Perception and reality
The narrative that malls are dying and retail overall is struggling gained more momentum earlier this year when Macy’s, J.C. Penney and Sears announced store closings. Several companies in the always volatile specialty and teen apparel segments went bankrupt and there were also notable bankruptcies from Marsh supermarkets, electronics and appliance retailer HHGregg, and off price department store chain Gordmans.
So there would appear to be a huge disconnect when Tom McGee, CEO of the International Council of Shopping Centers (ICSC), offers a favorable description of the industry’s fundamentals. “Were not trying to spin things in any unsubstantiated way. The fundamentals of the retail real estate industry are strong and supported by facts,” McGee said.
Those fundamentals, things like net absorption, project completions, space availability and rent growth, are indeed favorable, which has a lot to do with the reaction of developers and retailers in the wake of the recession. Developers slowed the pace of new construction and retailers stopped expanding in reaction to the extreme financial situation that emerged in 2008. While new space was slow to come online, as the economy improved retailers looking to grow found limited availability and higher rents. The result is strong occupancy rates, especially at well-located properties and grocery anchored centers, and lease rates that on average are around an eight-year high and projected to rise further this year, according to CBRE, the world’s largest commercial real estate services and investment firm.
“There are still plenty of retailers expanding and you see many more international retailers coming to the U.S.,” said Brandon Famous, CBRE’s Senior Managing Director and Retail Leader for the Americas. As for the mid-tier department store closings, those aren’t exactly unwelcome events because it means mall owners can adjust rents to market rates. “Owners can refresh a tired mall. It gives them an opportunity to create something special.”
Famous was among the record number of 37,000 attendees at ICSC’s global retail real estate convention known as RECon, which McGee described as having a mood of “focused optimism.” In other words, although the fundamentals of the industry are strong, there are trends impacting retail real estate that represent challenges and opportunities.
“There is a big demographic shift happening in the country that isn’t fully appreciated,” McGee said referring to Millennials who outnumber Baby Boomers and are entering their peak spending years. The shopping center industry, which is still department store centric, “is evolving toward the needs of the Millennial generation. Malls and shopping centers have always been community centers that offered goods and services and they continue to fulfill that value proposition, but the desires and what the folks in the community want has changed so the focus is becoming less product driven and more experience and service driven.”
A key milestone in the evolution of the retail industry occurred in March 2016. The role of food and the prevalence of dining options in retail centers was a trend underway for at least a decade, but last year was the seminal moment when food away from home sales exceeded food at home sales.
“More and more landlords are looking at food and beverage operators for their retail properties,” said Stephen Taylor, Vice President of CBRE’s Retail/Restaurant Practice Group. He cites key trends as the growth of food halls and chef-driven concepts while casual dining chains are under pressure and intensifying competition in the fast casual space.
“We are doing more food in malls and that will start a transformation,” said Stephen D. Lebovitz, President and CEO of CBL & Associates Properties. The company owns, holds interests in or manages 123 properties of which 80 are regional malls or open air centers, and recently acquired five Sears and four Macy’s locations it plans to put to better use.
“You have to create the type of convenience that works for the shopper,” Lebovitz said regarding the company’s strategy to evolve its malls to suburban town centers by adding dining options, entertainment, value and off-price concepts, health and wellness, services and non-retail uses.
CBL is not alone in its desire to add food, which is why there are some aggressive forecasts around how the tenant mix in shopping centers is going to change. For example, JLL projects that by 2025 the amount of space dedicated to food within existing properties will reach 20 percent, up from 5 percent a decade ago.
In terms of retail tenants, food is clearly the hottest segment right now but so are value and home, according to Greg Maloney, President and CEO of the Americas Retail Group at JLL, a global professional services firm that manages 4.4 billion square feet of space.
“We never used to talk to grocers and now we talk to them all the time. Just think about all the different ways people eat,” Maloney said.
In addition to the changing tenant composition, Maloney also sees “massive structural change,” related to the location of retail properties because many of the places built 30 years ago are now in the wrong places.
Amid the ongoing transformation of retail, a pillar of relative stability has been the grocery anchored shopping center where, despite recent headwinds, operators are looking to expand.
“We are seeing a lot of interest from tenants,” said Matthew Harding, President and COO of Levin Management, an owner and operator of 95 properties encompassing 13 million square feet in the Northeastern U.S. “You can’t stick your head in the sand, because retailers are closing stores and there are now fewer retailers per category, but there are also lots of retailers and entertainment concepts looking to expand.”
He cited specialty and ethnic grocers who are able to thrive in the Northeast because of the diverse population as examples, including Filstop, a Filipino grocer, Aqui, a Hispanic grocer, H-Mart, an Asian concept and Seabra, a supermarket focused on Portuguese and Brazilian foods.
Beyond such niche players, there were plenty of growth oriented retailers among the exhibitors filling all three halls of the expansive Las Vegas Convention Convention Center where RECon was held. There were roughly 100 retail companies represented on the show floor including notables such as Walmart, Kroger, TJX Companies, Wawa, 7-Eleven, Dollar General, Dollar Tree/Family Dollar, CVS, Ahold, Save-A-Lot, and Home Depot, along with foodservice concepts and fitness centers. These companies were present to tell their own growth stories to brokers, leasing agents and developers who help facilitate their expansion.
One such company is Phillips Edison & Company, which owns and operates 346 properties containing 40 million square feet. Its properties are 93 percent occupied and include as tenants major grocers including Kroger, Publix, Albertsons, Safeway, Ahold and others.
“We are in a pretty good environment right now with strong demand for space, but it has been a tough time to be a grocer because of deflation,” said Jeff Edison, a partner and CEO of the firm. “We would love every one of our grocery tenants to offer click and collect and gas because it ties into their sales and makes shoppers more committed to the retailer.”
The way Edison sees it, Walmart went from zero to 25 percent of the food market over the course of several decades and supermarkets survived. Now comes Amazon, a company probing the food space for 10 years, with hardly any impact.
“You have to keep your eye on the Internet but you can’t blow it out of proportion,” Edison said.
Ron Wheeler, CEO of The Sembler Company, owner and operator of primarily grocery anchored centers encompassing 28 million square feet, isn’t blowing the Internet out of proportion. However, he does have his company focused on food, health, beauty, fitness, wellness and restaurants, or as he puts it, “all things that you can’t have similar experience with on the Internet.”
“We are a 50 year old company but our focus the last few years has been grocery anchored development and acquisition,” Wheeler said, noting the company’s centers are at 95 percent occupancy. “I don’t have a crystal ball. All I can do is stay as abreast of the trends as possible because what we think is going to happen doesn’t always happen.”
Because the company is near full occupancy it has been able to adjust rents upward, but Wheeler doesn’t want retailers getting over extended on rents if demand for space outstrips supply.
“The canary in the coal mine is when a grocery anchored center starts to have rents in the high $30s,” Wheeler said.
Another concern he has is the lack of new retailers to occupy spaces in the 20,000-sq.-ft. to 50,000-sq.-ft. range.
“Retailers are looking for smaller spaces than they have before so it is going to be bumpy to replace some tenants,” Wheeler said.
Winners and Losers
A strange mix of strong industry fundamentals, digital angst and the fact that all real estate is local, have made it challenging for those in the retail real estate world to accurately gauge the long term outlook.
“The big question today is about malls and who will be the winners and losers. The values for anything other than A malls have moved down so the other big question is how deep is the demand for re-tenanting,” said Richard Latella, Executive Managing Director and Retail Practice Leader, Retail Valuation and Advisory with Cushman & Wakefield. “There will be more bankruptcies and closures, but it’s not the end of retail, just a major structural shift.”
Latella leads a team of 75 people at Cushman & Wakefield whose job it is to understand all of the countervailing forces affecting retail and assign values to properties the same way a property appraiser does during the sale of a home. He’s in the camp that views retail and retail real estate as a highly resilient industry that knows how to adapt and will benefit from department store closures.
“The department stores are paying virtually nothing for rent and we have moved beyond the time when a mall needs them as anchor tenants,” Latella said.
New anchors have emerged that offer a way for center owners to repurpose space and add value for other tenants. Entertainment uses such as theaters and recreation are the most often mentioned uses.
“We live in the experiential world,” said Greg Silver, CEO of EPR Properties, a REIT focused on entertainment, recreation and education uses, some of which are suitable for malls and other types of shopping centers. He also cautions that adding entertainment or other experiences isn’t a silver bullet for a center with underlying problems. “Entertainment makes good properties better, but it doesn’t fix bad locations that result in bad properties.”
“Retailers are becoming smarter about their real estate decisions,” CBRE’s Famous said, noting the company’s Forum Analytics group can forecast within 10 percent a retailer’s sales for a location under consideration.
They have to be smarter, because as David Green, Vice Chairman of Colliers International, said, “it is a really, really challenging and interesting time.”
In his role at the global real estate services company with operations in 68 countries, Green understands it is important to discern between macro and micro issues when evaluating the retail world.
“You can’t look at the entirety of retail and make assumptions. The macro doesn’t always affect the micro,” Green said.
In other words, while there are certainly overarching trends affecting retail generally — the growth of e-commerce and shifting buying patterns — other trends impacting the industry need to be layered on. For example, some retail properties that cater to tourists have been negatively affected by the strong dollar, which reduces foreigners’ purchasing power. Retailers’ costs have also increased in many areas and low interest rates have pushed up the prices of many of the assets held in REITs that generate income.
“You don’t normally have a convergence of so many factors affecting retail,” Green said. “We are in a phase of disruption and repurposing.”
On that point, there’s no argument from ICSC’s McGee, who expects next year’s RECon will be bigger and better than this year’s as the industry continues to evolve, shifting away from the traditional “mall” emphasis to a new way of thinking.
“I sometimes think the word retail real estate can be a little bit limiting because it has really become consumer real estate and all the things that includes such as goods, services, entertainment, food and beverage — all those things consumers want,” McGee said. “The word retail can conjure an image of only a store.” RL