Smaller Formats, Huge Investment Potential

We are entering “the incredible shrinking store format” period. Thanks to the increasing popularity of e-commerce and changing tastes of shoppers, retailers are shuttering low-performing outlets and reducing real estate footprints.

Target is expanding in densely populated areas with smaller-format stores, typically 12,000 – 40,000 square feet. These smaller-format stores are a far cry from the retail company’s suburban, full-size, 130,000 square-foot, centers.  Target is not alone in the size reduction, Walmart, Kohl’s, and Nordstrom are also experimenting with smaller formats.

It’s too soon to understand the full effect of shrinking-stores impact on net-lease space. There is, however, a great deal to like about the trend, so far.

Big Things, Small Packages

Keeping costs down to stay competitive with Amazon is one reason why Target and others are experimenting with smaller formats. Another reason is to reach younger adults who live and work in urban cores or heavily populated inner suburban rings.

For retailers, smaller-format stores offer better efficiencies and lower costs. For example, the small-format Kohl’s stores require less electricity and employees. Lower operating costs can mean a more profitable retailer and a more attractive tenant.

Smaller formats can be squeezed into what was once considered hard-to-fit spaces, meaning more stores can open. An increase in the number of stores, especially net-lease stores, is positive; for the past several quarters, the net-lease sector has been characterized by high demand and low supply. Additional stores mean additional investment opportunities. This, in turn, could lead to more realistic pricing for net-lease property buyers.

A Different Type of Investment

In recent news, a 22,000 square foot, net-lease Target store in Oak Park, IL sold at a 5.5% cap rate, a significant premium to the average big-box cap rate of 7.2%. The sale represents a shift in “investor demand from traditional suburban NNN retail to core market assets with reduced footprints and replaceable rents,” commented Britt Raymond with SRS Real Estate Partners.

Raymond is correct. Investor demand for the smaller-format stores will likely increase, due to the following:

• Lower operating costs
• More flexibility to fill the space, should the tenant not renew
• Prime locations in high-trafficked urban cores
• High-credit national tenants

To summarize, giant retailers are experiencing huge success with shrinking real estate footprints. Net-lease investors can benefit from owning smaller-format stores.

The views expressed here are the author’s own and not that of ALM’s real estate media.