What's in Store for Retail?
Taking Stock of the Market
Over the past decade, the retail real estate market has gone from boom to bust to bloom. The "malling of America" and the recession bruised an already overbuilt market, but now the retail sector is budding with regrowth. And while deals may not yet be flourishing at the rate of years past, caution and careful attention to detail characterize the more successful deals and the players who make them.
Consistent with today's cautious thinking, the outlook for retail comes backed by hard data and flanked by caveats.
The National Association of REALTORS©'s 1993-1994 National Real Estate Review supplies this good news for retail:
In 1993, the average retail vacancy rate declined to 10.1%, reversing its upward climb of the past several years. Construction continued to drop off in 1992 and fell below absorption levels. Absorption, while remaining considerably below levels of recent years, reversed its downward slide and increased in 1992. Although average asking rents fell slightly in 1993, average effective rents held steady and the value of concessions declined, reflecting a modest improvement in conditions.
An even more optimistic note sounded in a recent survey of more than 200 retailers by Shopping Center World. Each respondent reported plans to open an average of 33 new stores a year for the next four years, compared to 27 shops opened in 1993. Nearly a quarter of those surveyed also said they are contemplating expanding their average store size or launching a new chain within the next four years.
Toys "R" Us, for example, plans to open 125 new stores this year. Home Depot, the nation's fastest-growing home- improvement chain, is expanding from its bi-coastal and Southern base by entering the Midwest, with 23 stores planned in the Chicago area alone over the next four years. Wal-Mart, meanwhile, is rumored to be considering an expansion into Canada, according to a report in the Toronto Globe and Mail. This follows a successful foray into Mexico where several stores are already open, in locations such as Mexico City. The discount giant also is eyeing up to 5,900 new markets in the continental United States, according to Dan Weir, CCIM, of the Dan Weir Company Real Estate in Manhattan, Kansas.
Retail's outlook is particularly bright in certain areas. For example, Las Vegas, with its booming population and favorable tax climate, provides fertile ground for retailers, according to Charles Mack, CCIM, of Mack Realty Corporation. "We have no corporate income tax. Corporations love us here because there's no franchise tax and no inventory tax," Mack said. The mix includes big-box discounters, national retail and restaurant properties, and high-end stores like those at the Forum Shops at Caesar's Palace. (See sidebar.)
The Dallas area, too, has seen a sharp upturn in the number of retail deals since the market bottomed out three years ago, as shopping centers that were taken over by the federal government or financial institutions have returned to private ownership, said Rex Anderson of Acres, Inc. One shopping center, he noted, valued near $3.5 million when it was built in the mid-1980s, went through not only foreclosure and repossession, but also the closing of its savings and loan. Listed first at $2.5 million, then $2.2 million, and finally $1.4 million, the center sold in 1990 for $400,000 cash--about $6 per foot. After being resold for $10 or $11 per foot, it is now back on the market for $20 to $22 per foot.
But in today's marketplace, any display of pennant-waving must include a flag of caution. "I think retailers are more cautious in structuring deals than they may have been in the past," said retail real estate consultant Bill Bugg, CCIM, of Bugg & Associates in Memphis, Tennessee. “They watch every penny and quite often they want some kind of exit strategy in case the store isn't successful."
Up Against the Wal-Mart
Meanwhile, a battle is brewing among the big-box discounters and category killers, regional malls and specialty stores, and convenience centers and mom-and-pop enterprises.
In the '80s, regional malls eclipsed smaller retailers in community and strip centers. Now, "power centers,” with big- box discounters such as Wal-Mart and Kmart or category killers like Toys "R" Us, are casting their shadow over the regional malls. The reasons for the success of such chains range from investor and customer preferences to issues inherent in the regional mall format. "Society today is looking more for value and convenience," Bugg added. "They don't want to go to 15 stores at the mall to find the right toy."
"The concept of the typical regional mall is having problems, and will probably continue to have problems because tenants are heating and cooling large common-area spaces," Anderson said. By contrast, open-air factory-outlet malls house similar tenants but offer them savings in common-area maintenance (CAM) charges.
Neigbborhood stores struggle Independent stores, such as groceries, also are struggling. At the National Grocers Association convention in Atlanta, owners of smaller stores complained of losing business to warehouse discounters and category killers including Sam's Club, Home Depot, Office Depot, and Toys "R" Us. While some argued that greater modernization and efficiency would increase the smaller independents' competitive edge, others stressed that greater attention to customer service would strengthen the neighborhood grocers' market niche, according to Associated Press reports.
Security of the income stream is driving the trend toward big boxes, noted Larry Baumgardner, CCIM, of Baumgardner- Hogan, Inc. in Louisville, Kentucky. "Investors are looking to reduce risk. The way to do that is to invest your dollars with a credit-worthy tenant," he said. "That type of tenant tends to come in a big box.
Turf battles But even among the big boxes, competition is growing fiercer and the limitations of the concept are growing apparent. Wal-Mart, Kmart, Target, and others are having difficulty expanding without launching a turf war in an already low-margin business, Real Estate Research Corporation's 1994 Emerging Trends in Real Estate report indicates.
For their part, investors are growing concerned that big-box retailers, especially warehouse clubs, have reached saturation levels. Wal-Mart discount stores, for example, posted a 13% increase in same-store sales between February 1993 and February 1994, while the company's Sam's Club outlets reported a 2% decline.
Building boxes "I see a movement toward the retailers controlling and building their own properties. That happened with Wal-Mart, particularly in the mid-'80s," Weir said. "Wal-Mart got tired of developers that were not capable of finishing the deal. So it turned to a concentrated group of cash-strong developers."
Offsetting investor concerns, Wal-Mart now builds 85% to 90% of its stores; Dayton-Hudson builds about 50% of the Target stores it operates; and Kmart builds 20% of its properties, according to Korpacz's third-quarter 1993 Real Estate Investor Survey.
On the other hand, Kmart's building program contributed to its $1.19 billion net loss for the quarter ending Jan. 26, 1994. The company set out to replace 500 of its 2,324 discount stores with larger outlets, rather than renovating them as originally planned. This is double its construction rate of a few years ago. Meanwhile, Kmart is losing market share to Wal-Mart and Toys "R" Us, according to a recent report in the Wall Street Journal.
Wal-Mart, too, is adopting a larger store format and closing some of its older locations, creating vacancies, noted Henry Rudner III, CCIM, of Fred's, Inc., a chain of mid-size discount stores, based in Memphis, Tennessee. While in the long term, Wal-Marts' closed locations may prove advantageous to other retailers looking for a foothold in the marketplace, in the short term, such a large empty storefront can appear daunting to landlords, prospective tenants, customers, and investors.
"A landlord gets used to earning $250,000 a year rent from their Wal-Mart tenant. Then Wal-Mart vacates and builds a new store down the street and pays 'dark rent' on the space. The investor's income stream has suddenly dropped to $87,500. And if that investor has financed or refinanced that property, he could be in jeopardy. So I see some movement away from the big boxes as far as investors are concerned," Weir remarked. In fact, he said, one of the REITs he's been working with has expressly said they don't want any big boxes; they prefer neighborhood centers or other more broadly leased centers with less risk.
Bigger not always better Additionally, the sheer size of the big-box space will inevitably exacerbate any unwise leasing decisions. "If the deal isn't right for you, not only will you have a real estate lease with terms that are too tough for you, you'll also have too much space. [The problem] feeds itself," Rudner said. "I think a lot of the [big boxes] that weren't successful made the error of sacrificing tough, negotiated real estate deals for getting a number of stores up quickly."
And the idea that bigger is better may ultimately clash with shoppers' demand for convenience. Anderson remembers one super center with a building so extensive and a parking lot so large, "You needed roller skates to get around the property." People who had shopped there told him they would never return. The size and the crowds were too much for them.
The response of the consumers Anderson encountered underlines the demographic trends and attitudes behind the value and convenience factors of the big boxes.
Despite recent economic upticks, buyers remain hesitant, reflecting consumer pessimism about business conditions, employment prospects, and future expectations, the National Real Estate Review noted. The Consumer Confidence Index, after climbing from a low of 47.3 in February 1992 to a high of 78.1 in December '92, dropped through the summer of 1993.
Consumers now rate low price (39%) and selection (37%) as their top shopping motivators, according to a recent International Mass Retail Association study cited in Shopping Center World.
Value and convenience are the buzzwords of retail today. "Quite often, households have two incomes. People work all week, they are tired, they have their kids to deal with, and they just don't want to spend that much time shopping," Bugg said.
To save time, many consumers shop through catalogs, he added, or, as Emerging Trends suggests, televised home shopping. Trend guru Faith Popcorn, in her 1991 book The Popcorn Report, predicted that future buyers in America will browse on a computerized shopping screen, leaving their home cocoon to shop only at specialty stores or at major emporiums with a carnival atmosphere. (See sidebar.)
The movement toward home offices also will affect retail locations, predicted Robert Rosenberg, CCIM, of Inve$tnet, Inc., Commercial in Sacramento, California. As a larger portion of the labor force works alone, day in and day out, retail centers will take on the social role once held by the water cooler. Dual-career couples, too, he added, will rely increasingly on convenient retail and restaurant locations as a place to relax and retreat, without the responsibilities of cooking and cleaning.
If these forecasts materialize, the reinvention of the consumer marketplace could have a profound impact on retail real estate.
Today, the marketplace is adjusting to the new paradigm, as smaller retailers fight to stay in the ring with the big boxes. Whether they emphasize customer service, introduce new store concepts, or tag along with the big kids on the block, convenience centers, specialty retailers, department stores, and mom-and-pops are preparing to go the distance.
Service The next several years will see a resurgence among companies that emphasize service, Rosenberg said. Wal-Mart, with its in-store greeters, has packed the service ethic into the big box. To compete, the mom-and-pops must provide an even higher level of personalized attention.
Value On the other hand, the Nordstrom department store chain, already renowned for its service, has developed a value-oriented store concept: Nordstrom Rack discount outlets. The West Coast has 12 of these outlets, which recently made their Midwestern debut near the mammoth Woodfield Mall in suburban Chicago--where the Seattle-based chain plans to open a department store this fall.
At the same time, Minneapolis-based Dayton Hudson Corp., parent of the Target discount chain, is launching a value- conscious marketing and merchandising campaign in its department-store division, which includes Marshall Field's, Dayton's, and Hudson's locations. The campaign calls for the stores to expand their stock of lower-cost merchandise, and for advertisements to increase their focus on price.
Synergism Meanwhile, the image of the monolithic retail fortress, surrounded by a moat of parking, is yielding to a more synergistic concept, as big boxes find peaceable coexistence with other retail types. Home Depot, for example, will open its first Chicago location on a vacant parcel near the inner-city Brickyard Mall. In Las Vegas, too, mom-and-pops are locating in the centers anchored by Wal-Mart and Kmart, Mack said. Grouping seems to be another trend; Mack added that another local shopping district features four major furniture stores within easy walking distance.
Manhattan, Kansas, a town of 45,000 people, supports a Wal- Mart, a Kmart, and a 60,000 square-foot food store, all within 800 feet of a 600,000-square-foot shopping mall. "We've created a terrific economic engine because it's all there, Weir said. It took this town from being a local shopping area to a smallish but regional shopping district. When you get to the critical mass, you become a true shopping destination."
From urban centers to heartland communities, retailers are taking advantage of trends that will shape the market for the rest of the millennium.
Consumer emphasis on value and pricing bodes well for owners, developers, and tenants of discount centers and outlet malls, as well as for well-located sites that can accommodate big boxes, the National Real Estate Review projects.
Even the idea of new development is receiving attention again in markets such as Dallas. Prices are floating upward enough now that I see the cross between economic development and an existing center on a cap rate. When you see that equilibrium reached, you'll find new development going up," Anderson said. As a hedge, he cautions investors to secure long-term financing with "absolutely fixed rates."
But federal budget deficits and the growing national debt may hamper developers in securing that financing. "The government has been borrowing almost 70% of the total capital for years, and that borrowing seems to be continuing and increasing," said Michael Morse, CCIM, of Morse Retail Realty in Des Moines, Iowa. The result will restrict the amount of capital available for private use. "If we can't borrow that money, or we can't borrow it at a reasonable cost, it's going to strangle the development, and that development provides the basic tools for us to grow our economy," Morse added.
Regardless of available capital, a rush toward development seems unlikely while the lessons of the '80s are fresh in the minds of developers and tenants alike. Caution remains the watchword of the decade.
There's probably a little more strategic planning going on than there was back in the ‘80s when the economy would cover up a lot of mistakes," Bugg agreed. "People are being more cautious and planning more carefully."