Retail is one property sector that never has time to rest on its laurels. As they battle the lingering effects of the recession and increased online shopping competition, retailers are once again shifting store strategies.
The steep economic downturn forced many retailers to clean house by eliminating underperforming stores, upgrading locations, and taking a hard look at their broad approach to future growth. The chief task going forward is how to squeeze more efficiency — namely lower costs and higher sales — out of brick-and-mortar stores in a world where online shopping is rapidly increasing.
“I think that the number of stores are going to be reduced, the size of the stores is going to be reduced, and the operating functionality of the stores is going to increase,” says Henry Englehardt, CCIM, a senior vice president at Colliers International in Walnut Creek, Calif.
Big-box retailers are already shrinking store footprints to reduce expenses. “Office supply stores were the first, but now you see retailers across the board looking to reduce their store footprints,” says Chad Gleason, CCIM, a principal at Real Estate Investment Services in Kent, Wash. Big boxes that currently occupy 20,000 square feet to 25,000 sf are looking to slim down to 12,000 sf to 15,000 sf. “It is a big chunk of real estate, and you have to pay that bill every month,” he adds.
Big-box retailers are also using smaller footprints to access urban markets. Target, for example, plans to expand its new urban prototype in 2012. The urban stores range between 60,000 sf and 90,000 sf — half the size of a typical suburban store. Walmart is also looking for new locations for its neighborhood grocery, which, at 40,000 sf, is about one-fourth the size of its superstore format.
Bricks and Clicks
Retailers are challenged with the task of transforming strategies and operating models into a “store of tomorrow” to attract greater customer loyalty and a larger share of customer spending. Certainly, brick-and-mortar retailers are doing everything they can to embrace the high-technology shopper, working to combine the in-store experience with the convenience of online shopping with either direct delivery or in-store pick-up.
But online retail continues to exceed sales growth from traditional brick-and-mortar channels at an alarmingly high rate. In fact, the average growth rate of online sales has been about 20 percent annually, while the growth rate for traditional retail sales is averaging about 3 percent per year, according to a 2011 retail study by Deloitte Consulting.
The good news for brokers and investors is that brick-and-mortar retail stores are not going the way of the dinosaur. But retailers do recognize the importance of adapting store strategies to meet the demands of a changing retail environment. “The forward-thinking retailers and merchandisers are partnering and figuring out how to get more efficiency out of the existing bricks and mortar,” Englehardt says. Many retail executives believe that the role of the physical space is shifting from a transactional model to an experiential one, in which customers have a personalized experience with the brand. In fact, 85 percent of retail executives polled in the Deloitte retail study indicated that providing customers with a compelling brand experience will become a store’s primary role in five years.
As such, retailers are looking at innovative changes to draw more people into stores, such as expanding on the store-within-a-store concept, notes Englehardt. Although this concept has been around for years, retailers hope that partnering with the right brand will create more buzz and help draw added customer traffic. Sears is leasing 43,000 sf inside its high-performing Costa Mesa, Calif., store to teen clothing brand Forever 21, a prototype arrangement that, if successful, could be repeated in other markets. Target is partnering with Radio Shack to house 1,500 mobile phone stores, and is reportedly working on a deal with Apple for in-store kiosks.
Signs of Life
Other retailers have remained active throughout the recession, notably discounters such as Family Dollar, Dollar General, and Ross Dress for Less. The wireless stores fueled by AT&T, Verizon, and Sprint have also continued to aggressively roll out new stores. “There are a number of small shop retailers that are actively looking and transacting deals. The challenge is that they are all chasing the best sites,” says Jonathan E. Lindsey, CCIM, a broker with The Shopping Center Group in Birmingham, Ala.
Fast-casual restaurants are another active segment of the market. For example, Lindsey represents Smashburger, which recently executed the brand’s first lease in Alabama with a location in Madison. The restaurant group is looking for multiple locations in that market, and may open as many as 10 new locations in central and northern Alabama over the next five years.
Entrepreneurial growth is driving retail activity in areas such as the Rio Grande Valley in Texas. Operators that have a franchise or license agreement with brands such as Domino’s, Cash America Pawn, and T Mobile are looking for space. “We’re still having a hard time getting out leases that need a finish-out allowance, because everybody is still cash poor,” says Cindy Hopkins, an independent broker and owner of HCRE in Harlingen, Texas. “But I think franchisees have a more active outlook and want to make things happen in 2012.”
Activity is coming from the mom and pops who have either retired or been laid off and now want to open up a store, agrees Gleason, who serves clients in the secondary and tertiary markets outside of Seattle. “A lot of these new entrepreneurs are going into older, second- or third-generation space in smaller downtowns on short-term leases and having success with it,” Gleason adds.
Backfilling Empty Space
Across the country, many markets are still working to backfill vacancies left when large category killers such as Borders, Circuit City, and Linens N Things closed hundreds of stores. In addition, many cities have been hit by the loss of local and regional players. For example, Bruno’s Supermarkets closed more than 60 Bruno’s and Food World stores across Alabama and Florida.
Empty big-box space has created attractive opportunities for retailers that are jockeying for position in top markets. The greater San Francisco Bay Area has virtually no big-box vacancy, as new retailers entering the market have snapped up space. Sprouts Farmers Markets, Fresh & Easy, and Hobby Lobby — “those retailers have stepped up very aggressively and picked up some of the vacant space,” Englehardt says.
Fitness centers also have been expanding in northern California. Engelhardt represents Safeway, which has closed a number of its stores as the chain consolidated. Brands such as LA Fitness and 24 Hour Fitness have been very interested in leasing those spaces, which typically span about 28,000 sf.
Other markets have seen creative re-use of vacant big-box spaces. For example, one opportunistic local investor in Alabama converted a more than 40,000-sf Bruno’s Supermarket into a climate-controlled self-storage facility. That investor is looking at similar conversion opportunities throughout the Southeast, notes Lindsey. Other empty big-box stores are being carved up to create multitenant space. For example in Jasper, Ala., a former 48,000-sf Food World store has been re-configured to house tenants that include a new Goody’s, Hibbett Sports, and a thrift store.
Big boxes aren’t the only empty spaces seeing creative re-use. “Many office users are still using retail space for their general office requirements — mainly due to the lack of available office space, or the cost associated with finishing out new offices,” adds Hopkins. Finish-out costs for office buildings outweigh the cost for retail space in the Rio Grande Valley.
The retail real estate sector was hard hit by the economic downturn, leaving hundreds of store closings and major bankruptcies in its wake. But current industry data is pointing to a market that has stabilized and is on a tentative cours e for recovery.
The net absorption of retail space for 2010 and 2011 was a combined 119.9 million sf — nearly triple the amount of new construction that came online during the same period. That absorption has helped to reduce vacancy rates 50 basis points to 9.7 percent at year-end 2011 and vacancies are forecast to improve further to 9.2 percent by the end of 2012, according to Marcus & Millichap.
The retail picture is improving, but those gains are not even across the board. Markets vary widely depending on the specific economies and dynamics within local markets. There continues to be a big divide between the A locations and older B and C properties. Top malls, luxury retail stores, and well-located grocery-anchored shopping centers, as well as wholesale clubs and off-price outlets have outperformed the general retail market.
All 44 markets tracked in Marcus & Millichap’s National Retail Index are expected to post job growth, vacancy declines, and effective rent growth in 2012. However, certain geographic markets are bouncing back faster than others. San Francisco, San Jose, Calif., and Seattle ranked as the top three cities in the index. Those top cities are bolstered by technology, a strong outlook for job and population gains, as well as tourism growth. At the bottom of the index are markets that are still struggling such as Jacksonville, Fla., Cleveland, and Detroit.
“Retailer activity is not nearly at the pace that existed in 2006 and 2007, and in many ways, that is good,” Lindsey says. The aggressive expansion that was occurring during the peak of the market led to overbuilding and poor decision-making for many retailers and developers. The retail activity that has emerged today is driven by a more-conservative, strategic approach.
Retailers that are in expansion mode are highly focused on strategic growth that makes sense, which is why there is heightened competition for top locations, he adds. “The constant rule of location, location, location is valued even more.”
Beth Mattson-Teig is a business writer based in Minneapolis.
Appetite for “A” properties
Buyers may not be venturing too far out on the risk spectrum. Yet the rise in sales volume over the past year is an added vote of confidence in the retail market recovery.
Investors continue to favor “best in class” retail properties. Grocery-anchored centers and “A” credit single-tenant properties such as Walgreens are widely sought after. “Those single-tenant deals are very much in demand. There is much more demand than there is supply right now,” says Jason Donald, director of retail brokerage services at Cushman & Wakefield of Florida, in Tampa, Fla.
Despite a third-quarter pullback in buying activity, retail property sales totaled $42.4 billion in 2011 — a 91 percent increase in volume over the prior year, according to New York–based Real Capital Analytics, the largest gain of all the property sectors. Major metros continue to generate the most transactions; the top five most active markets by volume for retail sales include Manhattan, Los Angeles, Boston, Chicago, and Atlanta.
Investment continues to trickle down to secondary markets such as Charlotte, N.C., Nashville, Tenn., St. Louis, Atlanta, Birmingham, Ala., and Tampa. “Capital has started to find its way into these smaller markets, be-cause what you would pay for one property in New York, you can potentially capture two or maybe three properties in the Southeast,” Donald says.
For example, Cushman & Wakefield is working with a private buyer based in Manhattan that is selling off some existing properties and reinvesting that money in Florida, because he feels that the market has hit bottom and there is some upside. “Like most, he is looking for a deal,” Donald says. The buyer is looking at single-tenant and multitenant properties, as long as the amount of small shop space is not greater than the anchor tenant.
“The retail market does offer plenty of opportunities for today’s investors, particularly if the buyer has a tenant in tow or excellent tenant relationships and has the horsepower to hold, market and re-fit, and lease,” agrees Tom Hill III, CCIM, owner of Tom Hill Realty & Investment in Waterbury, Conn. Grocery-anchored or national pharmacies such as CVS and Walgreens are generating low capitalization rates of 6.0 percent to 7.5 percent, while non-anchored centers are seeing cap rates upward of 10 percent and are not moving quickly. “There are lots of bargains, but you need all cash to get one, and many buyers with cash want huge discounts due to the re-leasing risk,” Hill adds.