(Continued from e-newsletter)
1) Retail reality check
Headlines about the looming and certain death of the physical retail store are everywhere. But the truth is, brick-and-mortar stores still dominate. According to the U.S. Census Bureau’s Quarterly Retail E-Commerce Sales Report (2nd Quarter 2017), e-commerce sales in 2017 accounted for 8.9% of total sales. That means that 91.1% of retail sales were conducted in-store. Moreover, ShopVisible, via ICSC, reported that consumers make purchases in shopping centers an average of 7.5 times per month in comparison to an average of only 2.2 times at online retail websites. The same study also reported that consumers spend significantly more in a physical store — $1,710 per month versus only $247 in an online store. This hardly spells the demise of the physical retail store.While the facts clearly tell the story the headlines miss, they point to the past, and as investors, you’re not interested in the past, you’re interested in the future. What we know is that retail is changing because the way consumers shop is changing. But consumers are not abandoning the physical store, now or in the future. In fact, 73% of consumers indicated a preference for wanting to touch or try on merchandise before making a purchase. This is leading many native online stores to open physical stores sparking an omnichannel push from the big brands of the digital world, including Amazon, Warby Parker, Pintrill, and Rent the Runway, among many others.
Amazon recently announced the acquisition of Whole Foods which the retailing giant will not only integrate with its Amazon Fresh offering but also begin testing as a drop-off location for its shipments. In addition, Amazon has been opening physical grocery/convenience stores that will eliminate checkout and lines, and continues rolling out physical bookstores, with its eighth such store opening in Manhattan’s Time Warner Center. The bookstores follow a boutique/content-curation concept, selecting which books it offers using online sales data. Bonobos, another online native, opened its 31st “Guideshop” in Detroit and according to BOF, plans to open its 100th physical store by 2020.
In addition to the push by native online stores to open physical stores, the omnichannel trend is sprouting new forms of partnerships between the two platforms. In November, Rent the Runway opened its sixth permanent location in Neiman Marcus’s San Francisco store, while Amazon expanded its Prime Now delivery service in New York City to include “one-hour delivery from local stores offering items such as groceries, prepared meals, and baked goods from D’Agostino, Gourmet Garage and Billy’s Bakery”.
Meanwhile, traditional retailers are finding new ways to omnichannel by offering BOPUS, buy online, pickup in store. Stores such as Kohl’s, Nordstrom, Best Buy, and even O’Reilly Auto Parts have jumped on the BOPUS bandwagon with many more joining the ranks. In a survival of the fittest environment, retailers that adapt will survive, and those who don’t, won’t. For investors, the key is in seeking out retailers with a future vision and strategy, whether they omnichannel or don’t, instead of those that hold on to the old ways of doing business.
2) The market is changing
The market is changing because consumers have changed. Generational, demographic, and psychographic shifts are translating to how consumers shop. Consumers today want what they want, when they want it. They want to shop for more experiences than products, and want to experience more while shopping. Slicing the population by generation, we get a glimpse of the potential impact on retail real estate and lifestyle decisions.
- Millennials want to drive less, share more, and live in the suburbs, and what millennials want is important. With a population of 80 million people, millennials are the largest generation in history. They make up approximately 25% of the U.S. population and account for approximately 21% of all purchases. Born between 1977 and 2000, the youngest millennials are still in their teens with their mindset and purchase decisions poised to affect shopping, development, and lifestyle patterns for decades to come.
- A demographic slice offers another view and with other factors affecting the future of retail real estate and development. According to The Brookings Institution, “racial diversity will be the most defining and impactful characteristic of the millennial generation. Newly released 2015 Census data points to millennials’ role in transitioning America to the ‘majority minority’ nation it is becoming.” With 56.6 million, the Hispanic population of the United States (as of July 1, 2015) is the nation’s largest ethnic or racial minority, constituting 17.6 percent of the nation’s total population. How Hispanics shop, live, and make purchase decisions is different than the rest of the population and will affect development, retail, and lifestyle patterns.
- A geographic slice, shows even further changes that will impact development in the future as population shifts continue the ongoing ebb and flow of consumers. Another report by The Brooking Institution stated:
Big-city populations are still growing, according to new mid-decade Census Bureau statistics. That is, between 2010 and 2015, the annual growth rates of cities with over half a million people were double the average annual rate between 2000 and 2010; and the combined urban cores of the nation’s major metropolitan areas continue to grow at faster rates than their surrounding suburbs.
Both of these national trends counter pre-2010 patterns, providing further evidence that 2010 to 2020 could be the “decade of the city”. Yet the new data highlight some changes in city and suburb growth, in conjunction with broader Snow-Belt to Sun Belt population shifts, which somewhat alter that earlier picture.
More warehouses to accommodate easier and faster distribution to the suburbs and growing city centers will need to be built to accommodate for “the last mile”, and we’re already seeing this take place. For example, Amazon opened a warehouse or “fulfillment center” in the middle of New York City to service its Prime Now customers in the Big Apple. According to the Amazon website, the online retailer boasts 70 fulfillment centers across the country to meet its growing needs. In the U.S., California and Pennsylvania lead the pack in the number of Amazon fulfillment centers with 12 each (as of Q4 2016), while California adds to that 17 sortation and delivery stations. California’s fulfillment growth for 2016 represents a YOY growth of 171.43% and a whopping 466.67% growth in the number of sortation and delivery stations for the year. And Amazon isn’t done growing and neither is the trend.
All of these changing consumer patterns and shifts will have an impact in the types of properties, sites, and stores the market will demand.
3) Retail industry expertise is more important than ever
The business of investing in retail properties is about more than real estate. Now more than ever, if you’re investing in real estate, your broker must have in-depth knowledge of the retail sector at the micro and macro level. Like stockbrokers, your real estate broker must be more than someone who completes a transaction for you. They must be an advisor with the right combination of investment sales, financial, and retailing experience and expertise to have an in-depth understanding of the landscape and knowledge of how the market moves, what moves the market, and where it’s going. Moreover, they need to see the transaction from all sides and offer informed insight on the various categories, which one’s are doing well and are the better tenants, which ones aren’t, and why
For example, while department stores are struggling, there are two retail categories that are growing: off-price retailers and dollar stores. According to Retail Dive, while Macy’s, Sears, Kohl’s, J.C. Penney and Dillard’s have collectively shuttered a total of 700 stores since 2013, shopping activity at off-price stores grew by 4% in 2016. Category leader TJX (parent company to T.J. Maxx and Marshalls), saw revenue for the quarter rising 6.9% to $8.29 billion. Also bucking the trend are dollar stores which seem to be spreading like wildfire. Dollar General is expected to open approximately 1,000 new locations in 2017 while Dollar Tree said it will open 650 new stores this fiscal year.
The right retail advisor will be able to tell you both that the trend is occurring and why it’s occurring.
4) Real estate fundamentals are a starting point
In today’s changing retail and financial environment, it’s important to recognize that real estate fundamentals are a starting point, not an ending point. The mantra location, location, location still rings true today, however the characteristics of what contributes to the quality and value of a location are changing. While most brokers will look at traffic patterns and complementary retailers, there is more to finding the right location than that. In the same vein, while evaluating credit ratings for existing and potential tenants, and rent rolls for leased properties is common practice, there are other factors at the micro and macro level that will have an impact on the health and potential upside of your portfolio. Are you and your broker considering those other points?
Determining your portfolio’s short- and long-term health requires a quantitative and qualitative analysis. Like a stock portfolio, real estate investors must look beyond the property and cash flow and consider their risk/return ratio including the investment’s potential upside in real estate value as well as cash flow. That potential must be weighed against the risk, time investment, and development opportunities, among other factors. This will more comprehensively inform what your cap rate is actually reflecting and allow you to make better comparisons and decisions on sale and acquisition opportunities. When seeking the advice of a broker, make sure they are looking at your real estate portfolio as a reflection of the quality of your investments individually and as a whole. Is it large cap or small cap growth? What is your risk exposure? Is your portfolio balanced in a manner that achieves your overall objectives? This is not as simple as it may seem. At MRA, we have developed a proprietary analysis to measure a portfolio’s risk exposure and illuminate potential vulnerabilities against the market at the micro and macro level. This kind of comprehensive analysis considers the big picture and the details, essential at this critical point in the evolution of the retail landscape, and allows you to mitigate risk, protect and grow your investment, and most importantly, enjoy greater peace of mind.
5) 1031 Exchange regulations may be changing
Another important factor to take into account is the possibility that the Internal Revenue Code’s Section 1031 tax deferment benefits may be eliminated. As noted in the Wall Street Journal’s “1031 Exchange, a Cherished Real Estate Tax Break, Faces Extinction” article on June 6, 2017, House Republicans are working on a proposal that may completely do away with or greatly restrict 1031 exchanges. While nothing on the matter has been confirmed, Real Estate Roundtable President and Chief Executive Officer Jeffrey DeBoer testified this week before the Senate Finance Committee on the impact changes to the tax laws could have warning while some actions may offer a short-term boost, the long-term effects could be more damaging than good. Potentially on the proverbial chopping block, is the IRC’s Section 1031, also known as the 1031 exchange code, which allows investors to sell their real estate property and defer their capital gains taxes by reinvesting in, or exchanging their asset for another “like-kind” asset. Since many investors that take advantage of the 1031 tax deferment opportunity invest in retail properties, changes to this code could potentially affect your portfolio to the tune of millions of dollars in taxes.
While there are many changes taking place in the retail landscape one thing is clear — the time to review your real estate portfolio and create a new game plan is now. Money is made in every cycle, and money is lost. Investors that wait to act, will be too late. Those that are proactive, well-informed at all levels, and act fast, will be in the best position to profit and win.
Matthew has over 30 years in the business and is an internationally-recognized retail and mixed-use expert. He has consulted internationally, served as an expert witness, and keynoted or spoken at major retail real estate conferences across the country. In addition, Matthew leads Urban Land Institute’s Retail Program Committee in Los Angeles, participates as a committee member with ICSC, and has published several articles on the real estate industry. Read Matt’s full bio here.