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.
Ikea to open its largest U.S. store, in Burbank, California
New York — Ikea will open its largest U.S. store on a 22-acre site in Burbank, California. As the first step in the construction process, the retailer must demolish 19 existing structures on the site. The new 456,000-sq.-ft. store is slated to open in spring 2017.
Reflecting the company’s commitment to sustainability, Ikea plans to recycle, repurpose or salvage as much of the existing buildings’ equipment, materials, and parts as possible.
Retail Rap: Shacking Up
The end of a retail icon is always big news in commercial real estate, and it’s particularly relevant when the brand in question is closing more than 4,000 stores around the country.
The retailer, of course, is RadioShack. There are a range of factors that have contributed to RadioShack’s downfall — brand identity and points of differentiation have eroded over the years, and in a competitive category where more and more electronics are being sold online (more electronics are sold on the web as a percentage of overall sales than in any other retail segment) — but one of the most interesting storylines in the wake of the company’s recent bankruptcy announcement is what happens next with those 4,000+ locations. RadioShack has already announced the imminent closure of more than 1,700 of those stores, and if early reports are accurate, many of those stores will be in high demand among retailers looking to take advantage of the newly vacant locations.
What is it that makes these soon-to-be-former RadioShack locations so desirable? First and foremost, whether they are located in the interior of a center or on the street, these locations tend to be quite visible and accessible. RadioShack is especially fond of corner locations, and a significant percentage of those stores are located in the kind of grocery-anchored neighborhood centers that have generally been strong performers in recent years relative to other categories of commercial centers. Just to be clear, all locations aren’t created equal, and not all RadioShacks were in highly desirable positions. The grocery anchored spaces are clearly better than the B and C mall spots.
That said, there might be more going on here than simply quality real estate. RadioShack’s longevity (the company was just five years short of a century old when it filed for bankruptcy) and influence has given the brand significant leverage over the years, and that, combined with long term leases have created a situation where many RadioShacks have been located in Class A real estate while paying Class C prices in today’s dollars. In that sense, RadioShack’s demise is actually good news across the board for everyone else: a win/win for both retailers and landlords. I wouldn’t be surprised of many landlords are generating a significant rent increase as they re-lease former RadioShack locations. Consequently, retailers looking to expand not only have access to an abundance of quality locations, but also might be working with landlords who are happy enough with their increase that they are subsequently more likely to be willing to negotiate a lease agreement at slightly less than market rate.
As for what types of retailers will be looking closely at these former RadioShack locations, I think we’ll see a mix of predominantly service retailers and fast casual dining concepts. Mobile phone companies, electronic game stores, and restaurant chains are all good candidates to fill those spots. Retailers that rely heavily on a high volume of everyday foot traffic will take a long look at RadioShack locations.
Store size adds another interesting wrinkle. The typical RadioShack store size is somewhere in the neighborhood of 1,500 sq. ft. to 2,000 sq. ft. — a format that is particularly popular right now. To look at a contrasting example, consider Caché, the women’s clothing retailers that announced plans to liquidate last month and close its remaining 153 stores. Unlike RadioShack, Caché is typically located in regional malls or lifestyle centers, and, with a typical footprint of 4,000 sq. ft. to 5,000 sq. ft., I suspect those stores will be much tougher to fill. There just are not as many uses that work well in that store size. The vast majority of new retail concepts today are looking for stores in the 2,000-sq.-ft. range, and demand for that store size is much higher (especially in the fast casual food arena). That said, store size is only one factor, and those Caché stores located in well performing lifestyle centers and malls will find that their real estate will still be quite valuable.
In the weeks and months ahead, as you head to work, go shopping, or go out to grab and bite to eat, take a moment to notice the RadioShack(s) in your area. I’d be interested to hear from you and find out what retail brands you see moving in to those spots. Do see the same optimistic outlook for RadioShack sites? Let’s keep the conversation going — leave a comment below, or email me at [email protected].