The Institutional Real Estate Inc Sponsorship brochure, Connected-Investor Focused, We connect people, data and insights, sponsorship, events, IREI Products
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All property types face leasing risk, supply risk, and credit risk. However, retail is arguably the most diverse property type, encompassing projects that present wide variations in risk. Also, retail property serves an industry with significant churn and a relatively high historical bankruptcy rate. With e-commerce and digital marketing driving yet another evolution in the industry, many have rushed to falsely conclude that risk has increased for retail real estate. It hasn't increased, but it has changed. TECHNOLOGY MAKES A HUGE IMPACT The retail industry is always evolving but this time it's more momentous. E-commerce and social media have become extremely influential, driving a significant shift in retail business models. It's now clear that a retailer needs both an online and physical presence and each retailer has to figure out the balance that works for them. Increased competitive forces will likely accelerate the failure of underperforming centers and obsolescence of certain boxes as space needs continue to evolve. It would be hard to overstate the impact of technology on the retail industry. Retailers must spend heavily on IT to compete in an environment that is still defining itself. The competitive retailer uses an omni-channel strategy, offering consumers the ability to purchase whatever they want, wherever they are, quickly, and with an inexpensive, easy-to-return option. But developing the information and distribution systems required to be competitive has proven difficult. Some retailers have been better at it than others. And substantial IT spending, more often than not, requires cost cutting in other areas. Management and real estate expenses in particular have been under the axe. A digital platform provides another viable path to sales and, in some cases, has diminished the utilization of physical stores, forcing retailers to be more critical about physical store locations. This trend should alleviate some of the risk of overbuilding by eliminating the more marginal construction. We have seen an evolution in targeted store size and configuration before, but this time there is a new twist. Some retailers are shifting inventory from the store floor to warehouses while others are adding order fulfillment to the back room. Overall, there is likely to be slower growth in the physical space needs of most retailers; especially national retailers who have reached full saturation. The above trends are shifting risks in retail property. In general, constraint of new store expansions will reduce supply risk and but at the same time increase leasing risk. There will be less new space to fill, but also fewer prospective tenants to backfill vacancies. Risk has increased for large box space as consolidation, down- sized formats, and competitively priced e-commerce create leasing challenges. Conversely, the value of outparcels and pads has increased at the better locations as investors see opportunities to add value. Demand for space in the better centers is likely to rise at the expense of less competitive centers, thereby lowering risk for some but increasing it for others. Anticipation of Sears' demise is surely making some owners anxious or excited, depending on their locations. Credit risk has always been relatively high in retail real estate. The retail industry has historically been highly fragmented and labor intensive with high operating leverage generating thin margins. Smaller, private operators comprise a significant share of retailers, many with limited experience and resources. The added competitive component of digital capability may be elevating credit risk for retail property as not all retailers will be able to execute the strategy. Until the digital shake out is complete, credit risk in general is rising. Also, since most retail tenant improvements are highly customized, the cost of unanticipated turnover due to tenant default can be significant. While it's true that even the better properties cannot completely insulate against the increased credit risk, it should be easier for these centers to upgrade the credit quality of their tenancy as retailers place greater value on these locations, thereby diminishing their exposure. REPORTS OF THE BRICKS' DEMISE HAVE BEEN GREATLY EXAGGERATED Online offerings continue to expand and provide a convenient and cost effective way to purchase just about anything you could want. But who doesn't stop at a retail facility at least a couple of times a week? Consumers are still spending the majority of their dollars in traditional stores and retailers will continue to expand their physical presence. Several surveys of online shoppers support the view that physical stores remain an important channel for retail distribution and are integral to the buying process. According to the PwC publication, They Say They Want A Revolution, based on a survey of nearly 23,000 online shoppers, physical store space is still considered critically important to purchase goods. Most people shop both online and in-store with less than 10% choosing online exclusively or almost all of the time for any category with the exception of books, movies, music, video games. Additionally, 40%-52% of purchasers never buy online in the furniture, grocery, home improvement and household appliances categories. 31 NAREIM DIALOGUES SPRING 2017 ShopWithMe Photos by Benny Chan, Fotoworks