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Retail Newsline: Prime Day, Pokemon, BREXIT and the Extra Crunchy Colonel… Is the World Coming to a Fiery End? Naaah…

By Garrick Brown, Vice President of Retail Research, Americas

SmartphoneTake a couple of weeks off for vacation and the whole world goes to hell… Or, at least it almost seemed that way judging by some of the messages I got from nervous market participants. Of course, the last time you heard from me was late last month. Since that time, the Brits voted for BREXIT, Q2 numbers showed increasing weakness for Malls and High Street retail, Pokemon began showing up everywhere and Amazon had its biggest day ever. And strangest still, the “Extra Crunchy” Colonel released a video on the proper use of pocket squares…

OK, actually that last bit was pretty great. Nice job KFC. The weirdness of your rotating Colonel ad campaign has strangely struck gold with George Hamilton as the Extra Crispy Colonel…

But let’s get back to all that ugliness I mentioned… Glass definitely half empty, right?

Of course, I forgot to mention that June’s job report was stellar, the U.S. stock market wavered for a few days post-BREXIT but actually bounced back to now record levels. That’s not to say that there aren’t significant risks ahead. Definitely with the stock market where it is now, the next bad news to the economy is bound to create a sell-off opportunity/overreaction, but let’s start with Amazon’s stellar, if predictable, performance on Prime Day…

Amazon’s Prime Day 2016 was its biggest ever; the eCommerce behemoth reports that orders were up globally by 60% and in the U.S. they were up by more than 50%. What may be even more important is that Amazon likely signed up about 1.5 million more Prime members. This is critical because Amazon Prime members were likely to outspend non-members by a ratio of 2:1. If you want a great summary of Amazon activity, Deborah Weinswig and her group over at Fung Global has a great one and she is one of the analysts I strongly recommend you follow. She’s one of the best in the business. You can check out their report on Prime Day by clicking here.

In my opening statements I mentioned increasing weakness for the Mall and High Street retail markets. Is there a connection between this trend and Amazon’s huge Prime Day performance? Of course… Albeit, an indirect one. It comes down to this simple fact… Sales growth for eCommerce continues to outpace that of bricks-and-mortar retail by a ratio of roughly five to one.

In Q1 2016 alone, total retail sales grew by 3.3% but eCommerce sales grew by 15.1%.

Of course, the catalyst behind all of this has arguably been Amazon’s massive ramp-up in eCommerce infrastructure over the past five years. The eCommerce behemoth now has more than 80 million square feet (MSF) of eCommerce distribution and fulfillment space in the U.S., enabling it to ship goods to almost every market in the U.S. with unparalleled speed. While much has been made of the race to create same day delivery capabilities, it is actually the creation of next-day or second-day delivery capabilities that has been the game changer. We would argue that this, along with the continued rise of the tech-savvy Millennial consumer (the first generation to have entirely exited within the digital age is now the largest consumer age demographic in the U.S.) as well as improvements in smartphone and tablet technologies and the betterment of online shopping interfaces has driven this seismic, game-changing shift.

This isn’t exactly new information for most of you… And while I always need to temper my remarks with the statement that no one believes that eCommerce will ever replace the bricks-and-mortar shopping experience, the fact is that this is obviously the most disruptive trend to impact retail since the rise of the suburban mall that began in the 1960s. No one knows how deep eCommerce penetration will ultimately be; but few of even the most tech-biased futurists or theorists envision a future where more than 25% or 30% of all retail transactions are done online. Regardless, this still means exponential growth for eCommerce in the years ahead and sharp contraction for those retail categories that will be most impacted by this growth.

And it is at the category level where we are seeing the greatest weaknesses emerge.

So let’s get on with the bad news about Malls and High Street retail…

First up… the Mall marketplace. Let me begin by stating that we here at Cushman & Wakefield do not directly track Mall vacancy and absorption statistics. The reason for this is that this marketplace has historically been plagued by a lack of transparency. As an analyst I cannot tell you how many times over the years I have attempted to get actual availability or asking rent information from some of the major Mall players to only be refused or be given vague, and often questionable, information. This is not the case with all Mall operators and I definitely see much more transparency with Class B and C properties but this is likely due to the fact that these landlords are typically much more anxious to fill existing vacancies and so have become more visible in marketing their space opportunities to the commercial brokerage world. This has been much less the case for Class A or trophy Mall owners who typically lease their own space (hence their availabilities and asking rates are usually kept close to the chest) and who see little competitive advantage in being transparent with this data… especially when it comes to asking rents. This may eventually change as vacancies climb, but since Class A and trophy assets continue to be in the strongest position of all Mall assets, I doubt it will change much.

All that being said, for Mall data there are two major third party data providers that attempt to track that market nationally in the U.S.; Costar and REIS. Unfortunately, they face the same challenges that all the rest of us analysts do in terms of transparency. Given those difficult circumstances, both do as good a job with it as could be expected. But the fact is that U.S. Mall vacancy and rent data frankly has historically been extremely questionable.

As of the close of Q2, Costar is reporting mall vacancy remaining static at 5.3%, while REIS reports that it climbed from 7.8% to 7.9% in Q2. This was the first time in more than two years (Q1 2014) that REIS had seen this metric climb. Obviously differences exist in what each of these data providers track and that is one of the factors behind these disparate reporting trends. But in this case I would have to say the REIS data is probably a lot closer to what is really happening than Costar’s is.

So mall vacancy is climbing… but this same trend is also playing out on the High Streets. I happen to be in New York this week, so let me share a few tidbits about what is happening in the nation’s largest High Street retail markets…

Upper Fifth Avenue in Manhattan has been the most expensive retail real estate in North America for the last decade. Just 18 months ago, the average achievable retail rent for prime, ground floor space stood at $3,500 per square foot (PSF), annually. That number is now down to $2,980 PSF and the gap between asking rates and actual deal rates is growing by even more. The average asking rent may still be close to $3,000 PSF and landlords are obviously reluctant to back off of those numbers, but the reality is that an increasing number of listings aren’t quoting rates anymore. It’s increasingly a “make me an offer” world (not uncommon when there is a lot of movement in rents, either on the upswing or downswing), but I’m hearing anecdotal tales of space that would have gone in the $3,300 PSF range inking actual deals closer to $2,200 PSF.

In fact, for the 11 distinct Manhattan retail submarkets that we track, asking rents have fallen (on a year-over-year basis) in seven of those markets. This includes Upper Fifth Avenue, Times Square and Madison Avenue… the three trade areas that have traditionally been New York’s highest rent markets. The reason for this decline is pretty simple… retail vacancy and availability is up. On Upper Fifth Avenue it climbed from 7.4% a year ago to 11.6% currently. In Times Square overall availability has jumped from 13.3% to 22.2% over the past twelve months.

Now for those of us active in the suburban shopping center market… especially those of us who deal with the lion’s share of American shopping center space (i.e.; community/neighborhood, power or strip centers), these rents are still mind blowing. In that arena, we are tracking a national average of just $26.64 PSF.

But remember… you really can’t compare the two. Prime Manhattan urban space typically sees more daily foot traffic and higher retail sales PSF than even the most successful trophy malls can dream of. It’s one of the highest density, highest income, highest foot traffic markets on earth. We’re not talking apples-to-apples, much less apples-to-oranges here. It’s more like apples-to-stacks of money… which is what you needed to pay those rents… The cyclical nature of retail real estate means that those rents were bound to fall sooner or later. The greater question here is whether this current decline is merely the reflection of a cycle coming to an end or the beginning of a greater structural shift.

The fact is that many retailers active in High Street locations in the past have been able to justify these rents as not just a real estate, but a marketing cost. It hasn’t been uncommon for some New York High Street rents to equate to 50% or more of total occupancy costs for retailers. Obviously, even in a very high producing location you are not going to be profitable on a locational basis if you are spending half of that on rent. Of course, marketing budgets were used to supplant those budgets and it could be argued that these flagship shops more than earn their keep globally because of the brand awareness and prestige they bring. But in today’s retail environment, with ever increasing pressure on the bottom line… one has to wonder whether this paradigm is starting to shift.

hip o meter retail cushwwakeGreater competition from emerging new urban markets… the Cool Streets… is partially to blame. You can check out our newly released report on the phenomena by clicking here. But that is, at best, a secondary cause. Those markets are still mostly about up and coming new concepts, independents and incubators. Mainstream brands are looking there increasingly to connect with Millennial consumers and to enjoy rents that are a fraction of what they will find on the High Streets, but this trend is in its infancy. While the Cool Streets will increasingly take a piece of the action from the High Streets, this is not what’s driving increased vacancy in the nation’s upscale urban shopping areas.

The culprit behind rising Mall and High Street vacancy remains eCommerce right-sizing, the trend for which I have been obsessively ranting about all year in this newsletter. For years we have been talking about the barbell of prosperity… basically the notion that eCommerce was creating the greatest disruption for mid-price hard goods retailers but that discounters (on the low end of the economic scale) and luxury (at the high end) were relatively immune from the trend.

Certainly there has always been the argument that this is an outgrowth of experiential retail. At the discount end, part of the experience is digging through sale bins and finding bargains. Plus, many of those retailer’s models are based on minimal omnichannel presence. How does Primark manage to sell $3 t-shirts and $7 jeans? They don’t mess with eCommerce at all and don’t have those expenses to deal with. That equation isn’t much different for Marshall’s, T.J. Maxx, Ross, Nordstrom Rack, Macy’s Backstage, etc. Nor is it much different for the dollar stores or the warehouse clubs. At the luxury end of things, the experience has been about being pampered. Go shopping at Tiffany and you may be treated to a glass of champagne while you try on watches. We still believe that luxury is much less impacted by eCommerce, but the reality is you can drink champagne at home while shopping online. Luxury demand hasn’t fallen off a cliff, but it has faltered somewhat. Still, that’s not the primary driver behind the latest weakness in the Mall marketplace… it’s still contraction from the mid-price guys with some more upscale players now falling into that category.

And categories is what it is all about… Why? Because outside of the Mall and High Street markets, overall shopping center vacancy actually DECLINED in Q2 2016. Yep, you heard me. It fell.

Overall shopping center vacancy (excluding Malls) in the U.S. stood at 7.6% as of the end of Q2 2016, down from 7.8% three months ago and reflecting a more significant decline from the 8.1% vacancy rate that was in place one year ago. This is because most of the consolidation that we are seeing remains concentrated in just two retail categories; apparel and department stores as chains active in those arenas continue the process of eCommerce right-sizing. And while both are high profile sectors, the impact of this trend has almost exclusively been felt at the nation’s malls (primarily its aging Class B and C enclosed regional malls) which actually account for only a small portion of the nation’s retail space.

The lion’s share of the nearly 4.1 billion square feet of shopping center space that we track in the United States are community/neighborhood centers, which account for over 2.5 billion square feet of that total. These, combined with power centers (another 800 million square feet), account for more than 80.0% of the nation’s shopping center inventory and these are the two retail shopping center types where we are seeing the most leasing activity and occupancy growth.

While community/neighborhood and power centers have not been immune to the impact of e-commerce right-sizing, these have been more than offset by growth from multiple sectors. Sporting goods is the largest category in consolidation mode that is impacting these chopping center types (primarily power centers). But even there the impact has been minimal; most of the space that has been returned to market so far has garnered significant tenant interest.

Expanding retailers occupied nearly 12.1 MSF of shopping center space in the second quarter of this year. Year-to-date, the market has recorded roughly 17.9 MSF of positive net absorption through the first six months of 2016. Discounters, dollar stores, off-price apparel and food related concepts (both restaurants and grocery store chains) are the sectors that are currently driving growth and that have accounted for most of the expansion over the past six years. And that is going to increasingly prove to be a challenge to the marketplace as many of these categories are starting to reach saturation point. The dollar store sector alone has added an average of one new store in the United States every 4.5 hours for the past five years straight—the most active chain in this field is adding a new store every 10.0 hours this year. But for now, these retail categories are still churning out growth for the lion’s share of the U.S. shopping center marketplace.

So… back to the question: is the glass half full or half empty? If you are a retailer it depends on your category. If you are a landlord it depends on your asset type… However, shifting strategies on the part of savvy landlords have created lesser vulnerabilities here. This is why the old definitions of tenant mixes are largely being thrown out and it is the reason why you are increasingly going to see grocery or warehouse stores popping up at Malls or food concepts emerging as anchor tenants.

Will this dichotomy in performance continue going forward? Will Community/Neighborhood, Power and Strip centers continue to see growth while Malls and High Streets feel the brunt of consolidation trends? Yes, though the runway for growth is shortening for many of the retail categories that have been driving growth. And the bad news is that eCommerce right-sizing (the trend driving consolidation for department store and apparel players) is going to be with us for the next few years. And there is another factor to worry about…

I will let my colleagues do the lion’s share of analysis and forecasting in terms of the global impact of BREXIT. You can check out a great report we just did on the topic by clicking here. I am going to be doing a more detailed piece in the next few weeks on what to expect in regards to the impact on U.S. retail, but let me share with you one way that it already is starting to impact us in the states… tourism.

The strength of the dollar was already expected to have a chilling effect on foreign tourism this year, but the passing of BREXIT has resulted in even greater disparities between the U.S. dollar and the British pound. As I finished this narrative this morning, the exchange rate remained near a 31-year low.

The bad news for the U.S. is that strong tourism markets like New York, San Francisco, Miami were already expected to see less European tourism this year and BREXIT just made visiting the States a much pricier proposition for English travelers. The good news for hotels and restaurants that domestic tourism is up; it is expected to more than offset any declines in international tourism the market sees in 2016.

There is only one little problem. Foreign tourists spend more money buying stuff than American ones do. According to the U.S. Travel Association (USTA), while domestic travelers in the U.S. spend an average of 7% of their travel budgets on retail expenditures, international visitors allocate roughly 30% of their travel budgets to retail purchases.

But the news isn’t really all that bleak. According to the USTA, there were approximately 75 million foreign visitors to the U.S. in 2015. Tourists from Canada and Mexico accounted for just over half of that total. The U.K. accounted for just under five million guests in 2015, or a little over 5% of all global tourism. All told, European tourists account for a little over 25% of visitors to the U.S. annually. Meanwhile, Asian tourism continues to rise. So what’s it mean? The decline in British tourism will barely be felt even in our most tourism-heavy marketplaces. But if BREXIT transforms into greater European weaknesses, those headwinds could become much more pronounced. Regardless, it doesn’t change the fact that retail remains overwhelmingly about local drivers.

That’s it for this week… I gotta go find some Pokemon.

In case you missed it, at ICSC ReCon we released our inaugural version of the 2016 Cushman & Wakefield North American Retail and Restaurant Expansion Guide. This report represents the growth plans (as we interpret them) for roughly 2,000 major chains throughout the U.S. and Canada.

You can also check out any of our latest research reports by clicking here.

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 garrick.brown@cushwake.com.

garrick-brownGarrick 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.

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