Risk-Averse Strip Mall Landlords Seek ‘Internet-Proof’ Renters in Smaller Spaces
By Neil Axler
“You can’t get your nails done online, you can’t get dry cleaning done online and you can’t eat the Internet.” These are the dominant themes from retail clients (property owners) over the last few years. Today’s shopping center acquirers are looking for “necessity centers” with a stable rent roll. These centers consist of restaurants, nail salons and other destination retail that is not competing with e-commerce.
Twenty years ago, property owners would acquire large shopping centers with big box tenants. That’s not the case in 2015. The risk of one large tenant vacating a property can significantly adversely impact its net operating income (NOI) and lower property value. The bigger the tenant, the harder it is to lease up the space or re-purpose it, as exemplified by large vacancies left by Circuit City, Borders and other large retailers that filed bankruptcy. The big-box space left behind by these bankruptcies is much more difficult to re-lease or re-purpose than smaller spaces, often leading to extended vacancies, decreased NOI and lowered valuations of properties.
Retail clients today are buying properties with specialty grocers, discount apparel and dollar stores, which provide steadier cash flows and often serve blue collar markets. These clients are also seeking shopping centers with shadow anchors such as Wal-Mart, Target and Home Depot.
According to McGladrey’s chief economist Joe Brusuelas, the pace of economic growth and hiring accelerated during 2014, creating conditions for modest wage growth in 2015. Consumer spending is rising due to lower gasoline prices. The 60% drop in oil prices has led to a 40% decrease in the cost of gasoline since mid-year 2014. Lower gas prices are expected to give U.S. consumers an additional $150 billion in purchasing power.
This additional purchasing power should be good for the health of the retail real estate market. However, it is still perceived as the lowest of all major property types for investment and development because consumer preferences are volatile, and obsolescence occurs more quickly than other asset classes. While some obsolete retail properties are transitioning to other uses, often times the cost is prohibitive. It all comes down to location and tenant mix.
Despite forecasts of the ‘demise of retail’ predicted by some at the outset of e-commerce, e-commerce currently accounts for approximately ten percent of consumer sales, while brick-and-mortar accounts for 90%. Retail landlords (and others) understand that while e-commerce has hit certain parts of retail, it hasn’t hit everywhere. The majority of consumers still enjoy congregating and touching products prior to buying. Even Millennials, who are highly technical and use their devices to research products and services to make purchasing decisions, often use those devices to compare prices and features while in stores. In fact, reportedly 80% of consumers now use their devices to research and compare products and services – either before or during their visit to a store.
Not only that, but according to Carol Lapidus, consumer products industry practice leader for McGladrey, Millennials use technology to share their experiences with family, friends and work colleagues. They are highly likely to use social media to tell others about their recent purchases or visits to restaurants or entertainment venues. In fact, reportedly 80 percent of all consumers now use their devices to research products and services and compare either prior to or during their visit to a store. Therefore, it’s understandable why “internet commodity” stores are performing more poorly than necessity stores. In addition to nail salons, dry cleaners and restaurants, other necessity stores include grocery stores, hair salons, dollar stores, liquor stores, check-cashing and pawn shops also provide NOI stability.
Another shopping habit of Millenials: they have a strong preference for boutiques, trendy restaurants and coffee shops – all unattainable on the internet. Understanding the technology habits of shoppers who tend to share their experiences with family and friends via social media is imperative for the landlord’s tenant selection. The tenants who use technology to connect with this demographic often build and maintain customer relationships more than the tenants that do not.
And while there is no discounting the importance of millennial consumers, it’s also important for landlords to think about tenants that cater to baby boomers and their interests, as well. Just one example of how landlords are considering this still important demographic: shopping centers across the country are being repurposed into medical offices, as health care tenants are increasingly becoming another internet-proof tenant that is helping stabilize properties, increase NOI and increase value.
On the other end of the spectrum, major national retailers searching for smaller spaces, since it’s not as important for them to house vast amounts of physical inventory. So the lines between e-commerce and shopping centers are becoming increasingly blurred. Traditional retailers are now relying more on their websites and social media to connect with customers, while e-commerce retailers are opening showrooms to allow customers to embrace products in person. This shift in dynamics has been quick. Landlords who can identify the right tenant mix are likely to be rewarded with high occupancy, low vacancy, high NOI and higher valuations.
Neil Axler is Director, McGladrey LLP, a national provider of assurance, tax and consulting services.
Retail Not Reaping Full Benefit of Consumers’ Savings at the Pump
By Stephen Metivier, TD Bank
Oil prices are down, in part due to OPEC’s failure to reach an agreement on production curbs, and are expected to remain low through much of 2015 because of the abundance of supply in relation to demand. Naturally economists, lenders and retailers conjectured late in 2014 that the dropping gas prices would lead to an increase in retail spending because consumers would be saving money at the pumps, leaving them with more disposable income. Additionally, in the fourth quarter, with the stock market performing well and unemployment at its lowest since 2008, economic indicators pointed to a positive environment for spending.
The assumption has not proven to be true, especially when considering the situation of the typical consumer. For many Americans, the savings at the pump are being directed towards savings, the reduction of debt, increased housing costs and medical expenses. We all know, medical expenses are increasing, forcing more of our income to be put towards those expenses. This is what makes the current retail environment unique when compared to previous periods.
In my 20-plus year career working with retailers, when sales do not meet forecasted expectations, gas prices and the weather are always the factors retailers point to for explanation. Oil prices are low and are expected to remain so for the next two quarters, so why haven’t we seen robust spending? For the first time I can recall, a decrease in gas prices does not immediately equate to an increase in consumer spending. As mentioned above, there are multiple factors at play here.
Weather is always a major concern for retailers. Prior to mid-January, the Northeast had a relatively mild winter. Temperatures were not initially as severe as last winter and into December, you would occasionally hear New Englanders comment on the balmy winter we were having. Of course, Mother Nature is fickle and the cold (and snow) quickly piled up in the back half of January into February.
For retailers, inventories are built around cold weather purchases from October on, consequently a mild winter means consumers are not buying the cold weather accessories and equipment that typically sell during this time. Because winter weather came so late into the season this year, retailers have been able to sell off some of the remaining cold weather gear. However, the “late” winter means that most retailers were likely to have already taken “hard” markdowns on this inventory – up to 40% off – which reduces gross margin and, more importantly, the profitability of the retailer. The impact, however, is not limited to regional retailers because national retailers have exposure to states with inclement weather as well.
Consumers’ unwillingness to pay full price, which has become part of the “new normal” in the U.S., is having a lasting impact on retailers’ inventories as well.
What growth we have seen in the retail industry has been driven by two key factors: the continued spending power of wealthy consumers and an apparent increase in spending on groceries, restaurants and technology. Although lower gas prices are estimated to save American consumers $220 billion over the next 12 months, the savings is only achieved "$10 to $15 at a time," which may be one factor limiting the ability to spend savings on big ticket items. It appears households are focused more on purchases that improve the quality of their day-to-day lifestyle, like dining out and vacations, as well as technology to keep them better connected, like smartphones and tablets. Economists believe we’re likely to see spending maintain a 3% increase pace throughout the year driven by these factors.
Internet sales continue to be a main focus for retailers, particularly while gas prices are low. According to the National Retail Federation, last November and December saw a 6.8% increase in Internet purchases, and overall, online purchases accounted for approximately 9% of consumer spending in 2014.
With a significant number of purchases taking place via Internet, free-shipping offers are becoming the status quo for retailers. Pure online retailers like Amazon have established an expectation among consumers that free shipping is included once a certain price point is reached. This tactic is now prevalent across online stores and is considered part of the discount retailing approach, an adjustment to meet the “new normal” where consumers are not willing to buy at full price. Although retailers may not see an uptick in consumer spending due to gas prices, they will be able to see the benefits, particularly as it relates to free shipping, as those costs decrease in the supply chain.
With the amount of increased consumer spending not guaranteed, it’s likely that in 2015 retailers will focus less on following gas prices and more on improving their entire store base and website. We expect to see credit utilization creep back up to its pre-recession levels at 35%, compared with less than 20% over the past few years, due to the investments in new stores and upgrading infrastructure.
Needless to say, it’s an exciting time for the retail industry with a lot of opportunities ahead as retailers adapt to the “new normal” of customer expectations and take advantage of the current positive economic environment.
Stephen Metivier is head of asset based lending retail finance at TD Bank.
Destination XL Group swings to Q4 profit
Canton, Mass. — Destination XL Group Inc. grew sales and margin and swung to a profit in its fourth-quarter, reporting net income of $1.6 million, after a $55.1 million loss in the same period a year earlier. It also announced plans to open 40 DXL stores in 2015.
The retailer of men’s big and tall apparel reported revenue of $119.6 million in the period. Sales per square foot in DXL stores rose 10% to $165. Total same-store sales increased 8.9%.
"We are extremely pleased with our fourth quarter results, as our DXL stores delivered for the seventh consecutive quarter a double-digit comparable sales increase," said president and CEO David Levin. "The comparable sales increase in DXL stores this quarter was +16.4%, which is quite impressive, given that it was on top of a very strong comparable sales increase the prior year.
For the year, the company reported that its loss narrowed to $12.3 million. Revenue was reported as $414 million.