Trends and Tips for Those Heading to RECon This Weekend

In advance of the 2018 ICSC RECON expo in Las Vegas, it’s an opportune time for our annual “Analysis Without Paralysis” retail market predictions. As we’ve done in the past, our analysis takes a qualitative view of the unique insights we’ve obtained with over 90,000 commercial properties placed in our marketplace. We hope you enjoy our views and find them interesting if not accurate and we are always grateful for feedback.

YEAR OF THE HIPPO

2018 is what I’m calling a “Hippo Market” – not quite bull or bear but a massive animal that can hard-charge when opportunity arises or shy away when danger approaches. Primitively put, there are two factors which directly affect value: yield (cap rates) and net income. Yields are expanding with interest rate and resulting costs of capital increases in addition to an increase in bond yields pushing cap rates up with them. Increasing yield requirements bring deflation (to get the greater desired return at the same income you must pay less). However, net incomes – often a function of the economy (occupancy, rates, inflation/operating expenses) – are still growing in this low vacancy environment offsetting some of the yield-driven deflation. The net result is flat value, and in many instances, modest deflation. We’ll see deflated values up to 15% (an approximate 100bps of cap yield expansion) or more in some secondary and tertiary markets. Values for strong assets in strong markets will remain stable, and in some instances up, as a glut of sidelined capital continues to chase good deals.

TRANSACTION VOLUME

Here’s a dirty little secret: transaction volume is down (but still healthy). A widening bid-ask gap, or buyer vs. seller value perception resulting from buyers reacting in real-time to changing conditions and costs of capital while seller’s expectations tend to lag until trend becomes norm. Following a long and active expansionary cycle, deals are becoming more challenging to transact and taking more time. While the market commentators who often control the tone of the market are still professing: “hot, hot, hot” sellers with property in the market are seeing slowed timelines and slightly softer pricing. There was cooling from 2016 to 2017 and there will be some more cooling in 2018. That said, pricing is still strong and plenty of transactions are occurring for well-priced and well-positioned assets as we softly land from the last cycle. We recommend sellers hire strong brokers to navigate the changing environment, push their deals over the finish line, and capture what are still very strong asset values.

EVERYONE IS ZAGGING – TIME TO ZIG/?

Overreaction to the Amazon effect is causing retail to be product type non-grata. Retail is not changing, it has already forever changed. As many seem to be zigging away from the product type, I see opportunity. Consumer behavior and preferences have changed, yet good centers still have full parking-lots, grocer sales are strong, and some goods and services can’t be virtually obtained. Retailers selling homogenous products (ex: paper towel, books) could struggle from the Amazon effect. However, retailers selling heterogony and experiences instead of goods (restaurants, gyms, luxury) or convenience will continue to prosper and successful landlords and investors will learn to better optimize their tenant mix. Creative landlords and opportune investors will backfill vacant boxes creating value-add opportunities for entrepreneurial investors. Who will they backfill those boxes with? How about industrial users who are more and more seeking centralized last-mile centralized locations near population clusters, are becoming desensitized to double digit rents, can utilize loading docks and large parking fields for truck aprons, and can possibly use storefronts for hybrid retail distribution? Why not?

HIGH-STREET ISN’T RETAIL – HOLISTIC VIEW

I’ve said this in the past: well-known luxury retailers are often writing off their high-street rents as showrooms and advertising costs (“brickboards”?) and the stores aren’t always viewed as direct profit centers. Many high-street retailers recognize that their retail location is a branding vehicle and a place to get customers to try on products before buying them online. Additionally, the store serves as a return-outlets where a customer can return something bought online and often ends up buying more. While rents are typically high, footprints are small and staffing needs are usually low. Assuming a well-thought out brick and click solution, many high-street retailers are poised to adjust to the changing environment. Once exclusively online retailers like Warby Parker (who once professed they would never have a store), Toms, All-Birds and Amazon are recognizing the value of a physical location and rolling out stores. Analysts, investors, and landlords should take a holistic view of their tenants and also analyze corporate health.

SELL YOUR CLOTHES OR DIE

Selling other brand’s products – especially apparel – can be a dangerous game. If a customer tries on a pair of Nikes at a Nike store, but then purchases them online, Nike will still realize the revenue. If a customer tries on a pair of Nikes at Sports Authority, but then buys them at Nike.com, Sports Authority will not realize the revenue despite paying the rent and human cost to service that eventual non-customer. While Nordstrom and other department stores have done okay, Sears, Macy’s and others have been challenged for a myriad of reasons including selling other people’s products which are tried on and then bought online directly from the brand.

PRIVATE EQUITY

Yes, the retail landscape has changed and sales are down for many concepts, but often the deathblow to a struggling chain which could have otherwise recovered is their corporate ownership structure. Leveraged Buy Outs (LBOs), now more-politely called Private Equity, have resulted in many companies balance sheets being loaded with debt. When a private equity firm buys a business, the debt used to acquire the business typically goes on the acquired companies balance sheet. If a PE firm buys a retailer for $1B with 80% leverage, the retailer now has to service a $800MM loan. Servicing that debt is expensive and there is little room for error. A decrease in sales which could have once been recoverable is now catastrophic. Many of the high-profile Private Equity owned retailers have taken their medicine, but there are more out there.

FOLLOW THE PEOPLE 

Urbanization is real as is southern migration. Study the demographics. Populations are moving from the iconic northern cities to younger southern cities to find opportunity, escape taxes, benefit from more business-friendly environments, find better weather, and to retire and service those retirees. Many of these markets are young and raw and still require some basic development to infill grocers and other basic needs. I love young warm weather markets with some physical barriers to prevent sprawl and I believe the rise of the small city continues (8 Cities to Watch).

CRE TECH

I’d be remis not to mention our focus, commercial real estate tech. CRE Tech, like the CREXi platform which boasts 55,000 properties available for sale valued at approximately $350B, are becoming a major conduit for supply-and-demand, workflow management, and increased liquidity.

We wish everyone a safe and productive 2018 RECON conference. Here are some tips (10 Tips). The views expressed in this column are the author’s own. Eli Randel is VP of sales at CREXi.