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Psychological Recession

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Conversations dance around the “R” word, but whether or not the current economy can be defined as a true recession, retailers are faced with harder times and new challenges. Ironically, the economic uncertainties may also present opportunities for improvements.

Executive leaders from Boston-based Gordon Bros. Group, which specializes in dispositions, appraisals, acquisitions and capital solutions, discussed with Chain Store Age some of the key issues confronting their retail clients.

“Uncertainty is going to be the watchword for this year,” stated Gary M. Kulp, president of the retail division of Gordon Bros. “The low-end consumer will be hurt the most, but it is affecting everyone—we’re even seeing some of the better luxury retailers being impacted. There’s a large macro effect; we haven’t seen anything like this in eight or 10 years.”

Discretionary income, particularly for lower-income households, has been diminished by the rising costs of fuel, food and basic necessities. Consumers have become more value-oriented and price-sensitive, which Kevin J. Kulinowski, principal and managing director, Gordon Bros. retail division, suggested would have an impact on retailers’ promotional activity.

“On the upper end [of incomes],” noted Jeffrey C. Bloomberg, principal, managing director and office of the chairman of Gordon Bros., “people don’t feel it in discretionary spending as much but they don’t feel good about the economic uncertainty or the volatility of the stock market. Regardless of whether we are technically in a recession, we’re in a psychological recession and that has hit the upper-end consumer.”

The consensus was that retailers had begun to scale inventories to lowered expectations long before the disappointing fourth-quarter sales were tallied. Retailers will have to continue to manage inventory more efficiently, but real estate assets and plans for expansion are also being impacted dramatically by the economic downturn.

“Retailers are retrenching, cutting back on growth and not putting money into capital expenditures,” stated Andrew B. Graiser, co-president of DJM Realty, the real estate division of Gordon Bros. “We are seeing retailers walk away from signed deals as well as from oral commitments they’ve had with landlords for years. Retailers are also having a real problem getting financing for acquisitions or for owned real estate.”

“Clearly, surplus real estate inventories are starting to build and there are fewer takers,” Graiser continued. “From the calls we’ve gotten in recent weeks from retailers and lenders, I expect we’ll start seeing more vacancies in C and D malls and in some of the strip centers, but not the A-quality strip centers. Also, in the secondary and tertiary markets we’ll start seeing big boxes come available and it will take longer to fill these spaces again.”

The silver lining is that this sets the stage for retailers to evaluate their portfolios and turn the assets that aren’t producing. Relative to store expansion, Bloomberg said the current climate presents the perfect opportunity for retailers to “take a step back before they step forward.”

“We’re going to see a lot of introspection in terms of announced store closings—the only thing that will limit this is the impact it would have on the retailer’s income statement for a reported period,” he continued. “Also, the LBOs [leverage buyout companies] are basically all under water—leverage is no longer at 7.5x EBITDA, it’s now 5.5x or 6x on a stretch basis. As a consequence, equity is effectively under water, too. To get back to their equity positions, retailers will have to earn money the hard way—by improving their operations.”

One step in that direction is to dispose of underperforming locations or renegotiate leases for better rents. Additionally, Graiser shared that Gordon Bros. has seen retailers with large portfolios make adjustments to right-size their footprints. For instance, a retailer with a number of 20,000-sq.-ft. stores in its portfolio may have discovered that a 30,000-sq.-ft. format is more productive. In that case, the retailer would likely relocate to the better size and dispose of the excess properties.

“The analysis is always based on the retailer’s ROI,” concluded Kulp. “You have to ask ‘What is the cost of exiting one location to move to a format that is more productive?’”

Similar to trends in consumer spending, retailers on the low end of the earnings curve will have to take more drastic measures, but even those with higher earnings will feel the squeeze. Like their customers, retailers have become more value-oriented and price-sensitive. Reevaluating assets may be the best way to salvage earnings by spending less.

© 2014