Investors, Lenders Adjust As Change Remains A Constant In The Retail Industry

by SCB Staff

— By Bryan Cornelius, President at X Team and Principal at Venture DFW Commercial —

The debt market has recalibrated following four rate increases in 2018 and a recent cautionary pause by the Federal Reserve. The market is hoping to take advantage of the strength of the economy, the stability of inflation, and the forecast of no further rate increases and/or decreases by the Fed throughout the balance of 2019. The capital markets are firing on all cylinders, providing very compelling financing and refinancing options across all commercial property segments. That said, lenders are still disciplined in their underwriting and as they evaluate a property’s go-forward business plan, which includes local market dynamics and tenant health.

Lenders remain a bit cautious with regard to retail assets surrounding the ever-changing nature of brick-and-mortar retail, but their underwriting takes much of this into account. Lenders are active and engaged when it comes to the re-pricing of non-core retail. The debt market will remain robust and liquid throughout 2019. As such, it will provide significant impetus for the financing and refinancing of retail assets. The new normal for property owners in 2019 will be to carefully weigh the benefits and opportunities of a property sale versus a refinance, as the spread between the two has narrowed due to the compelling capital markets environment.

Wading Back into the Retail Waters

The investment buyer pool narrowed considerably in 2018 and into first quarter of 2019. However, we are now seeing more activity as the spread between buyers’ and sellers’ expectations has closed a bit. This, combined with the repricing of many retail assets, has compelled investors to re-enter the market. The fundamentals of a retail property are still paramount, however, and the underwriting remains extremely diligent. Retail continues to encounter some challenges as this real estate generally occupies some of the best real estate in their given local markets. As such, investors give greater value to quality of retail, as opposed to other asset classes, especially as construction costs have escalated. Investing in existing retail only improves this investment strategy.

The balance of 2019 should be a good year for the retail investment market, both in terms of finance/refinance and sales transactions. The economy is forecasted to remain strong in the near term and, as such we believe retail activity will do the same. There are certainly challenges within brick-and-mortar retail, but retail has always been dynamic and fluid. Those who embrace this and understand the fundamental strengths that make retail unique will prosper. Retail is decidedly tenant driven and absolutely market specific. Underwriting with this in mind, 2019 will remain opportunistic for investors and owners in terms of investment options to buy, sell, finance or refinance.

A Transformational Strategy

Thanks to this last cycle, retailers have learned change is constant. They have internalized the notion that they must adapt to compete in the current economy. This includes the fact that consumer demands are driving the evolution of retail like never before. Retailers, restaurants, service providers – basically any businesses that provide goods or services to the public – are under pressure to adapt or die. This is true both from a store operations standpoint and from a real estate standpoint.

This intense transformation can best be observed in the restaurant arena where fast-casual concepts have exploded. New locations now provide curbside pick-up parking, online order only drive-thru lanes and home delivery. This has created new real estate prototypes for some concepts, which sometimes involves relocating existing locations to accommodate these services. Chipotle, Dunkin and Panera are examples of this trend. Retailers are fast determining what they need to do to be competitive. Some are able to handle delivery and fulfillment of orders directly from their stores, while others may be opening fulfillment centers to centralize that function. A few are partnering with logistics or delivery companies to provide these services. The bottom line is, well, the bottom line. Whatever keeps them competitive while still remaining profitable is the answer.

Internet disruptors have entered the scene in the past several years with concepts that were formerly online-only expanding into physical stores. These digitally native, vertically integrated brands (DNVBs) have an advantage over many other retailers as they have already figured out the logistics of getting their products to the customer. Warby Parker, Peloton, UNTUCKit, Sugarfina, Sierra Trading Post, Casper and Bonobos are a few examples of previously ecommerce-only companies that are doing brick and mortar right. Their next challenge will be to consistently provide a great customer experience in these physical stores. This trend has become so significant that the recent 2019 ICSC Open Air Center conference announced that more than 1,000 DNVBs have already launched physical locations.

Owners of shopping centers are also adapting to the changing retail landscape. They are integrating technologies to their properties to attract tenants. These can include delivery services, return kiosks, parking sensors and indoor navigation that help provide customer conveniences. Non-retail uses are also being embraced by many mall and shopping center owners. These include co-working spaces, healthcare providers, ghost kitchens, pet services, education and hospitality. Landlords are fast evolving to help attract tenants and fill spaces.

Retailers and landlords must be able to redesign their organizations and deliver what the customer wants, when they want it, if they are to compete and stay relevant to their customers. Those that are continually improving their services will reap rewards for years to come.

— By Bryan Cornelius, President at X Team and Principal at Venture DFW Commercial. This post was published as part of Shopping Center Business’ Retail Insight series.

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