Retail Faces a Mixed Prognosis
The COVID-19 pandemic has illuminated weaknesses, strengths, and areas of potential growth for retailers of all kinds.
Retailers and landlords reeling from business closures in the wake of the COVID-19 pandemic have reignited fears of a retail apocalypse. The global health crisis has dealt a harsh blow to a retail sector that was already struggling amid pressures from e-commerce and changing consumer behavior. Performance within the retail sector in recent years has been a mixed bag of shopping concepts that ran along a spectrum of thriving, surviving, or barely hanging on. COVID-19 will likely hasten the demise of those retailers that were already on shaky ground. In particular, department stores and mid-priced apparel and accessories retailers are among those that face the biggest risks for failure.
Though on a state-by-state basis, retailers, for the most part, are likely to be open for business heading into the fall. However, they will be unlikely be able to flip a switch and go back to what business was like before the pandemic, says James Cook, director of retail research, Americas, at JLL. Social distancing recommendations and consumer fears about contracting the virus will continue to weigh on foot traffic to stores and shopping centers in the near term. In addition, by April, the lockdown dragged the U.S. and global economy into recession. “Consumers' recessionary spending is a different animal, so retailers who were struggling before COVID are really in trouble right now,” says Cook.
Prior to the virus outbreak in early 2020, malls were already sitting on the highest vacancy rates in a decade, at 9.7 percent. In comparison, vacancies within neighborhood and community centers have held fairly stable at about 10 percent for the past three years, with relatively flat rent growth, according to data from Moody's Analytics REIS. The near-term outlook will depend on the speed of the economic recovery — CCIM Institute Chief Economist K.C. Conway, MAI, CRE, CCIM, is predicting a W-shaped recession as detailed in this issue's cover story (pg. 24). REIS's worst-case scenario forecasts negative net absorption of close to 67 million square feet in 2020 and another negative 24 million sf in 2021, which would push the vacancy rate to 14.6 percent by the end of 2021.
The global outlook also is grim. Research firm Forrester is predicting a 9.6 percent contraction in global retail sales for 2020, which amounts to $2.1 trillion in losses. However, retail remains a very bifurcated market, and the shutdown did not impact all sectors equally. Those essential businesses — including grocers, wine shops, home improvement locations, and convenience stores — remained open for in-store shopping, while others had to shift to online channels. “The winners are easy to identify. When you are out and about with your day-to-day activities, you can see and experience how companies are adapting to the COVID environment,” says Amy Barrett, CCIM, director of retail and office services at Colliers International in Tampa Bay, Fla. Both large and small companies have found ways to continue to serve customers in stores or through online or mobile channels. The losers are the ones who are over-leveraged, undercapitalized, and didn't adapt to COVID-19 quickly enough, she adds.
Wave of Closures Ahead
The industry is still in a wait-and-see period, with the reopening of business likely to continue throughout the summer and fall. Landlords may not have an idea of the true damage until the fourth quarter of 2020 or the first of 2021. Early fallout from COVID-19 has already started to ripple through the industry. Neiman Marcus, JCPenney, and J.Crew are among those major chains that filed for bankruptcy protection in May, and the expectation is that others, including Stein Mart and Sears, may not be far behind.
“I have seen some of the impact firsthand, including tenants packing up shop with no plans to reopen in response to the pandemic,” says Lauren Tabeek, CCIM, managing director at Newmark Knight Frank in Las Vegas. “Unfortunately, local mom-and-pop businesses, which generally operate on a shoestring budget, are being hardest hit.” However, while some retailers do not have the capital to weather the downturn, others are using the situation as a catalyst to shift gears and concentrate on specific portions of their business, she adds.
“We will certainly see some iconic retail brands, public and private, close multiple stores, and perhaps proceed into bankruptcy,” says Patrick Luther, CCIM, managing principal of the National Net Lease Group at SRS Real Estate Partners. However, there isn't quite “blood in the water” yet, he says. In the interim, many landlords have worked with tenants on rent abatement or deferral requests, and in turn have negotiated their own forbearance with lenders on loan payments. In addition, some retailers are finding added assistance through forgivable loans funded through the government Paycheck Protection Program. Landlords also are offering a helping hand to retailers. For example, Brookfield Asset Management is spearheading a $5 billion retail revitalization program that will help recapitalize retailers in markets where it has properties.
The retail industry has grown accustomed to constant churn created by bankruptcies and portfolio repositioning, as well as the arrival of new concepts and trends. Coresight Research recorded a total of 9,275 store closures from major retailers in the U.S. in 2019. On the positive side of the ledger, the industry also posted 4,454 new store openings. In fact, year-to-date through April, the firm was tracking retailer announcements for 2020 new openings that were outpacing store closures at 2,971 to 2,210, respectively. However, it remains to be seen how significantly COVID-19 will delay or derail those previously announced store openings.
The pandemic is going to shake out a lot of retail tenants for a lot of different reasons, notes Emil Gullia, CCIM, an executive vice president and principal at Retail Specialists LLC in Atlanta. One of those reasons is heavy debt loads. Private equity players that swooped in to provide needed capital for struggling retailers following the Great Recession of 2007-2009 have become grim reapers for the retailers they helped save, says Gullia. Heavy debt levels are now being exacerbated by the decline in sales.
Recycling Vacant Space
Looming store closures will put landlords in a familiar position of backfilling vacant space. Essential retailers and internet-resistant tenants meeting daily consumer needs will remain a sought-after category for retailers. However, commercial real estate brokers and service providers may need to get creative to find solutions in an environment where replacement tenants could be difficult to find. “The new buzz words are going to be repositioning and repurposing real estate uses,” says Walter S. Clements, CCIM, president and CEO at Dean Realty Co. in Kansas City. For example, the traditional model of a bank with a big open lobby and four or five drive-thru lanes will be less relevant because the pandemic has accelerated the move to online and mobile banking. “Even prior to COVID, if you ever had to go into a bank, it was like a ghost town,” says Clements.
COVID-19 will likely further accelerate the trend for landlords to adopt mixed-use strategies to diversify income streams and have different traffic drivers. “I think whole swathes of retail will be reimagined as non-retail use,” says Gullia. For example, some malls situated in evolving trade areas may see their empty anchor stores be redeveloped as Amazon fulfillment centers. These malls that were developed in the '70s, '80s, and '90s were built in areas of traffic with good access, desirable demographics, and growth. Those trade areas may have shifted, and some malls have become redundant in their offerings, he says. “I do think there is a lot of real estate that will be recycled into something completely different,” he adds.
Closures are always a tough pill to swallow. Yet, in some cases, closures also may create needed opportunities to get rid of tired retailers that weren't generating traffic or excitement. “There will likely be opportunities to reposition properties, and landlords will be able to strengthen their tenant mix with retail concepts that are more viable in today's world,” says Tabeek.
However, the experiential strategies that landlords have leaned on in recent years to revitalize properties may be on hold — at least for now. Those categories that have been instrumental in the transformation of retail — food, fitness, and fun — are among those sectors hardest hit by COVID-19 and new social distancing guidelines. Views are mixed on what the future holds for those tenants. On the positive side, some see huge pent-up demand for people to return to experiential retail that could fuel traffic and sales. “Once things open back up again, people are going to be champing at the bit to go out and have some fun,” says Cook. “So, all those trends that we had been talking about before COVID-19 will all come back — and I think they will come back with a vengeance.”
There will likely be opportunities to reposition properties, and landlords will be able to strengthen their tenant mix with retail concepts that are more viable in today's world.
— Lauren Tabeek, CCIM, Managing Director, Newmark Knight Frank
Lingering Effects on Consumers
The first orders of business for retailers and landlords are damage control, reopening, and restoring traffic and cash flow. Moving forward, the challenge will be sorting out short- and long-term impacts of the pandemic on consumer behavior and business strategies. “When the effects of this pandemic wear off, I think we are going to go back to the same preferences for social gathering as we did before, with more heightened awareness of how germs travel,” says Clements. Businesses across the board are already implementing new protocols and systems that prioritize safety for employees and customers, including better air filtration systems and touchless payment systems. In the past, landlords were focused on promoting sustainability; going forward, the focus will be on making buildings safe and green, he adds.
Another significant change is that people have gotten more comfortable in their own homes. Family and personal connections are as important as ever, and in-person interaction will never be fully replaced. But people are becoming accustomed to doing everyday things remotely from home, whether that is shopping, banking, telemedicine, or attending church service, notes Gullia. According to information provided by Forrester, e-commerce represented 17 percent of U.S. retail sales in 2019, with an expected rise to 19 percent by the end of 2020.
COVID also may accentuate bigger geographical differences. Some regions will rebound faster than others. Potentially, it also could spark a shift in location preferences and strategies. One view is that contagion hot spots that have emerged in high-density areas are going to create some outmigration and push people back to suburban and rural areas, especially among millennials who are starting families. “I do think there is going to be a big change in intracountry migration away from some of the densities on the coast, and these secondary and tertiary markets are going to flourish,” says Gullia.
Additionally, the pandemic has highlighted the need for omnichannel platforms and the ability to provide alternative delivery options that have allowed for business continuity. Such operations may increase consumers' appetite for convenience in the future. COVID-19 has spurred the use of drive-thrus, delivery services, and curbside pickup options for restaurants, as well as a variety of other product types, notes Luther.
“On the bright side, retail is an extremely resilient asset class, and I tend to believe that people have a short-term memory. Spending habits and patterns will change as a result of this, but the majority of businesses will come back,” says Luther. In addition, innovation among new and old retailers will continue to drive activity and change within the market. “Yes, you will see some retailers close, but right behind them will be new, stronger concepts to take their place,” he adds. “Innovation and cannibalization have been the keys to retail's past performance as well as its future.”
Surge in Online Sales Puts Spotlight on Supply Chains
Weeks of quarantine pushed consumers online to shop for a wide variety of products, ranging from grocery and household staples to electronics, sporting goods, and home improvement supplies — all of which has further accelerated the growth trajectory for e-commerce.
“Because consumers don’t have a choice, we’re seeing historic highs in penetration of online retail sales,” says James Cook, director of retail research, Americas, at JLL. That shift in consumer shopping is providing a further tailwind for online sales, even in sectors such as grocery that had traditionally lagged the broader market. According to research provided by Forrester, e-commerce accounted for 17 percent of all U.S. retail sales in 2019. That number is expected to rise to 19 percent in 2020 and to 24 percent by 2024.
Amazon is still a powerhouse, but it can’t take credit for all the gains. Retailers and restaurants were continuing to advance online and mobile sales before COVID-19 hit. “The pandemic has put retailers’ omnichannel platforms to the test in a way that they never expected,” adds Cook. “The retailers that had been investing in ship-from-store and curbside pickup are glad they did because they are seeing record growth in online sales.”
Broadly speaking, the rise in e-commerce sales has been a boon to the industrial market. Although industrial will certainly be negatively impacted if there is a prolonged economic slump, the sector had been a strong performer in recent years with an active development pipeline and steady absorption. For brokers who are looking to add value to retail clients, they will have to have a greater understanding of supply chain needs and how they fit with the omnichannel model of brick-and-mortar stores.
In particular, one thing that COVID-19 has done is forced a lot of people to the internet for shopping for basic supplies and food, which is going to put increased demand on third-party logistics to get food from manufacturers to the consumer, notes Walter S. Clements, CCIM, president and CEO at Dean Realty Co. in Kansas City. For example, Dean Realty is developing a 266,000-sf cold storage 3PL facility in Kansas City with 90-foot clear height and state-of-the-art robotics.
Retail strategies will need to focus even more heavily on 3PL logistics and efficient use of supply chains that can get goods in the hands of customers very quickly, whether they were choosing to buy online and have it delivered to stores, buy online and pick up in stores, or shop in stores. “Once this pandemic ends, we’re going to have more people than ever that are familiar with the internet and delivery to home and how easy and convenient that is,” says Clements. “So, I think you will see more people shopping online, and we’re building into that demand.”
For more on this topic, check out CCIM Institute's Coronavirus (COVID-19) Resources and Guidance.