By Garrick Brown, Vice President of Retail Research, Americas
And here is Part II of my thoughts on Fitch Rating’s release on the topic “Retail & Distribution Space to Converge Due to eCommerce.” (for Part I of this blog post click here). Again, my comments are in standard text font.
Fitch (continued): Ongoing changes for retail real estate and industrial/distribution space have put the future role of shopping centers and lower-quality malls in question. eCommerce continues to take share from bricks and mortar retail, resulting in tenant and retail property softness. We believe well-located retail properties and REITs with portfolios centered on consumer demographics will see continued demand as delivery and pickup services and an increased focus on demographics gain momentum.
Brown: I agree with most of these statement. I might be splitting hairs here, but the statement that the future role of shopping centers and lower quality malls is in question is one I have a minor issue with. No doubt the future of lower quality malls is definitely in question. But shopping centers in general? Listen, the quality of lower quality retail anything is what is in question here. But let’s look at this consolidation wave that is hitting us and that will hang over the sector for a few more years to come… right now the real damage is coming from contraction that is impacting mall, urban and power center space. Malls account for 8.8% of the nation’s inventory. Power centers account for 7.7% and while office supplies and sporting goods consolidation is impacting this sector… it has (so far) also been the greatest beneficiary of aggressive off-price apparel (Marshall’s, TJ Maxx, Burlington, et al) growth. Now this may change going forward as mall vacancies open up and those landlords increasingly seek to lure off-price apparel players to that space… but most of the damage is occurring in a very concentrated way for just a few retail product types. Neighborhood/Community centers account for 33.4% of the nation’s retail inventory and vacancy for this property type continues to slowly edge DOWNWARD. All I am saying is not all retail is being impacted in the same ways and not all retail is created equal. Class A across all asset types—even malls—is generally performing well. The challenge is lower quality in a retail world where there will no longer be room for mediocrity.
Fitch: Retail real estate sites and eCommerce last mile distribution sites now essentially serve the same purpose—the distribution (or staging) of goods for sale to the end user. One has a delivery focus without public access, the other has public access but without a delivery function. Retail centers that exhibit the best demographics, which include per capita income and population density, will be the most capable of managing the secular shift in how goods are sold and purchased in the 21st century.
Owners of infill retail locations that can also function as delivery and pickup locations—retail distribution (or ReDi facilities)—will likely be winners as this convergence accelerates. The need to distinguish between an attractive retail or last mile distribution site—zoning notwithstanding—will become less meaningful as the function of the real estate is the same: providing a way to distribute goods to consumers. The old real estate axiom, “Location, Location, Location” applies, possibly now more than ever.
Community shopping center and regional mall values have historically been measured by their proximity to population density and the region’s per capita income. While these measures will continue to determine the attractiveness of a site, last mile distribution and pickup purposes will also be considered in drawing consumer foot traffic and buying power.
In a rapidly changing retail world, lenders, investors and operators will have to refocus their attention to demographics. When it comes to last mile retail distribution, underwriting on location (based on consumer demographics) may take on as meaningful importance as in-place NOI.
Brown: So I in total enthusiastic agreement with what Fitch has to say throughout this part of the statement until they start talking about demographics. In the newCommerce age we are going to see the unified focus they mention when discussing retail real estate and eCommerce last mile distribution sites. It is important we keep that “last mile” in there because I certainly don’t think they are talking about port warehousing, regional hubs or any of the other concerns of major movers of goods. This is about that final mile. And that is where the convergence will happen.
Here is where I totally am splitting hairs, and perhaps being overly difficult—apologies to Fitch… but the idea that lenders, investors and operators have ignored or just not focused on demographics while making decisions just seems off to me. I can say this, if you have been ignoring the underlying density and net income demographics (and a bunch of other demographic indicators) you probably aren’t all that great a lender, investor or operator. That’s a critical component in figuring out the underlying fundamentals of a shopping center beyond whatever current challenges they may be facing. This is how you find diamonds in the rough. It is also how you find pigs with lipstick. Those numbers do mean a lot and perhaps nearly as much as in-place NOI.
But one thing they missed is the role of underlying retailer financial health in all of this. Surprising to me, since tracking financial health is what they do. But if you were looking to acquire a shopping center and it had great current in-place NOI and solid demos but a tenant roster chock full of retailers on the edge… you are looking at a radically different deal than one for the same center with a rent roll packed full of bulletproof credit tenants.
Fitch: With the advent of Uber and ride sharing and the eventual development of self-driving cars, some REITs are discussing what they can do with potential excess parking facilities. Depending on zoning and the configuration of a shopping center, using excess parking facilities or underutilized retail space to develop small scale last mile delivery and pickup distribution facilities may be an option.
Brown: This is where they really get it right. But remember when it comes to driverless cars we are still looking at an unclear window as to when these will be on the market and how quickly the radical changes that they will bring with them will play out throughout society as a whole. No doubt the landscape in ten years will be radically transformed, but this issue of where the cars will park themselves is a huge one. Will we see giant car parks on the edge of urban areas where all the driverless cars go? Will empty lots and brownfields in urban areas serve this role? Or will consumers still demand to want the convenience of having their car (driverless or not) nearby? I tend to think consumers will still want convenience. But, the idea of using underutilized space for some eCommerce function at existing shopping centers or storefronts is already happening and this is going to be one of the greatest trends defining the newCommerce Age.
Fitch: If the alternative is an antiquated or failing center in a municipality, zoning authorities and their communities will eventually be compelled to consider zoning changes allowing small scale distribution facilities at current retail zoned sites or face the prospects of a blighted center, lost jobs and tax revenue. Fitch expects real estate owners will find ways to make mixed-use retail/distribution sites palatable for residents.
Brown: This last paragraph is one that I would agree with… in a perfect world perhaps. Mixed-use is the answer for a lot of retail projects and mixed-use redevelopment will be the name of the game for retail developers over the next decade at least. This will mostly consist of razing excess retail space and boosting mixed-use components… but those are NOT going to be industrial. Don’t get me wrong… I do think the increasing number of smaller shop operators that will be doing eCommerce fulfillment from their stores will mean that shopping centers may need to reconfigure spaces. Larger areas for storing inventory off of the sales floor, revamping backdoor access to sites, adding docks… but do I see actual industrial facilities popping up, say, in empty Sears stores at malls? Not likely. Yes, this is probably the smartest and most efficient solution to the issue, and Fitch clearly understands some of the challenges. The idea that local authorities should consider rezoning for blighted centers to allow this is a good one. But not one likely to happen… certainly not when it comes to dead or dying malls… and it is in that space where this all makes a lot of sense… ON PAPER.
There were about 1,350 malls in the US ten years ago. Now there are about 1,150. Those 200 dead malls… well, about 150 of them are still retail properties. They just became something other than malls. In most cases, these were malls that death spiraled and then went back to lenders. New owners were able to acquire them for dimes on the dollar, leaving them enough capital to completely redesign these properties. Some malls became power centers, some entertainment focused centers and a few became lifestyle centers. Some even became neighborhood/community centers. Vacant anchor boxes were torn down, roofs were taken off enclosed malls, mixed-use components were added to many of these centers. Some are thriving today. Some not so much. But 200 malls didn’t vanish into nothing. Most are still retail.
I see about 300 malls going away over the next decade. The greatest period of this I foresee as taking place between 2019 and 2021. As bad as retail closures are this year, they will be worse next—but that’s the topic of my next Newsline and you’ve read enough already so I won’t get into that. But the question remains what will happen to those properties. Sadly, I can tell you, if any of them purely become industrial eCommerce distribution facilities (no retail component at all) you will be able to count those projects on one hand… and perhaps just a couple of fingers.
Here is why: even if a site can no longer support a major mall… it is almost certain to be situated on a prime commercial arterial within a community. Sure, there may be a few malls where the neighborhoods immediately surrounding have gone through drastic changes, or where the demographics now are radically different from what was there when the project was initially developed. But few of these are stranded in wastelands.
Local city governments obviously will want to replace the tax revenues of dead malls… but industrial eCommerce distribution centers will be an option that will be way, way down on that list. Top of that list, in most cases, will some sort of retail redevelopment—particularly if we are talking about taking a dead one million square foot mall and turning it into something more like a mixed-use project offering much less retail GLA (say 250,000 SF to 500,000 SF) and with strong office, medical, hospitality and/or multifamily components. And if there are no options for that, every single one of those categories will be higher on their list than industrial. And let’s not forget the ever popular auto mall as a potential replacement…
The fact is that for adaptive reuse of dead malls, industrial rezoning, in most cases will be opposed by most local residents. Remember, nearly every mall is located on a major commercial corridor. Do you think residents or city governments will be happy with the idea of replacing a blighted dead mall with a giant industrial structure that will suddenly mean trucking traffic on these major corridors explodes? No, dead malls becoming eCommerce facilities just isn’t going to happen. However, if you are talking about say a dead neighborhood/community center on the outskirts of town with an empty Kmart anchor and plenty of excess space… now, you’re talking.
OK, I took enough of your time. But, here are a couple of links that you might find useful.
Check out our new report on the Craft Brewing trend and its impact on retail and industrial real estate. Click here to check out The Craft Brewing Revolution and our latest Cool Streets video. In this episode I tour Cincinnati… a town where craft brew rules and has also been a driving force in urban renewal—especially in the super cool Over-the-Rhine neighborhood.
Cushman & Wakefield’s Q4 2016 USA National Shopping Center Report.
Our Bricks vs. Clicks Webcast Series Part I and II explores the impact of the 2016 holiday shopping season and eCommerce on supply chain and bricks-and-mortar retail. Bricks vs. Clicks reviews and further analyzes relevant data points, shopping trends and effects on the industry and its consumers in 2017.
Our Main Streets across the World Report tracks high street retail around the world and breaks out the globe’s premier shopping districts by continent and average asking rent.
Cool Streets of North America Report and accompanying video series.
This post is commentary from the latest weekly edition of our Cushman & Wakefield Retail Newsline, which you can subscribe to for free by e-mailing firstname.lastname@example.org.
Garrick serves as Vice President of Retail Research for the Americas. He speaks frequently at industry events and has been a keynote speaker at symposiums, conferences and market forecasting events for groups like the Appraisal Institute, Urban Land Institute, CREW, ICSC and PRSM. He is also a member of Lambda Alpha International, an invitation-only land use society for those who are involved in the ownership, management, regulation and conservation of land, but also those who are involved in its development, redevelopment and preservation.