CARLSBAD, CA–Changing consumer buying habits as part of a confluence of factors have created the perfect storm that is taking its toll on the retail industry right now, Real Capital Markets' COO Tina Lichens tells GlobeSt.com. We recently reported on the firm's May 2017 Retail Sentiment Report, which found that retail investors believe shifting consumer buying habits are the greatest threat to the industry, reinvention is the key to solving the industry's greatest issues, anchored shopping centers are the preferred property type by a margin of 3:1 and interest rate movement is not a significant factor in investment decisions. In addition, the report revealed that more than 57% of investors surveyed are net buyers of retail properties, an indication investors looking for opportunities and the ability to “balance” portfolios previously buoyed by other asset types.
We spoke with Lichens about some of these findings and what they indicate for the sector's future.
GlobeSt.com: How are shifting consumer buying habits the greatest threat to the industry, and what can the industry do about it?
Lichens: In the RCM Retail Sentiment Study, shifting consumer buying habits were identified as the greatest threat, statistically speaking. However, it really is the confluence of various factors, including those shifting habits, that has created the perfect storm that is taking its toll on the retail industry right now. In fact, many believe the various factors are too closely tied together to clearly identify one greatest threat.
It is true that consumer buying habits are changing, but these changes incorporate more than just increasing use of e-commerce. Consumers are demanding greater levels of attention, rewards programs and an exceptional overall “customer experience.” Those retailers that provide it are being rewarded; those that don't are increasingly challenged. Add to this the ease and popularity of online shopping, same- or next-day delivery and the typical evolution in retailing and you have the current state of retail.
As many we spoke to confirmed, there is no single greatest solution or cure to what ails the retail industry today. This may, in fact, be a good thing since it causes retailers and investors alike to more closely examine strategies and practices. Just as with many other industries, retail real estate is going through a natural course of evolution that is a necessary characteristic of a sector that is evolving to changing market conditions.
GlobeSt.com: How is reinvention changing where retail is heading and which investments make sense?
Lichens: Reinvention in the industry applies both to retailers and retail property investors. For retailers, reinvention often means developing a broader, two-part strategy with one part focusing on the e-commerce/Internet presence and one that hones the brick-and-mortar customer experience.
For certain retailers, developing and embracing an online strategy ultimately means changing the footprint of traditional retail operations. The changing operations could mean that where an original footprint was 40,000 square feet or 50,000 square feet, the new look would require only a portion of that space. Further, the actual design of the store may incorporate an area that accommodates in-store pick up of online orders. The exact amount of space required and the configuration of the space will vary from retailer to retailer.
On the property side, investors are looking at ways to minimize risk by attracting tenants that aren't as susceptible to the impact of e-commerce and the issues that can cause. In some cases, this strategy also seeks to leverage the growth/expansion of healthcare networks or so called “medtail” (medical and retail) users. Increasingly we are seeing hospitals and healthcare systems leasing spaces previously occupied by big-box retailers and converting them to clinics and treatment centers.
Depending on an investor's appetite for risk, we'll continue to see interest in these opportunities. Value-add investors will look to add considerable value by making these conversions, while investors that tend to be more core-oriented will be attracted to centers where the reinvention already has occurred but considerable lease term remains.
GlobeSt.com: What advantage do anchored centers have over other types of retail in the investment realm?
Lichens: The greatest advantage is the draw of the anchor and the traffic that anchor creates. The stronger the anchor, the better it is for the property. That is one of the reasons grocery-anchored centers (as well as those retailers like Target, for example, that have a grocery component to them) are held in such high regard by investors.
In spite of the increasing popularity of gourmet-prep specialty firms and the ability to purchase more and more items online, the grocery store isn't going away any time soon. People will always need last-minute, forgotten items. And to their credit, many grocery chains continue to enhance the customer experience at their stores by improving the offerings available to consumers like prepared foods, coffee and wine bars, etc.
One investor shared with us the importance of having control of the entire center, including the improvements occupied by an anchor. The investor highlighted a center where the grocery-store parcel was owned by a separate entity. When the grocer vacated the premises, but was still obligated to pay rent, the parcel owner had no incentive to re-tenant the building. The loss of the grocer had a significant impact on traffic and made it extremely challenging for the owner of the balance of the space to mount an aggressive leasing effort. The position of the center slowly deteriorated.
GlobeSt.com: With the majority of investors being net buyers what will this do to retail cap rates?
Lichens: Generally, the more demand there is for any given asset class, the more cap-rate compression (lower cap rates) you'll see. More buyers will drive up prices for desirable real estate.
However, you can't paint all retail with the same brush. It is necessary to look at the activity within sub-categories (i.e., malls, strip centers, anchored centers, etc.). If buyers are all chasing the same sub-asset category, such as grocery-anchored centers, this doesn't mean that they will necessarily substitute another sub-asset type (e.g., suburban mall) if they are outbid on their desired property. They may simply hold onto their “dry powder” until they can deploy it on assets that meet their acquisition strategy exactly.
We expect to see cap rates differ rather dramatically by sub-asset type as well as location within the main retail class.
GlobeSt.com: Why aren't rising interest rates affecting decisions in a significant way?
Lichens: Purchasing decisions typically are based on a number of different factors, of which interest rates may be a factor—and then only minimally. Very few investors base investment decisions solely or largely on the cost of funds. Instead they are focused on the intrinsic value or opportunity in the real estate, its location, tenant mix, unique value proposition, position in the marketplace and capital-improvement needs. These factors, generally, are things that interest rates, regardless of their movement, cannot impact.
There also are certain investor categories, including most notably pension funds, that typically are purchasing properties on an all-cash basis. Value-add buyers are another category minimally impacted by interest-rate movement. While a lower interest rate likely will have an impact on holding costs and capital-improvement expenses, the value created by the physical improvements made to the center, and improving occupancy and rental rates, will far outweigh the capital expenses of higher interest rates.
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