By Garrick Brown, Vice President of Retail Research, Americas
OK… I have to apologize in advance for the length of this week’s Newsline. Last week I promised to answer the question… Do I think that the recent trend of Wall Street analysts calling for more store closures (this trend, so far, has mostly been limited to publicly-traded department store and apparel players) is, in fact, the beginning of the end of this retail cycle?
I will share my answer momentarily, but first a few housekeeping items. We will be taking next week off as we attend ICSC ReCon in Las Vegas. For research analysts, retail real estate’s premier annual event kicks off Sunday with a number of breakout sessions and the ICSC Foundation Gala Dinner (Magic Johnson is the keynote) at the Wynn Hotel… but the real action begins Monday morning at the Las Vegas Convention Center. Attendance this year is expected to be at its highest level since the downturn… so we may be talking about as many as 40,000 retail real estate professionals descending upon Sin City for three days of seminars, speakers, networking and dealmaking in what is the largest single commercial real estate trade event in the world. I know some brokers who tell me that as many of one third of all the retail deals they negotiate annually are completed, negotiated or otherwise impacted by this one trade show. If you have never attended, it is something you should go to at least once in your career… even if retail is not your specialty. No other commercial real estate specialty has one event where literally everyone is there; brokers, developers, investors, landlords, retailers, bankers, lenders, appraisers, consultants and pretty much every other type of retail real estate related business that exists… from landscaping and signage firms to the guys that make those inflatable air dancer things… to public sector economic development groups and the guys creating and selling beacon technologies.
While you or there, or if you cannot make it, be sure to tune in to Howard Kline and his broadcasts. If you are not familiar with Howard, he is a legend in the business—he runs CRE Radio & TV. For longer than I can remember, Howard has done an incredible job covering the entire CRE market with an in-depth perspective that is unrivaled and he always lands compelling guests on his broadcasts. He has a full slate of very interesting interviews lined up for ICSC (click here to check it out). His shows are always informative and worth listening to.
But back to ICSC Vegas… while attendance at ReCon is expected to be at its highest level since the recession this year, it falls at a time when the retail real estate indicators couldn’t be more mixed.
Last week the Commerce Department released consumer spending data for April that indicated a month-over-month surge of 1.3%, the highest level of growth since March 2015. Yet, simultaneously retail stocks (particularly for apparel and department store chains) have been wracked by weak first quarter earnings reports and planned bricks and mortar store closures are now at the highest level that we have tracked since 2010.
So what does this all mean and what will be the impact on the nation’s retail real estate market? Is the retail real estate cycle over?
The answer is NO—the retail real estate cycle itself IS NOT OVER. NOT EVEN CLOSE.
But let’s change the question… Are we seeing the beginning of the end of this retail real estate cycle?
The answer is most likely, YES. But the answer to this question is actually a little more complex than that. And here is where the problem exists today… the answer is both complex and nuanced and if boiled down to a stupid soundbite… it becomes problematic.
First off, let me share with you the analogy that I think actually fits what is happening right now. This is the analogy I have been giving people (both reporters and at a couple of speaking events in the past week) as to what is happening in the retail world…
Picture a long train that is going over a hill. The first few cars may have already gone over the peak and have begun descending into the next valley… yet, even while this is occurring, most of the cars in this train haven’t reached the peak yet. They are still plodding up the hill and, this being a very long train, it may be quite some time before those cars actually pass the peak and also begin their descent into the next valley.
That train is the retail real estate market.
This metaphor holds if we are talking about that train being symbolic of all the different retail sectors (and right now it would be apparel and department stores in those lead cars… but discounters, dollar stores, off-price apparel, grocery, service-related retail and restaurants are all still in growth mode).
The metaphor also holds true geographically… Retail recovery began in 2010 but was mostly concentrated in a few key coastal markets and Texas. It spread from there, but there are some secondary markets (like my hometown of Sacramento) that didn’t really start to see significant recovery until 2013 or even 2014. Rents have been climbing for premier retail space (urban and shopping center alike) at an aggressive pace for five years now in Manhattan, the San Francisco Bay Area, Boston, DC, Miami, Los Angeles, etc. For many top properties in top markets we have been seeing double digit annual rental rate growth for most of that time. These were aggressive gains that were not going to be sustainable forever. And we are starting to see rental rate growth flatten in a lot of those very same markets now for the first time in five years. Yet, many of those secondary markets that were late to see any improvement… guess what… their rental rates for premier space (while climbing over the last couple of years) are still bargains comparatively and they have been landing a lot of growth from national chains that have been looking to keep their growth numbers up while avoiding some of the higher pricing in primary markets. That’s not to say there is no growth in primary markets… it is still happening… but it has slowed. Meanwhile, the secondary markets still have more runway left both in terms of growth and rents.
But LET ME REITERATE… a train going over a hill is NOT one going over a cliff. But while the news is extremely challenging for some key sectors, it also presents some opportunities. And I don’t mean that in the lame challenges = opportunities way that you usually hear as someone is telling you that they are laying you off. Really, there are real opportunities here… but let’s refocus on getting things right to begin with.
As I stated in last week’s column, I don’t disagree with any of the findings of that recent Green Street Advisors report that suggested that department stores need to close 20% of their units to return to 2006 levels of sales productivity. I do think that trying to live up to 2006 levels of sales, when the American consumer was engaged in an orgy of credit card use and abuse and was using their homes as ATMs is a little unrealistic. Let me put it this way… I could stand to lose a few pounds. What’s more realistic…? I shoot for getting back to what I weighed when I was 30 or when I was 20? One would be nice, the other would be fantastic. One is actually realistic and the other… well, good luck!
But my concern all along wasn’t with the Green Street analysis being correct… it pretty much is. My concern is that Wall Street is incapable of nuanced thought. As is much of our media, particularly once you get outside of the business journals and trades. Which is why I can’t apparently say something as simple as my train metaphor which is about some retail categories facing challenges even while others remain in strong growth mode… without that being twisted into some sort of image of a cataclysmic freaking disaster!?
You want to understand what is happening here?
It’s real simple… the department store and apparel guys (most of them, at least) were already looking to right-size for e-commerce. Most of them had long-term plans in place or were working on them to close 20%, even 30% of their units in the years ahead.
But they were going to do it intelligently. They were going to try to do it based on leases expiring to minimize costs. They were going to try to do it by shutting down the weakest locations and keeping the strongest. They were going to try to do it in the most economical and thoughtful long-term manner that they could.
Those e-commerce closures were ramping up this year. Which is why this year’s typical retail closure season was much heavier than usual… throw in an uptick in retail bankruptcies and suddenly we are dealing with a negative news cycle that has built its own momentum.
That negative news cycle builds and begins to impact Wall Street opinion. A few key reports are released and many influential analysts begin to worry that retailers are not moving quickly enough to right-size for e-commerce. Meanwhile, apparel and department store retailers are in the midst of releasing Q1 2016 results… which were almost universally weak and below goals. These all heighten the pressure on these retailers to close stores more quickly and stock prices start falling for many…
That’s where we are.
This pressure means that many publicly-traded chains are going to be forced to move more quickly than ideal on these real estate issues. Let me give you an example that goes in the other direction… about 15 years ago a certain chain I will not name was under immense pressure from Wall Street to grow very rapidly. They were opening as many as 1,200 units a year for a few years in a row at one point. It was not uncommon for this concept to end up opening units across the street from one another in many places. This chain, once the downturn hit, had to close an awful lot of stores simply because of issues like that. Had the Wall Street pressure to grow so quickly not been there, would they have avoided a lot of mistakes… would they have been ultimately even more profitable (they are doing great today, by the way)? The answer is probably yes. But Wall Street has a way of forcing companies to make penny wise, pound foolish decisions.
When it comes to closures, the same rule applies. Let’s say your department store chain is starting to see its stock tank and your investors are screaming for you to ramp up your closures. Your ten year plan was to cut 30% of your stores while building your e-commerce/omnichannel capabilities and stepping up the growth of your off-price banner. But now your stock is tanking and there are calls for you to turn that ten year plan into a three year plan.
But your ten year plan was based on lease expirations and getting out of those locations with little, if any, cost. Now you suddenly aren’t looking at closing say 20 stores a year for the next few years… but trying to figure out a way to shut down 60. And only 15 of those you targeted actually are locations where you can get out of it with minimal or no cost. The landlords don’t have much of an incentive to work with you (unless perhaps you can use them for the rollout of your new off-price concept… but those use less space and still provide little leverage to you)… so you are facing a very expensive proposition. Now, under those circumstances, what if you had a store at a Class A trophy mall where a lease was expiring. This is a location with great sales and should be one you don’t even think about shutting down. But as circumstance has it… you could get out of this one because of the expiring lease and even if we are talking about a lease that had five years left on it… this is a situation where you might actually find a landlord willing to work with you simply because the Class A trophy malls are the one place where backfilling a dark anchor spot might not be too much of an issue. Under those circumstances, and immense pressure from investors to see lower unit counts, could we see some players shutting down stores that they shouldn’t even think about walking away from? Uh, in a world driven by rational thinking… no. But that’s the problem, isn’t it. This new wave of pressure on apparel and department store chains to shut stores down is not very nuanced and there is a strong chance that retailers will be forced into very difficult situations like these. This will, of course, create opportunities for many. But challenges for most.
Now… as to my statement that we are seeing the beginning of the end of the retail cycle…
Clearly that might sound like it is at odds with what I just said about some retail categories facing challenges while others remain in strong growth mode. But it is NOT. It is an issue of timing…
First, let’s start with the big picture.
Against all this gloom (and remember the bad news is mostly coming from two retail sectors alone)… the economic news is actually pretty decent right now.
Retail sales for April actually increased by the strongest amount in over a year: 1.3%. But they also demonstrate a few key weaknesses… they were driven largely by increased car and online sales. But the fact is that the news is not all awful right now despite this negative news cycle we are in.
No one knows how much longer the economic expansion will last. We are now in our seventh year of growth and the average length of expansion cycles since WWII has been about five years. However, while the U.S. economy is far from perfect, it does continue to outperform nearly every other world economy and the biggest current economic threats all revolve around global weaknesses… historically, these have rarely had a major impact on the U.S. economy. That’s a fact… one that I continue to find people extremely confused about. You have to go back to the 1970s before you find a downturn that originated overseas… and the Arab oil embargo wasn’t a situation of foreign weakness spreading here, but was actually a concerted effort by energy interests to torpedo our economy… the reality is overseas events often provide us with headwinds but they rarely drag us into recession.
In fact, there is a growing school of thought that current growth period may end up usurping the 1990s growth cycle (roughly 10 years) as being the longest expansionary period in U.S. economic history. However, if that happens, it would also be remembered as one of the weakest expansionary periods.
But there are a number of huge positives for U.S. consumers in play currently. Though job growth has been slowing the last couple of months (160,000 new positions in April), it remains at respectable levels, follows two years of robust growth and there remains the strong potential that these numbers will increase back above the 200,000 jobs per month threshold over the summer (the most recent Job Openings and Labor Turnover Report from the Bureau of Labor Statistics indicated that there were 5.8 million job openings in the U.S. as of March 2016—this figure remains near its highest level in a decade).
The increasingly tight labor market is creating real upward pressure on wages. Wage growth has averaged about 2.0% annually since 2009, but there are indications that this metric is growing in 2016. This trend has only just begun and so middle class consumers are barely beginning to feel the positive impact and, frankly, in an election year where the decline of the middle class over the past 15 years has become an issue… you aren’t going to hear a lot of people cop to this… but the state of the middle class consumer is finally, albeit marginally, starting to improve.
Meanwhile, cheap gas pricing also remains a huge net positive to the American consumer; we estimate that individual gas savings in 2015 translated into more than $500 per person in the United States and that similar levels of savings will be in place throughout 2016.
All of this points towards the U.S. consumer being in the best place they have been in since the Great Recession. In the past, trends like these have been directly connected to rising levels of retailer expansion in the U.S. and increased retail real estate activity.
And it still is… for discounters, dollar stores, off-price apparel, service-related retail, grocery stores (at least small format, niche players) and restaurants. But clearly, there are some significant headwinds out there.
So what does all of this have to do with that train going into the valley analogy?
Simple… it is highly unlikely we see a recession this year. It is also still probably unlikely we see a recession next year. But the farther out we look, the harder it is to forecast things like this and really… the smart money says (for no particular reason other than we are “due”) that we probably see some sort of downturn in the next 24 to 36 months.
If that is what we are probably facing, do I think that the current contraction trend for apparel and department store players will be over before that next downturn? No, those train cars are heading into the valley and that is where they are going to be at least until the next cycle begins.
But what about all of the other retail categories? Remember… consumer spending still accounts for just under 70% of total U.S. GDP. Most of that is retail spending. The retail sector, as a whole, is vast and it includes dozens of sectors ranging from apparel and department stores to home furnishings and DIY stores to automotive service and convenience retail. And it also includes pretty much everything in between.
The health of these various sectors impacts different types of retail real estate differently. Community or neighborhood shopping centers are typically anchored by grocery or drug stores and feature a mix of inline, smaller retail tenants that traditionally has consisted of restaurants, service retail (dry cleaners, post office stores, etc.) and only a small percentage of hard goods retail. Those categories have, so far, only experienced a minimal (if any) impact from the encroachment of e-commerce.
Personal needs retail (and these users make up the bulk of the tenancy at community/neighborhood centers) have not only felt little e-commerce impact in the post-recession era, but most of them have thrived.
The challenge here is that a few select retail sectors have driven the lion’s share of bricks-and-mortar growth over the past six years of expansion… and dollar stores, off-price apparel and discounters all have elevated growth levels for 2016. The same goes for grocery players and food related retail, including restaurants. Also for service retail ranging from automotive players (from lube and tune shops to afterparts) to financial services (tax firms, insurance, etc.).
These cars in that metaphorical train are still moving upward and have yet to peak… But I emphasize the word YET.
Here is the problem…the same pillars of growth that have kept retail demand positive during the post-recession era are all nearing saturation levels.
Restaurant growth has been one of the primary driving factors behind overall vacancy declines in shopping centers over the past few years. But how many meals a day can Americans eat? How many food outlets can we support? Remember that a new fast casual hamburger concept doesn’t just compete against the other new fast casual hamburger concepts… it competes against every single restaurant category and every single grocery store simultaneously. Over the final half of 2015, the restaurant failure rate went up for the first time in five years.
Though there will be plenty of restaurant concepts in expansion mode throughout 2016 and 2017, we will see more restaurant failures. And as minimum wage laws change, mom-and-pop franchisees on the fringe (many of which already can barely support their labor) are going to feel it.
By the way, every year I have been compiling the growth plans for more than 2,000 national retail and restaurant chains… this year we are presenting them in a new report; the 2016 Cushman & Wakefield North American Retail and Restaurant Expansion Guide will be released at ICSC ReCon in Las Vegas on Monday, May 23rd. Here is something to keep in mind…
Prior to 2008, restaurants typically accounted for about 33% of all the planned unit growth in terms of the expansion plans we were tracking. Since then, this sector of the market has accounted to nearly 50% of all the planned unit growth. These numbers should cause growing concern for the marketplace. They concern us most in terms of what we discovered while compiling this year’s report. Most of the restaurant growth in the U.S. is driven by franchise concepts. It has become traditional practice for many of these companies to share annual franchising goals, as opposed to solid store opening plans. This year, while gathering this data, we decided to make a determined effort to limit these chains to citing actual opening plans. We found a shocking number of franchise concepts to be uncooperative. Worse yet, we were routinely given inflated numbers that were simply not plausible. It was not uncommon for chains to state intentions of opening 100 locations or more, even though records of 2015 actual openings often were flat or barely positive… or even reflected negative net growth.
Why do we mention this?
We still see strong unit growth ahead for all of the retail sectors that have driven growth over the past six years. But we see little runway. Meanwhile, we will see ramped up closures of apparel and department store players impacting the mall and lifestyle center markets throughout this year. So what’s it all mean?
Let’s go back to that train metaphor… the restaurant car is still working its way up that hill. It isn’t going to be reaching that peak this year and it might not even reach it before late 2017… but it will go over that peak and begin descending into the valley in the not too distant future…
And that is the story for nearly all of these other current growth categories… There is still more growth ahead… but the peak is likely coming sometime over the next 18 to 24 months. And do I see another growth spurt kicking in before the next overall economic downturn? Well, assuming the current expansion period just lasts another two to three years… no.
So is the current pressure on department store and apparel players to speed up their closures (which the publicly traded ones will almost certainly be forced to do to bolster their stock values) the beginning of the end of this cycle? Ultimately, yes… but to just say that alone… would be to give you such a dumbed-down response as to border on it actually being wrong. But we are in an age that struggles with nuance.
Oh well… enough of that noise. Shifts ain’t cliffs people. Retail isn’t going away. In fact, read the Seeking Alpha article in the Top Five… there is a solid, reasoned Wall Street piece that gets it. See you in Vegas!
By the way, we recently released our Cushman & Wakefield Q1 2016 U.S. National Shopping Center Report. You can check it out by clicking here. Or you can 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 email@example.com.
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.