won't want to live at a mall, says John Melaniphy III, president of Melaniphy & Associates, a Chicago consulting firm. Apartment developers in the city and suburbs have gravitated toward transit-oriented projects in recent years, believing that access to transit is a deciding factor for many apartment tenants.

"I just don't see many of the malls having that benefit," he says. "But the benefit they do have is proximity to restaurants, entertainment and services."

At Northbrook Court, Toronto-based Brookfield aims to do more than just build some apartments at the 1 million-square-foot mall, which opened in 1976. The firm plans to add a food hall, outdoor plaza and a great lawn that will serve as a connector between the residential building and the mall.

Brookfield doesn't plan to stop there. Tritt could see hundreds more apartments and even office space there in the future.

"There is an opportunity to explore more," he says. "If one day we bring some office component there, you truly could live, work and play at Northbrook Court."