By the Numbers Retail

COVID-19 and the Retail Debacle

The global public health and economic crises have exacerbated pressures that retailers have faced for years.

Driven by shutdown policies related to containing the spread of COVID-19, the U.S. economy is likely to go through its worst economic downturn since the Great Depression. Moody's Analytics forecasts that U.S. GDP will decline by 6.6 percent in 2020 - a figure that is 1.7 times as bad as the Great Recession of '07-'09. Compared to that financial meltdown, which took place over six quarters, this recession will move at light speed, with most of the distress happening in the middle of this year.

The retail property sector, in particular, is expected to experience significant distress. Already under pressure from the rise of online commerce over the last 20 years, the sector entered the current downturn in a position of relative weakness. Mall vacancies were at 9.7 percent at the end of 2019, a historic high - higher than the 9.4 percent level at which vacancies peaked in 2011 during the last downturn. Since the pandemic's effect on the economy escalated significantly in mid-March, major retailers like J.Crew, Neiman Marcus, and JCPenney have already announced plans to enter bankruptcy. Large operators like Macy's and REITs like Simon Property Group preemptively closed their stores in mid- to late-March as precautionary measures; they have since encountered challenges attempting to reopen a handful of locations.

Retail Construction


But we need to be nuanced with the analysis. Not every retailer was asked to shut down given shelter-in-place policies. Groceries and pharmacies remained open, having been deemed essential activities. One of the handful of job categories that actually posted gains in the April jobs report, released by the Bureau of Labor Statistics on May 8, was the category that covers warehouse clubs (which posted a job gain figure of 93,000). Not every retailer found it difficult to make rent payments for May or June, although all retailers have incentives to ask their landlords for some form of rent relief.

With that said, because the current crisis is expected to hit the retail property sector both in the immediate term as well as over the long run, most analysts expect the shift to online distribution channels to accelerate significantly, in the expectation that COVID-19 is not the last pandemic we will encounter. REIS's forecasts are, in general, historically grim. REIS expects that neighborhood and community center vacancies will rise from 10.2 percent pre-pandemic to a record high of 13.3 percent in 2021, before slowly recovering.

The recovery will also be exceedingly slow, and REIS expects vacancies to remain relatively elevated through 2024. Several large markets are also likely to experience continued reduction in demand, given the shift to online purchases. Interestingly, smaller markets might experience better performance metrics over the next five years, given how local stores tend to have relative dominance in a limited trade area. Therefore, as shown in the accompanying chart, which aggregates the top 50 largest retail markets, we expect vacancies to remain elevated above the cyclical high from 2008-2009.

Economic distress will likely savage rents as well. Effective rents are expected to decline by 11.1 percent in 2020 alone, a historic dip. That is almost double the 6.1 percent total decline that the property type experienced from 2008 through 2011.

What is next for retail? There are three predictions that are likely to come true post-COVID-19.

First, online channels will be even more important. If they have not done so already, retailers must acknowledge the need to diversify away from brick-and-mortar and accelerate plans to sell their products and services through online channels. This will likely hold true across the spectrum, not just for consumer products and durable goods. In late March, for example, the horological giant Patek Philippe, whose watches retail for a minimum of $20,000, began offering some models for sale online via a select group of authorized dealers. The firm, which celebrated 180 years of business last year, had previously refused to sell any of their products online - but the COVID-19 crisis has forced their hand.

Most analysts expect the shift to online distribution channels to accelerate significantly, in the expectation COVID-19 is not the last pandemic we will encounter.

Second, the pressure on brick-and-mortar stores will be even more intense. This follows naturally from the first point. Simon Property Group, which operates mall properties that perform better than the market average, may survive the current debacle, but it will have to think even more carefully about which malls and outlet stores ought to remain part of their portfolio, once battles about rent payments and defaults are settled with the surviving tenants. Macy's has already begun to pursue a retail reformatting strategy, building smaller experiential stores dispersed in off-mall properties like lifestyle centers, even as it plans to close 125 mall locations. The COVID-19 pandemic will just accelerate plans like these.

Finally, dense urban areas may fall out of favor. If retail destinations favored co-location, benefiting from an agglomeration of households that can support sales, then any post-COVID-19 trend that prompts households to shy away from concentrated urban areas will influence how the retail landscape evolves. New York, the epicenter of the COVID-19 crisis in the U.S. in the spring, might endure a permanent demand shock if tourism levels do not climb back to previous volumes. A sustained outflow of households preferring less dense suburban areas could also diminish demand. If this demand shock persists, high rent levels commanded by Fifth Avenue storefronts may become a thing of the past as well.

For more on this topic, check out CCIM Institute's Coronavirus (COVID-19) Resources and Guidance

Victor Calanog, PhD, CRE

Victor Calanog, PhD, CRE, is the chief economist and senior vice president at Moody's Analytics Reis.

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