Green Street Advisors

 

 

Retail: Survival of the Fittest


In May, Green Street hosted a retail webinar ahead of the International Council of Shopping Centers (ICSC) annual RECON convention in Las Vegas. The negative narrative surrounding the retail industry continues to strike media headlines every day. Are these concerns warranted, or are they overblown? DJ Busch, Managing Director and head of retail research at Green Street, presents what market participants need to know about the dramatic shifts underway.

What's happening?
DJ Busch started by acknowledging the elephant in the room: “Retail as we know it is going through a dramatic shift, and the negative narrative is loud as ever.” Consumer behavior is changing, retailers are trying desperately to compete, and owners of retail real estate are working to ensure their properties are positioned for the future. “But not all the news is bad,” he said. Some landlords should be positioned not just to survive, but to do quite well.

Public market fears
In the public market, mall REITs have been trading at large discounts to the underlying value of their assets for quite some time. This investor skepticism has spilled over to open-air shopping centers (i.e. strip centers), which are now also trading at discounts. While mall REITs own 80% of mall value in the U.S., these signals from the public market can have important, and often overlooked, implications for private market players. Is the narrative in the public market – which has materially impacted share prices - correct, or are private market values on the decline as well? Regardless, the net asset value (NAV) discounts are steep and understanding the forces driving them can help identify areas of risk and opportunity in the sector.

retail REITs trading at discounts to NAVOver-retailed or under-demolished?
“It’s no secret that the U.S. is over-retailed, and we have a substantial amount more square feet per capita than any other country,” Busch explained. With e-commerce nipping at the heels of brick-and-mortar retail, Green Street sees the low-productivity malls and power centers/community centers at the greatest risk for attrition. These types of retail properties will have the hardest time remaining competitive. Retail centers can be better positioned to compete by incorporating defensive strategies, such as adding grocer or service tenants.

Game changer
E-commerce growth in the U.S. has been nothing short of spectacular. “E-commerce is a formidable competitor for almost every property type,” Busch said. Under specific assumptions, Green Street expects two-thirds of retail sales growth in the foreseeable future to come from growth in e-commerce.

When it doesn't fit, you feel it
Department stores continue to be a meaningful headwind in the mall sector. The department store industry is in a structural decline and the business is not getting better. Productivity continues to plummet, which should mean that more stores will close. According to Busch, “Store closures are not enough, the business is in desperate need for reinvention.” If meaningful changes aren’t made, the downward spiral of sales declines and store closures will likely continue.

department store sales productivity gap

Mall landlords are addressing this issue. Most operators are strategically recapturing department store spaces and working to get ahead of the problem. The modest pace of department store closures thus far has opened up the opportunity for mall landlords to bring in new tenants. “When landlords have been successful at gaining this space back, they create value both by bringing in higher rent paying tenants and by making the property better,” Busch said.

Big box issues are no longer exclusive to malls. Strip centers have had to address their fair share of bankruptcies and there may be more to come. Mall landlords are looking for new big box tenants and now have their eyes on those that have traditionally operated in strip centers. That said, “We don't see a mass exodus leaving strip centers to malls,” shared Busch.

The Fundamentals
On the mall side, Green Street expects a greater deceleration in fundamentals compared to strip centers due to modest declines in occupancy and an absence of sales growth. On the strip center side, the deceleration should be softer with occupancy holding steady and rent growing modestly. Mall fundamentals significantly accelerated out of the downturn and then leveled off, whereas strip centers started slow, but then improved steadily. Fundamentals between the two retail sectors are now converging, and the growth outlook over five years is comparable. However, below the surface, performance is bifurcating. ‘A’-mall fundamentals are holding up better and are expected to outpace strip centers in aggregate. At the other end of the spectrum, low-productivity mall fundamentals should continue to deteriorate.

Similarly, grocery-anchored centers are driving strip center fundamentals higher, whereas power center fundamentals may be declining. “We like grocery,” Busch said. Even though it's a tough and low-margin business, fundamentals for grocery-anchored centers seem healthier and more resilient than any other retail property type. There is also occupancy upside in terms of the small shop tenants due to a slower recovery out of the recession.

Survival of the Fittest
In today’s retail environment, “Negotiating leverage is in the tenant’s favor,” Busch said. There are more mature retailers strategizing to close stores than new concepts looking to open them. New retailers exist, but the days of opening 100 stores over the next five to seven years are long gone. The question becomes, “Who is best positioned to weather this storm?” A few distinct advantages are access to capital, large properties with large cash flows, and strong balance sheets.

Watch the full, 30-minute replay of this retail webinar for deeper insight:

  • Proprietary data/charts and Q&A discussion
  • Who are the winners in this space? Who could be in trouble?
  • Long-term private and public return expectations for retail and compared to other sectors
  • Results and analysis from an audience poll question, “Out of the 1,100 U.S. malls in Green Street’s mall database, how many will be relevant retail destinations in 10 years?”
  • Key questions for consideration heading into ICSC week (Are cost ratios for apparel tenants sustainable? Are cap-ex requirements going up? Is there a bubble in food/beverage?)
  • Case study for identifying oversaturated markets across various retail property types. “Many retailers are going through this analysis, and if they’re not, they probably should be,” Busch said.

Green Street’s Advisory Group provides custom solutions for public and private operating companies and retailers, working as an independent advisor on strategies related to real estate monetization, store footprint rationalization, and leasing analytics. Learn more about the Advisory team and watch President Jim Sullivan discuss retail real estate in this brief video.

Visit the following pages for information about Green Street’s mall database/REIT research, annual Sector Outlooks, and solutions for retailers. The structural headwinds from e-commerce are universal. Green Street’s perspective on Europe retail headwinds via Retail UK: Lights Out at the Mall.

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