Retail Development - Cautious Optimism Rules The Day

Author(s): Daniel J. Villalpando

Source: Retail Perspectives - 2017 Forecast

1/19/2017

The retail industry welcomed 2016 with cautious optimism, not unlike the sentiment entering the previous year.  Statistically, calendar year 2016 turned out to be a decent year for retail developers (and retailers), with estimates that retail sales in 2016 rose approximately 3.3% over sales in 2015.  While such growth is not as robust as many had hoped, it does represent movement in the right direction, and begs the question: Can we expect to see even more improvement in 2017?  Based on positive news regarding the gross domestic product, continued growth in the job sector and the influx of foreign investment dollars, it appears that there may be reason to expect even better things in retail development this coming year.

One facet of the economy that has a major influence on the health of retail development is the gross domestic product (GDP).  The latest data indicates that the weak growth rates in the GDP of 2009-15 that stagnated around 2% may be a thing of the past as experts forecast growth of 3% in 2017.   In addition, according to the UCLA Anderson Forecast of December 2016, real consumer spending, a factor closely linked to retail development, is expected to increase 3% in 2017 and another 3.7% in 2018.  Another positive sign is that, according to the International Council of Shopping Centers (ICSC), holiday spending in 2016 rose by 16% over the 2015 season, beating predictions by 4%.

Although housing starts continue to be lower than hoped by homebuilders, the unemployment rate continues to fall, infusing cash into the pockets of many households.  According to the Bureau of Labor Statistics, non-farm payrolls expanded by 178,000 positions in November, and the unemployment rate declined by 0.3 percentage points, to its lowest level since 2007.  This news, coupled with predicted wage gains, indicates that more people will have jobs, and those jobs will, on average, be paying more in the coming year.  This should provide a boost to consumer spending, a driving influence for retail development.

In addition, analysts report that the U.S. market is becoming more important to international investors seeking diversification and solid returns.  According to Jones Lang LaSalle (JLL), foreign investors from Asia, Germany and Australia led the way in 2016, directing approximately $1 billion into major property purchases.  Many predict that such an influx in capital will help drive up prices for retail properties.  In addition, foreign tourism is also on the rise.  JLL reports that Chinese and South Korean tourism is increasing most rapidly, by nearly 15% year-over-year, and Middle Eastern tourism has increased by 4%.

While there are some positive signs, one issue that will likely continue to affect the retail industry, as well as consumers in general, is the short term uncertainty in Washington following the unexpected election of Donald Trump as President.  The real estate industry is anticipating potential changes in regulations and tax structures as a result of the new administration that may lead to uncertainty and volatility in 2017.  Since consumers drive the retail industry, any lack of confidence in governmental policies may result in a reluctance of consumers to part with hard-earned dollars.

Also, as the economy accelerates, the Federal Reserve may initiate a period of higher interest rates.  Such an increase could cause businesses (both developers and retailers) to pull back, or at least put expansion on hold, until they can better grasp the changing economic environment.

In terms of what is occurring with different types of retail projects, reports of the demise of the traditional regional mall appear to have been at least slightly exaggerated, although the strongest performing regional malls still tend to be located in more affluent trade areas.  And owners of regional malls certainly have had to adapt to stay relevant.  For example, as the public continues the trend toward healthier food selections and different types of cuisine, mall owners have been forced to re-envision their food courts through general upgrades in quality and the introduction of more “exciting” restaurant concepts.  In addition, regional mall owners have started to follow the trend of power centers by introducing sit-down restaurants and entertainment and internet experiences to make the mall more of an experiential venue where customers can shop, dine, socialize and be entertained.  The goal is to increase “dwell time”, or the period the customer stays at the retail project, so that customers will spend more money.

Grocery-anchored neighborhood centers generally continue to provide a good return for their owners.  Transactions involving grocery-anchor retail assets have seen consistent growth in volumes since 2009, with 2015 being a peak year at $3.9 billion of transactions and 2016 following close behind.  As in 2015, one of the larger growth sectors in retail is specialty grocers, such as Whole Foods, Trader Joe’s and Sprouts, while another is discount grocers like Walmart Neighborhood Market.  And although there remains uncertainty over the consolidation between large scale grocers, owners of neighborhood centers continue to be able to attract retailers eager to feed off of the foot traffic generated by a tenant mix that typically includes a grocery store and a drug store.

Other retail developers are being more proactive dealing with existing space by negotiating early lease terminations.  These developers are seeking to strategically take back certain spaces prior to the natural expiration of the applicable leases in order to remerchandise with better tenants and higher rents.  Some “mid-box” or “junior anchor” tenants like PetSmart and Old Navy, who are looking to downsize their footprints, may be willing to give space back early, allowing landlords to aggregate enough square footage to attract certain “hot” retailers in an effort to revitalize their shopping centers.   For example, so called “fast-fashion” tenants like Forever 21, H&M and Uniqlo are actively growing and scooping up second generation space.  Likewise, discount and dollar stores such as Dollar General, Family Dollar and Dollar Tree are also in the market for residual space, often in the 5,000 to 10,000 square foot range. 

Meanwhile, many retail developers have had to deal with the closures of anchor stores, such as Macy’s and Kmart, as well as sporting goods operators like Sports Authority and Sport Chalet.  In fact, Macy’s recently announced that it plans on closing 100 stores in 2017, on top of its recent closure of 40 stores, and Kmart said it plans on closing 64 stores.  As a result, so called “specialty leasing” is on the rise, with retail developers looking to re-lease large vacant space to concepts not traditionally associated with shopping centers, such as go-cart tracks, trampoline facilities, day care centers, painting studios and cooking schools.   For example, the tenant “Painting with a Twist” operates approximately 320 locations, where it offers its customers the opportunity to paint with a group of friends under the tutelage of an instructor, often with cocktails “blended” into the experience.  Of course, the ability to add such non-traditional tenants must be balanced against the rights of other existing tenants that may have the ability to keep certain uses out of a given project.  A non-traditional use may allow a retail developer to temporarily re-lease space and get some rent in return.  But adding such uses may upset major or anchor tenants at a project, who may decide to aggressively fight the new uses or to leave the project when their current term expires, rather than renew or exercise available options.

Other retail developers have begun using “pop up” stores to fill vacant space.  Such stores are very different from the more traditional “temporary” tenants, who offer Halloween costumes and Christmas ornaments in the latter months of the year.  They sell merchandise like local art and celebrity-backed goods and can have terms ranging from a few days to a year.  For retail developers, the goal of the “pop up” stores is to generate traffic and buzz by making under-the-radar brands available to the customer and, sometimes, bringing in start-ups linked to celebrities.   And such stores allow developers to have flexibility to create change in tenant mix that is not afforded by spaces that are leased to tenants for five or 10 years.  From the retailer’s perspective, “pop up” stores are attractive in that they allow the retailer the ability to test the market in a certain location before potentially committing to a longer term lease.

In the coming year, retail developers will continue to face the challenges brought about by the meshing of e-commerce and brick-and-mortar retail.  Developers are being forced to work more closely with their tenants to ensure that the space provided is not only physically desirable, but also accessible to mobile devices by improving in-store Wi-Fi capability.  In addition, many brick-and-mortar retailers are investing heavily to become e-commerce specialists.  And it appears to be working.  According to ICSC estimates, online sales by brick-and-mortar retailers grew by nearly 18% in 2016, up to $290 billion from approximately $250 billion the prior year.  According to the Urban Land Institute’s Emerging Trends in Real Estate 2017, “Research has shown that a consumer may touch the retailer at many points along the route to transaction, possibly researching a product online, experiencing it in-store, sharing with friends for input, and then possibly buying online later for delivery for in-store ‘click and collect’”.  To take advantage of this, some traditional shopping center retailers plan on fostering a more cooperative relationship with online retailers by providing back room space for products to be stored so that customers can pick up their products the same day that they are ordered.  Such retailers will benefit by allowing customers access to sizes and styles in the “cloud” that are not available in the physical store but which can be delivered from off-site warehouses.

Some regional mall owners are also using new technologies and media to better communicate with shoppers.  For example, new interactive digital directories are being rolled out to provide shoppers with, among other things, information regarding the fastest routes to certain shops and services which can be sent to the shoppers’ mobile devices.  The directories also provide “real time” information on special offers from retailers and restaurants.  Another change is the introduction of new or additional parking stalls for electric vehicles.  Since research has shown that customers with electric vehicles tend to spend about 50% more time at the mall than those with traditional gas powered cars, it may behoove the owner of a regional mall to provide additional electric parking stalls to try to keep customers at the mall as long as possible.

When it comes to the world of retail development, the undercurrent of optimism from the beginning of 2016 continues to grow.  While the needle on ground-up shopping center development may still not be moving, a solid uptick in the GDP, continued growth in the job sector and the influx of foreign investment bodes well for continued improvement for retail developers in 2017.

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