CCIM Feature

The Retail Revolution Will Be Online

As e-commerce grows and expands into more markets, retail can adapt if professionals know how best to position it.

It’s no secret within the commercial lending and investment community that retail is often the property type more institutional capital sources underweight for allocation of investment capital. Retail is notorious for tipping the scales regarding undesirable metrics like loan delinquency (the highest among core property types at 4.29 percent versus 2.98 percent for office) and value decline.

However, many vacated malls, shopping centers, and big-box stores have desirable location attributes — frontage along primary commercial arterials and public transit routes, proximity to employment centers, and site configuration or building design that’s well-suited for adaptive reuse. Adaptive reuse of these buildings — the most impactful, powerful trend for retail between now and 2025 — is ideal in meeting ongoing demand for affordable housing, industrial warehouse utilization, off-hospital campus medical use, and even coworking office space. The central question now, however, for legacy storefronts is one of best use to unlock its market value for retail. Both retailers and communities have a vested interest in putting these real estate assets back to productive use to recapture lost property value and return vacant buildings to new uses accretive to property and local tax revenues.

Moreover, according to a recent report by the International Council of Shopping Centers, “The Halo Effect II,” online and brick-and-mortar retail have a symbiotic relationship that produces impressive synergistic results on the bottom line. This halo effect increases not just overall spending by the consumer, but also the propensity to visit online and brick-and-mortar locations when a purchase occurs. For example, when a consumer spends $100 online and subsequently visits a physical store within 15 days of that purchase, the person spends an additional $131. If they start out with that same $100 purchase in-store and head online within 15 days, the average additional spend is even greater, at $167. Additionally, the consumer is more likely to visit both online and brick-and-mortar storefronts as a result of a purchase. ICSC’s research indicates customers complete an average of 2.1 in-store transactions within 15 days following an online purchase and 1.3 online transactions within 15 days of an in-store purchase.


 

Retail e-Volution: Predictions for 2025 - A Commercial Real Estate Insights Webinar


While there are several retail myths that need dispelling, one is most germane to this discussion — that Amazon and online retail have been the primary cause of store closings. The truth is, the real villain behind what many industry analysts have coined as the “Retail Apocalypse” is overleverage. Furthermore, online retail sales are still a relatively small portion of total retail sales that have yet to take a real bite out of retail store activity. Amazon merely tapped into technology to reinject growth into retail, enabling the company to dominate book and music sales and, more recently, generate a similar disruption into grocery retail. Retail success in its next iteration will be defined by alignment with services, such as hospitality, transportation centers, health care, and education. Here are just a few key highlights from the latest Commercial Real Estate Insights report, entitled “Retail e-Volution: Predictions for 2025.”

As Online Continues to Grow, Retail Reimagines Itself

Online consumption is here to stay and expanding to everything. Online retail sales will double by 2025. This prediction, though, is conservative when considering the expansion of online retail into more categories like grocery and automobiles. 

What’s driving online transactions for grocery, retail, casual dining, and more is the same as what initially drove online retail growth for music, apparel, and electronics. Consumers want reliable information, an efficient process, and guaranteed satisfaction if the item purchased online does not meet expectation. If those expectations are satisfied, online consumption of other goods and services in the economy — be it groceries, prepared meals, medicine, personal or business services, and the like — will continue to expand.

Online Takes a Bite Out of Grocery

No longer is online just for merchandise once consumed at the mall. Amazon’s acquisition of Whole Foods in 2017 foretold the next move into grocery. According to global market research firm Forrester, the $5 trillion (yes, trillion and not billion as in other retail segments) grocery industry is in the early stages of a global battle between offline and online retailers. 

In two short years, this trend has progressed quickly in the U.S. with Target’s acquisition of Shipt for its online grocery platform and Kroger partnering with Walgreens. Walmart is also succeeding with online grocery, realizing a reported 37 percent year-over-year increase in 2Q2019, although the adoption of online grocery shopping in America has lagged other parts of the world. While online shopping is just 2 to 4.3 percent of the total $641 billion U.S. grocery market, a study by the Food Marketing Institute conducted by Nielsen predicts that online grocery sales will make up 20 percent of total grocery retail sales by 2025.

While the technology enabling more online purchases is reducing the need for physical store space, it is not eliminating the need for retail real estate. Global customer data science company Dunhumby noted, however, that grocery stores are shrinking — not in number, but in size. The average sales area has contracted 15 percent since 2010. Looking ahead, the grocery stores of the future will be a third to a half the size they are today, with a more limited, locally curated assortment of products designed to fit the neighborhood — the model currently used by Aldi, a German-based grocer. 

Additionally, physical stores and e-commerce will become an increasingly connected omnichannel experience, and the role of the store itself will become more experiential. One future model attaches a “dark store” to a smaller footprint store with 5,000 items (a typical grocery store currently has 45,000 items) from which basic commodity products will be picked and staged for pickup or delivery. This model is along the lines of what Kroger is experimenting with its partnership with Walgreens in its online fulfillment model.

When you look at the online growth in retail, think beyond material goods and merchandise to consumption of services. Online consumption of services for home or business needs are already being undertaken by the likes of Angie’s List, HomeAdvisor, and Takl. 

E-Commerce Goes the Extra Last-Mile

According to Verizon’s 2018 Holiday Retail Index, average e-commerce retail traffic for the Monday, Tuesday, and Wednesday before Thanksgiving was 32.6 percent over the same period in 2017. Black Friday saw a similar year-over-year increase of 31.2 percent. Needless to say, the demands on supply-chain infrastructure from a rapidly growing e-commerce economy will only increase over the next decade.

Compounding the issue, the search for a cost-effective, last-mile fulfillment solution remains elusive. Amazon, FedEx, Walmart, eBay, and much smaller Shopify are all engaged at different levels to dominate land, sea, and air logistics to deliver online commerce while making a profit. Thus far, the goal of cost-effective, same-day order fulfilment while making a profit is a unicorn even Amazon can’t lasso. 

The expansion of e-commerce into every product category is limited only by logistics and the fulfillment network. Amazon demonstrated that fulfillment of any product is possible as long as profitability is not an immediate priority. Even big and bulky items like large appliances are now ordered online and fulfilled via warehouse. This relatively recent advancement can be attributed to a large CapEx investment by companies such as XPO Logistics and FedEx to revamp their conveyor systems and warehouses to handle larger and heavier packages. This upgrade impacts developers, too. As a result, contractor visitation is declining as large-scale shipments for building materials can be processed just-in-time and as-needed at the job site.

FedEx has spent billions over decades perfecting overnight delivery and evolving logistics to process virtually any size, shape, or weight package on a global scale while making a profit. Now, Amazon, after its FedEx divorce, aims to do it all with same-day delivery with its own fulfillment strategy without regard to profitability.

As Amazon enters more areas of commerce, retailers from Lego to Walmart worry about the threat Amazon poses should it succeed at global fulfillment. The good news is that this fear is driving new strategies for fulfillment by FedEx and much smaller Shopify. This battle over logistics is “Retail War Games.” One example of the evolving strategies is FedEx’s recent decision to partner with Dollar General for package fulfillment following its divorce from Amazon. FedEx will offer secure in-store parcel pickup and drop-off in 8,000 Dollar General stores by 2020, increasing FedEx’s retail presence to 62,000 stores in the U.S. — meaning that “90 percent of Americans will ultimately live within five miles of a FedEx hold retail location.”

As explored in “Logistics Infrastructure: Transformational Opportunities” by ACRE, the current logistics infrastructure in the U.S. cannot support a modern e-commerce supply chain that is growing 25 to 30 percent a year. The battle to conquer last-mile must include a massive CapEx investment to overhaul every aspect of infrastructure from connectivity advancing to 5G and faster, roads with embedded technology to facilitate autonomous transportation, and cybersecurity to protect the data being gathered from consumers via their online activity. No part of this solution comes cheaply or without a lot of public and private CapEx spend. 

The Role of Autonomous Vehicles

If you are still of the mindset that driverless trucks are aspirational, a technology that will not be realized in your lifetime, think again. Autonomous trucking is no longer a piece of the puzzle to be solved in the battle for last-mile — it is the kind of innovation that can bring down the cost of last-mile fulfillment to make e-commerce profitable.

Autonomous vehicles are already deployed by Walmart along our horizontal U.S. interstates, UPS is testing them out between Phoenix and Dallas, and Florida just hit the accelerator on this technology. In June 2019, the state passed legislation allowing driverless trucks to proceed on Florida highways by 2020. With autonomous trucking technology being deployed a decade ahead of most experts’ forecasts, changes to logistics and e-commerce warehouse design are needed immediately. 

Key design changes include: 

  • Larger land-to-building ratios to accommodate more truck pad parking and larger truck courtyards for dual trailers (the ratio is now 7:1, up from 3:1 or 4:1).
  • Different flooring systems, like Ductilcrete, to reduce expansion joints and cracks that interfere with electronic robotic forklifts.
  • Higher ceilings, measuring 40-foot clear and higher, to handle the larger package conveyor systems within the warehouses.

In high density MSAs where land is scarce and cost prohibitive, innovative warehouse design is essential to maximize utility and profitability. One such example can be found at 640 Columbia St., a three-story logistics facility in Brooklyn’s Red Hook neighborhood. Costar reported that when the 336,500-sf facility, a joint venture by Goldman Sachs Asset Management and DH Property Holdings, is completed later this year, it will not only be the tallest distribution center on the East Coast, but it will offer the fastest last-mile fulfillment in the largest city in the U.S.

NYC Warehouse

Impact on Industry Professionals

What do all these changes in retail mean for commercial real estate professionals? First, local communities will be impacted by the declining values from closed retail, producing a large funding hole that will deepen for local governments across the country. Second, CCIMs are in a unique position to advise investors on the financial feasibility and returns on commercial real estate. And lastly, some legacy metrics like same-store sales are becoming less relevant, and online sales figures like order-online-and-pickup versus order-online-and-delivered are evolving. How we measure retail activity and profitability is changing, and new metrics and data sets, like On Time In Full and national inline store closings and openings, are emerging to illuminate how to make retail more profitable. 

Retail has followed the rooftops from the get-go and will continue to do so. To begin with, it is important to recognize that the shopping center and shopping mall are essentially the mid-20th century adaptation of the historical marketplace. The 21st century version is Amazon and the virtual e-commerce marketplace. Each iteration disrupts the prior format, which is what is occurring today. Those who adapt will survive this extinction event. Those who don’t will go the way of the dodo bird, rotary phones, and Blockbuster.


Editor’s note: This article is an edited excerpt from CCIM Institute’s 3Q19 Commercial Real Estate Insights report, titled “Retail e-Volution: Predictions for 2025.”

KC Conway, CRE, MAI, CCIM

KC Conway, CRE, MAI, CCIM is senior vice president of Credit Risk Management at SunTrust Commercial Real Estate in Atlanta.  Contact him at Kiernan.Conway@Suntrust.com.

 

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