Demise of Retail Real Estate?

You would be forgiven to think that old fashioned bricks and mortar retailing is on its death bed. News abounds of stories of shuttered stores, bankruptcies, and ghost malls. The main villain in these stories tends to be the patriarch of online retailing, Amazon.

Retail real estate has had other issues too. Below I discuss the main issues currently facing the asset class, which are (1) E-Commerce, (2) Oversupply, and (3) New Trends.

E-Commerce

While e-commerce has a huge hand in the shifting landscape of retailing today, much of the traditional retailers' problems have been self-inflicted. Most retailers were slow to adapt to the dawn of the internet and embrace a consumer friendly online sales presence. Best Buy has often been referred to as the showroom for Amazon, where consumers can physically browse & inspect merchandise and then jump on their smartphones to Amazon and have the item purchased & paid for before walking out of Best Buy. In some big cities, Amazon can even have the delivery fulfilled the same day, before you have returned from the shops!

Some people have pointed to the fact that online sales still only account for 9% of all retail sales. However, when you strip out gas, food, and autos, Amazon alone accounts for 25% of the incremental growth of retail sales. This proves just how fundamental a shift there has been in peoples shopping habits.

Oversupply

Other causes of retailers' decline have often been overlooked. There is an oversupply of retail real estate on a macro level, nationwide. Localized, some large urban centers with growing populations still have undersupply, but on a national level it has been estimated that there is a Billion square feet of oversupply. The oversupply has built up for the past two decades as the US was in a deflationary environment. Merchandise was cheaper to produce & sell, and consumer demand was high, creating good margins for the retailer.

Also, with the low interest rate environment, consumers had access to easy credit, and the retailer could also access easy credit for expansion. This resulted in a lot of expansion to markets that did not justify the growth. Now there is more pressure on margins, and this is having a direct effect on any subpar markets that retailers entered with unjustifiable enthusiasm. As interest rates are expected to slowly rise over the next 36 months, this will compound the retailers' problems as their debt service increases, negatively affecting their free cash-flow. Expect to see further bankruptcies.

New Trends

Additionally, consumers' habits have changed. Today Millennials are more interested in spending their money on experiences and food, than on merchandise. In the past, a Mall operator would dedicate 70% of its space to traditional retailers, and the other 30% to entertainment & food. To attract more foot traffic to Malls today, savvy Mall operators are repurposing old space to 70% entertainment & food, and only 30% to traditional retailing.

Gloomy Prospects

The US Labor Department reported that the retail sector lost 60,000 jobs in February and March, the worst months since the end of 2009. The retail sector employs almost 16 million, and was one of the few sectors to report job losses.

The first four months of 2017 has seen 3,296 store closing announcements. These closures are mostly represented by your typical Mall tenants, such as department stores, and apparel & electronic sellers. So far in the first four months of 2017, 14 retailers have gone into bankruptcy, compared to a total of 18 retailers for all of 2016.

Examples of recent store closures and announcements of anticipated closures include Rue 21 (400 stores), Payless Shoes (1,000 stores), Bebe (168 stores), BCBG (400 worldwide, 50 US), Wet Seal (171 stores), Macys (68 stores), JC Penny (700 stores), Gander Mountain (160 stores), Staples (70 stores), Chicos (120 stores), Abercrombie & Fitch (50 stores), American Eagle (150 stores), Guess (50 stores), and The Limited (250 stores).

This has major implications for retail landlords. As the perception in the marketplace is of a looming disaster for the retail property owner, it can make it harder to convince a lender to provide financing, or to attract new tenants. It is estimated that up to 1 Billion square feet of retail real estate will need to be repurposed over the next few years. This means that this space will need to close, consolidate or be converted to an alternative use. This makes it harder for retail owners to sell or get financing. For example, The Hudson Valley Mall, in Kingston, NY, a 765,000 s.f. property had JC Penny vacate in 2015, followed by Macys in 2016. Smaller retailers began to follow leaving the smaller unit spaces at 33% vacant. This property appraised at $87.0mil in 2010, and sold for $9.4mil this January. Another example, the Bonita Lakes Mall in Meridian, Mississippi, sold recently for $28.0mil, a long way off the cost to develop this property in 1997 for $85.0mil.

Solutions

Some Mall operators are finding great opportunity in these uncertain retail times. They are specializing in acquiring struggling Malls, often at deep discounts to replacement cost and outstanding debt. This gives the new owner a lot of room to restructure leases to affordable rates for tenants, and to spend on much needed capital improvements. Strategies being adopted include repositioning the Mall as a retail destination, fitting in with the "experiential" demand by Millennials. A greater emphasis is placed on entertainment, such as movie theaters and amusements/gaming, like bowling alleys and Dave & Busters. Simple fixes include refurbishing restrooms, adding family restrooms, and changing old food courts into curated food halls featuring local food operators and not national franchised brands. Other creative solutions include redeveloping the sites to add multifamily, hotels, and medical offices to the properties, all adding to the property footfall.

Conclusion

Retail is certainly not dead, considering total retail spending is on the up, not the decline. The channels in which the retail spending gets deployed are shifting, and old retailers, and indeed old retail landlords, need to move with the times quickly or get lost into the quicksand of irrelevance.