LAS VEGAS — These are the best of times and worst of times for the shopping center industry. Rapid technological change is enabling retailers and property owners to be more creative in their spaces than ever before. Think augmented reality and ominichannel marketing. At the same time, the e-commerce model has proven to be quite disruptive for many brick-and-mortar retailers who are struggling to adapt. The spate of retail store closures continues. But retail is a living organism that inevitably evolves, adapts, and yes, thrives more often than not.
Against that backdrop, the editors of Shopping Center Business fanned out on the show floor of the Las Vegas Convention Center over the past few days to interview developers, lenders, brokers, and more. Here’s a sampling of what they had to say.
Retail Investment Activity Will Pick Up in the Second Half of 2019
There has been a general perception that the “retail apocalypse” is over, says Philip Voorhees, vice chairman of CBRE, Inc. – National Retail Partners – West. “Store closures will continue for dated retailers innovating to meet customer demands and adopting technology to enhance customer experience, but this is no longer headline news. Retail investors now price risk into underwriting; retail moves on and continues to evolve.”
On the investment front, many qualified clients lament that “there is nothing to buy” and that institutional owners continue to hold core properties, Voorhees adds. In particular, there is a lack of grocery-anchored centers for sale in the West. “If a center cannot be replaced, it will not be sold,” he says.
But he does expect things to pick up later this year: “While transaction volume seems down, pipelines are full from the RFP/BOV standpoint. This indicates more inventory will hit the market during the second half of the year.”
He notes that we are seeing perhaps the widest ever spread between cap rates for “core” retail — mid-4 percent to low 5 percent range in coastal/primary gateway markets — and the least desirable retail properties, such as enclosed malls in tertiary or low population growth markets, where cap rates are mid teens or higher.
Meanwhile, he adds, we are seeing a historically wide spread between cap rate and 10-year Treasury yields, which creates excellent leveraged cash-on-cash returns at modest loan-to-value levels.
“CBRE expects strong to exceptional transaction volume during the second half of the year, much like 2018,” Voorhees predicts. “Sellers are adjusting pricing on non-core assets to meet buyer expectations, and the capital markets remain open and favorable.”
Retail Investors Don’t Want to Miss an Opportunity
People were noticeably more positive about retail at this year’s ICSC RECon compared to last year, according to Scott Holmes, Senior Vice President, National Director of the National Retail Group with Marcus & Millichap.
“Those in the business know that the fundamentals are strong,” he says. “Those who were afraid of making a mistake last year are afraid of missing out on opportunity this year. Most now see retail as a growth and yield play relative to the other asset classes.”
He notes that the fourth quarter of 2018 had a lot of uncertainty and volatility. That made for a slow first quarter for many. But, “the positive shift in mood in the market and the broader economy have led to an increase in activity levels and deals getting done which should bode well for the second half of 2019.”
As ICSC RECon is wrapping up, Holmes says that the convergence of private capital and institutional capital is notable. “Private investors are looking at larger retail deals that typically had been reserved for institutional investors. Likewise, we heard from many institutions that they are looking at smaller retail deals now,” he says.
2019 and 2020 Will Continue to See Store Closures, a Necessary Evil
While many ICSC RECon attendees were in agreement that things are more positive in the industry, there are still shadows over the sector.
As Fred Meno, president and CEO of asset services with Woodmont Co., points out, “Last year, there were about 35 retail bankruptcies; we’re on pace for 30 this year and another 30 next year. About 60 percent of those bankruptcies are attributable to retailers being overleveraged on their balance sheets, which have led to those leveraged buyouts.”
He notes, “Many people look at retail and see a sales problem — but, in many cases, that’s secondary to the fact that they’re overleveraged and their balance sheets don’t allow them to grow and be profitable.”
In the long term, more store closures will be a good thing, Meno says. “We’re seeing the law of the jungle in retail wherein the strong eat the weak and continue to dominate. Overall that should be good for the industry. We are still in an over-stored retail market, and as mall product starts to diminish and disappear due to malls that can no longer survive as malls or get repurposed, you’re going to see a lot of that gross leasable area (GLA) taken off the market, which will be healthy as well for the industry.”
He sums up the current situation: We’re in the eighth inning of the game wherein occupancies are not only declining, but so too are rents — a dual indicator of the retail cycle being in its later stages. By the end of the year we’ll probably have somewhere between 8,000 and 10,000 additional store closings and probably 6,000 to 8,000 in 2020. So there’s still this churn that’s taking place, but it’s a necessary evil.”
E-Commerce Isn’t Necessarily the Reason Stores are Closing
“I think one of the challenges that we face as a society is how e-commerce has come along into the retail sector,” says Jeff Berta, senior director of real estate with Structured Development.
“It’s really interesting to watch. It’s absolutely not the death of retail. It is evolving and has to evolve, but it’s not the death,” he says. “You’re always going to have people that will go buy products and go to stores. Retail includes gasoline, eating and going to see a movie. It also includes going to see, feel and touch something.”
But we do see a lot of vacancy that needs to be replaced, he adds. “Maybe it’s replaced with entertainment or office or residential. Residential is going into traditional malls, which are going to be torn down. The malls are going to be replaced.”
But he asserts that e-commerce is not necessarily the reason stores are closing now. “A lot of stores are closing because they just haven’t kept up. They’ve been exposed. It’s a different world today in how people look at products and what they buy and how they live. Millennials are spending less on stuff and more on experiences. It’s not just about retail, it’s how we as a society are living our lives. We still believe in retail but it needs to be mixed-use and have an experiential component.”
Are You Ready for Shoppers who Rent by Choice?
In a survey conducted in March by JLL of more than 1,500 adult consumers across the United States, some 70 percent of Millennials and Gen Xers indicated they would be willing to rent items such as clothing and electronics rather than purchase them. That raises the question of whether the future of a mall looks more like a library where customers check out items on a temporary basis and return them?
Greg Maloney, CEO of JLL Retail, who participated Monday in a retail trends panel discussion hosted by JLL at its booth, said it remains an open question on how retailers will react or adapt to the idea of consumers having a preference for renting versus buying items in their stores.
“We all know we don’t want to wear the same-old, same-old. Can you imagine the future of having a different phone every week or every month? I don’t know, but those are the types of things we have to start to investigate. How do we gravitate toward that consumer and give them what they want? That’s our challenge,” said Maloney.
While this is a time of great uncertainty in the shopping center industry due to disruptive forces like e-commerce, Maloney views the challenge as an opportunity.
The shopping center industry is entering a new phase, Maloney emphasized.
“We used to have a build-it-and-they-will-come mentality. The developer would pick a piece of property, build the mall and everybody would come because nobody had any choice. It was a developer-driven business. Today, it’s a consumer-driven business. If we don’t deliver to the consumer what they want, we’re not going to achieve [the sale]. What are we going to deal, and how are retailers going to adapt to be able to get into the rental business?”
Lender Targets Transitional Properties
Marty Reasoner, managing partner, originations, for Westbury, New York-based ACRES Capital, says the specialty finance company has carved out a niche focusing on transitional assets across property types nationwide. “We do anything from adaptive reuse to repositionings to ground-up construction to heavy value-add type transactions in all asset classes.”
The average deal size for the non-recourse lender today is $20 million, but can range from $5 million to $75 million. In 2018, the company closed about $550 million in transactions and is on pace to complete $800 million in deals this year. Retail accounts for about 15 to 20 percent of its lending portfolio.
The live/work/play phenomenon that has spread across the country isn’t just limited to big cities, Reasoner points out. Many homeowners in secondary markets seeking to downsize are looking for a similar lifestyle.
“We’re even seeing that in places like Birmingham, Alabama. We’re doing a ground-up construction loan there where it not only has a multifamily component, but also a retail component on the first floor that is going to cater to a beer garden, coffee shop, and hair salon,” says Reasoner.
Developers are converting a lot of older office buildings in secondary markets into residential, observes Reasoner. “There has to be some retail supporting these people who are moving in. We feel there is an opportunity there, maybe not in sheer volume and size, but there always is going to be that service component that is needed in these markets.”
Many lenders, such as banks, take a macro view of the market, says Reasoner. Because of the rash of retailer bankruptcies and store closures, some lending institutions are understandably pulling back from retail. “We feel that there will always be opportunities in quality markets with good operators inside a sector that may be out of favor. That’s generally how we look at it.”