Is Retail Still Considered Core Real Estate?

It’s no news that retail real estate is in a downward spiral. It started slowly 10 to 15 years ago as timed constrained shoppers were getting tired of getting stuck in traffic and reduced their mall trips. E-commerce accelerated the trend. Efforts at trying to make mall shopping more experiential have fallen flat.

And stuffing brand stores into high-street urban locations has run its course too—rents are dropping along the most coveted shopping strips in the country. We’re at the top of the economic cycle and the retail real estate tailspin is savaging NCREIF performance—the core index delivered only a 1% return in the second quarter. So what happens in a recession when chain stores inevitably retrench further? The number of closings could be unprecedented.

All the ongoing disintermediation raises a crucial question. Can institutions still consider bricks-and-mortar retail investments core real estate? Or have shopping centers turned into a much too volatile, high-credit risk component unable to reliably support income-producing strategies with tenants vulnerable to going belly up or reducing their footprints at any time in the economic cycle. Even the once-seemingly impregnable fortress malls catch a whiff of the unimaginable—losing brand names, cutting rents, shrinking store formats, looking for non-traditional tenants. In the 1960s, who thought Woolworths Five and Dime would ever disappear? Now anchor department stores—whose ranks have been shrinking for several decades–really look like dinosaurs and even once seemingly insulated luxury purveyors, the province of the one percent, go bankrupt. At strip centers local and regional grocers have been eviscerated by Wal-Mart, Target and Trader Joes, among other national behemoths. And in cities, do we really need any more corner drug stores or Starbucks?

The rationales for owning retail properties have been capsized in the rising tide of red ink. Markets need less of it and rents need to recalibrate down. The shakeout will pick up pace in the inevitable economic downturn and may continue afterwards as online shopping becomes even more easy and accepted.

Once true-believers are in full retreat. Big institutional players can’t look like they are panicking for fear of creating a fire sale, but they want out. “We’re strategically selling” translates into let’s try to dispose of as much as we can as quickly as possible before it gets worse. But the reality is most players know they are going to get caught with some real stinkers and writedowns will be increasing as buyers grow scarce especially in the face of the economic storm clouds. Everyone is looking at alternative uses—medical office, apartments, warehouses—whatever will help cushion against big losses.

Under the circumstances, many retail properties will become value plays—buy at very low prices and reposition into something you can sell off in an economic upturn. And that something may not be retail at all. The idea of owning a 20 to 30 percent component of retail properties in an institutional core fund has been blown up whether we all realize it yet or not.

Those days are over. Like the Five and Dime.

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