According to a recent Forbes article by VTS’ Ryan Masiello, “it’s no surprise that AI has emerged as the next frontier in real estate technology.”

CRE retail experts don’t disagree with this assessment.

“AI has come a long way in retail leasing over the past five years,” said Brent Loomer, Lead Managing Consultant of RealFoundations. “What used to feel like a future-facing concept is showing up in practical, everyday ways across the leasing process.”

At the same time, Loomer and other experts told Connect CRE that artificial intelligence won’t replace jobs, and it isn’t effective without the human factor.

Legend Partners’ Managing Partner Tanner Olson said that AI helped cut his workload by 1% to 10%, depending on the transaction. “I think it’s making agents more efficient, but it’s certainly not taking off the workload that a lot of people might think it possibly could,” he added.

Upsides and Downsides

There’s no doubt that AI has evolved from basic data analytics to wider-range capabilities. “These advanced systems can now predict market trends, compare lease terms, provide lease abstracts, and even assist in tenant matching,” according to Jon Brecher, JLL Vice President.

These days, artificial intelligence supports real estate transactions in the following areas.

Documentation

Paperwork is a given with real estate. AI can help reduce the red-tape redundancies.

“You can take a 50-page lease and ask AI to do an abstract,” Olson said, adding that 15 companies right now are building AI platforms for abstracting leasing. While fact-checking is essential once the job is done, “AI does expedite that process a bit,” he said.

Mark Sigal, CEO of Datex Property Solutions, went a step further, pointing out that tools like MRI Contract Intelligence and Prophia use a combination of OCR, AI and machine learning to find leases’ key provisions, categorize them based on logic and data, and report by portfolio, property or national tenant.

Additionally, “a fairly standard tool is the use of Chat GPT for structuring and crafting narratives,” Sigal said. “This can add value to both the retail lease drafting process and the deal proposal process.”

AI can also help generate lease addendums. “You can feed an AI a lease and then have it create a drafted addendum or five-year extension,” Olson said. The process saves time, as the addendum can be presented to an attorney for review rather than the attorney drafting one from scratch.

But Sigal cautioned that AI documentation needs to be watched. “The technology is at the proverbial 80/20 stage,” he explained. “Automated abstraction works 80% of the time in terms of covered use cases, but the 20% of the cases not covered are so human-capital intensive, it mutes a large portion of the value for retail.”

Data and Analysis

Sigal pointed out that artificial intelligence can be useful for analyzing a retail leasing deal’s numbers, including net present value, net effective rent, gross profit multiple and related job costs.

Brecher agreed, noting that tenants and landlords rely on artificial intelligence to “analyze customer trip patterns, shopping behaviors and specific demographics.”

However, the experts expressed caution with AI’s resultant data. For one thing, artificial intelligence output is only as good as the available input data. As such, data governance and stewardship continue to be long-standing issues. “Clean, well-structured data results in smarter models,” Loomer commented. “Without it, AI is just automating bad assumptions.”

Stephanie Skrbin, a broker with Axiom Partners, added that not all data eggs should be put into an AI basket. “Dealmakers only share information with people they trust, so AI won’t have the full scope of market info that a human with boots on the ground does,” she said.

Then, there are the privacy issues involved with AI. “These have led to restrictions on using certain AI applications on company platforms due to security concerns,” Brecher said.

Negotiation Support

When properly used, AI can help with negotiations. Loomer indicated that the technology can surface “prepared clause language based on past deals, helping teams enter discussions with better context and more consistency.”

Sigal agreed, pointing out that Chat GPT and Anthropic can coach stakeholders in areas like negotiation strategy, competitive and market gap analysis and new client pitches. “Reid Hoffman, founder of LinkedIn and investor-founder of a number of AI startups, calls this dynamic of AI an ‘Intelligence Amplifier’ and argues that every professional should be using AI deeply to realize this cognitive gain,” Sigal added.

However, AI results are only as effective as human interpretation. “Remember, AI is not a substitute for human judgment,” Loomer said. While AI can focus on trends and opportunities and help accelerate analysis, “it still takes experienced professionals to apply context and make sound leasing decisions,” Loomer pointed out. “The art of the possible still requires human reasoning.”

Current Issues, Future Potential

Additional AI challenges include the cost of implementation as well as integration with existing systems. Furthermore, “there’s always the potential for bias in AI algorithms,” Brecher said. He advised that retail tenants and landlords understand the need for data verification and human oversight when handling AI outputs. Also necessary is “an understanding of the legal and ethical implications of AI-driven decisions,” he added.

Furthermore, AI shouldn’t replace legwork or relationship-building. According to Skrbin: “AI can certainly be a valuable resource, especially as the technology advances. But it should never replace picking up the phone and talking to people.”

Even with the challenges related to artificial intelligence, the experts believe that the technology is here to stay and will continue to evolve and improve.

 “Predictive analytics will continue to advance, giving teams the ability to model expected sales performance and occupancy costs with greater precision, ultimately supporting stronger deal structuring, smarter tenant selection and more informed long-term portfolio planning,” Loomer said.

Brecher added that AI progress could consist of improved tracking, note-taking, follow-up tasks and more efficient email summarization. “These advancements have the potential to create more efficient data-driven and personalized leasing processes in the retail sector,” he said.

Still, the experts explained that artificial intelligence is a tool to assist rather than a replacement. Said Loomer: “By removing manual bottlenecks and surfacing smarter insights, AI gives leasing professionals more time and better information to apply their experience, intuition, and creativity to each deal.”

Cost issues like the monthly rent, capital improvements and maintenance expenses are often at the forefront of tenant strategy when considering double or triple net-lease arrangements.

However, an additional expense—occupancy costs—are just as important. “Occupancy costs is a metric that helps quantify a tenant’s merchant health, especially relative to their operating performance, within their merchant category and over time,” according to Mark Sigal, CEO of Datex Property Solutions.

However, the occupancy costs metric is on the rise for retail pharmacies and dollar stores. Connect CRE asked experts why this data point is expanding and what potential solutions are to arrest the increase.

What Are Occupancy Costs?

Here’s what the occupancy costs metric is not: It doesn’t measure buildout or tenant improvement expenses.

“Tenant improvements and build-out costs are capital expense items and typically one-time outlays prior to opening,” explained Axiom Retail Advisors Broker Paul Bartlett. “They, along with other items like furniture, fixtures and equipment (FF&E), become the depreciation expense line in the profit and loss but aren’t considered occupancy costs.”

Here’s what occupancy costs measures: “It involves rent, landlord marketing contributions, common area maintenance, taxes and insurance,” Bartlett said.

Occupancy costs is a percentage that is calculated as follows:

Tenant Base Rent + Pro-Rata Share of NNN Expenses/Tenant Reported Sales

Going further, Sigal pointed out that the opportunity costs metric:

• Determines what portion of sales are taken up by the physical location’s marginal costs

• Helps landlords and operators determine if the tenant can pay the current rent rate as well as rent increases

“Because occupancy costs examines the relationship between the real estate costs and the sales lift provided by a superior location, it’s a cleaner metric than retail sales per square foot data alone,” Sigal added.

Occupancy Costs on the Rise

As with most tenant expenses, a lower occupancy costs metric is desired. During the pandemic, drug and dollar stores were considered “essential businesses.” According to Datex’s numbers, their occupancy costs stood at 2.19% and 9.42%, respectively.

But that was then. Within the past five years:

• Drug store Occupancy Costs increased by 32.36%

• Dollar store Occupancy Costs increased by 26.78%

Jason Maier, Northmarq’s Senior Vice President of Investment Sales, commented that, in his estimation, 4,000 square feet of every retail pharmacy location loses money. “The average store is roughly 14,000 square feet,” he said. “This means that at least 30% of the space they occupy is either not generating enough revenue per square foot, or even worse, is losing money.”

Additional Factors Driving the Uptick

There are multiple reasons why occupancy costs rocketed upward.

Increased Tenant Costs

“On existing stores, we can attribute lower levels of profitability and higher occupancy costs on repairs, maintenance, taxes and, in many states, rising insurance premiums,” Maier said. “For the most part, these tenants self-insure for a large portion of the coverages required under the lease.”

Additionally, a double or triple net lease means tenants have to spend more to keep current. “To remain competitive, tenants must refresh the stores, maintain the buildings, parking lots and HVAC systems,” Maier said. “All of this leads to higher occupancy costs in a high inflationary market.”

Meanwhile, the increased frequency and severity of natural disasters boost insurance expenses. “Rising replacement and repair costs are inflating the cost of claims,” Bartlett said. “Added to that are more stringent underwriting and risk aversion by insurers.”

Higher Rents

Richard Rizika, agency partner and co-founder of Beta Agency, said higher base rents have been common for many tenants, including retail pharmacies and dollar stores. “There is also a shift in lease terms that often favor landlords, given historically low vacancy rates,” he explained.

Furthermore, while landlords are negotiating better lease terms, they’re passing along shopping center operating expenses. “These can include marketing and technology spend, and they’re pushed into the reimbursable triple net bucket,” Sigal explained. This, coupled with an inflationary environment, has put upward pressure on occupancy costs.

Sales Decline

As rents expand, sales decline. According to Datex figures, drug store sales declined by 22.78%, while dollar store sales weren’t far behind, logging a sales decline of 19.18% since the pandemic.

Additionally, an increase in theft is impacting profitability. “In some markets, stores need to lock up their products, which negatively impacts the shopping experience and can lead to store closures,” Maier commented.

Sigal agreed with the assessment, adding that “there’s the argument that by failing to deliver ‘differentiated retail’ experiences, both categories opened the door for more dollars to shift to Amazon and additional Merchant Categories,” Sigal observed.

Then there is increased competition.

“During the pandemic, folks switched to online, and while shoppers have returned to most brick-and-mortar businesses in general, many of those who switched to online pharmacies haven’t returned to brick and mortar,” commented Stephanie Skrbin, a retail broker with Axiom Real Estate Advisors. “Consumers are finding that online purchases tend to be less expensive and more convenient,” she added.

“Today’s shoppers have more options for purchasing school supplies, office supplies and greeting cards, including online and delivery,” Maier added. “The delineation between pharmacy revenue and convenience revenue has become skewed.

The Results?

Higher occupancy costs are driving drug and dollar stores to act by closing down unproductive locations. “Cost pressures, combined with falling foot traffic and competition from online and discount retailers, make it difficult to justify continuing operations in locations with increasing occupancy costs,” Rizika pointed out.

At the same time, tenants are renegotiating leases and downsizing their footprints. “Some are also focused on growing online and operations to reduce reliance on physical stores,” Rizika said.

Those stores that haven’t closed down have been taking other steps. Said Sigal: “Many operators are reducing in-store staffing, which has resulted in poorer merchandising and a rise in in-store theft, which has led to more lockdown of inventory, further diminishing the retail experience in these categories.” Unfortunately, this path means consumers might flock to competitors. “Merchants that fail to deliver a worthwhile consumer experience are doomed to fail,” Sigal commented.

What’s the Solution?

The experts explained that higher occupancy costs shouldn’t be a retail death knell.

Bartlett suggested that tenant representatives should educate tenants about the current cost environment and ways to lower expenses. Meanwhile, “landlords and landlord reps should be prepared to backfill Rite-Aids, Walgreens and CVS stores now, rather than wait and see what happens,” he advised.

Co-tenancy could also help reduce opportunity costs. “A key benefit of multi-tenant retail is the cross-leverage of different tenants at a shopping center, especially anchor tenants,” Sigal observed.

Then there is technology. “Savings can be found in automation like self-checkout-drones and robots in inventory management,” Bartlett said. Utility expenses could also be reduced by improving fixtures and equipment and adding solar systems, he added.

In all, dollar and drug stores are in a period of transition, much like other retail sectors. Maier noted that during the next five to seven years, as lease deals come up for renewal, there will likely be more store closures and consolidation. This could represent opportunities for investors and owners.

“Unfortunately, there will also be many locations where the current occupancy costs are too high to support the valuation and will be sold at steep discounts,” Maier added.

Once upon a time, grocery, quick service restaurants (QSR) and beauty retailers were considered on the edge of being obsolete. Many things were available online, including lipstick, eyeshadow and perfume. Furthermore, delivery services became available to bring cooked and uncooked food to folks at home.

Then, a funny thing happened after the COVID-19 shutdowns. Consumers wanted a dollop of experience with their retail experience. Bricks-and-mortar became popular once again.

“We are seeing an increased focus on experiential retail that offers personalized services,” according to Richard Rizika, partner and co-founder of Beta Agency. “Retailers are placing more emphasis on stores to create experiences that are more challenging to provide online.”

However, Rizika and other retail experts tell Connect CRE that while demand has been robust, supply not so much.

Does Size Matter?

One question that comes to mind is what the grocery, beauty and QSR tenants are looking for in their space. According to Stephanie Skrbin, it depends.

“A coffee tenant like Dutch Brothers does more of a kiosk location and only needs about 1,000 to 1,500 square feet,” said Skirbin, who is a retail broker with Axiom Retail Advisors. Meanwhile, the QSRs look for additional space, which can be anywhere from 2,000 square feet to 3,200 square feet.

Datex Property Solutions CEO Mark Sigal added that fast-food restaurants also like drive-throughs, “but in many markets, this is a scarce option and subject to zoning and usage restrictions.”

Meanwhile, some beauty product retailers—think Ulta Beauty—prefer larger formats up to 12,500 square feet, while others—think Sally Beauty—prefer smaller footprints of 3,000 square feet or less, Sigal said.

Then there are the grocers. Sigal pointed out that grocery chains cover a range of square feet, with Trader Joe’s seeking an average of 12,500 square feet, Sprouts and Whole Foods looking for 25,000 to 30,000 square feet and traditional markets interested in 75,000 square feet.

Chris Premac added that discount grocers are targeting former large retail pharmacy spaces, like former Rite-Aid locations. “They can take advantage of the size and prime corner locations,” observed Premac, who is Coreland Companies’ Vice President.

Additionally, the downsizing and departure of big-box retailers have provided interesting opportunities for grocers. “While supermarkets still prefer to build their prototypical footprints, with all the recent vacancies from big-box stores, there have been a lot of opportunities for grocers to take over these larger spaces,” said Sean Unsell, RDC Associate Principal. “It’s quicker and more sustainable to renovate an existing building than to build from the ground up.”

However, retail isn’t just about size. Keisha Virtue, JLL Retail Research Manager, explained that fast-food retailers focus on stand-alone locales with the above-mentioned drive-through lanes. Meanwhile, grocers look for space in centers that are close to high-density neighborhoods. “Beauty retailers perhaps have the most flexibility,” Virtue observed. “They typically take space in malls, community and neighborhood centers.”

In some cases, beauty retailers might end up with shop-in-shop arrangement with another retailer. Ulta Beauty taking space in a Target store and Sephora’s setting up shop in a Kohl’s department store are a couple of examples.

Can They Find The Space?

There’s a large gap between what grocery, beauty and fast-food retailers want in a space and their ability to get it. Similar to the entire retail sector, quality square footage has been difficult to find.

“There is a scarcity of available space, a scarcity of new development,” Sigal observed. “Furthermore, only a subset of the available spaces will fit the footprint and market needs of a given retailer in these categories.”

But what about the bankruptcies taking place in retail? Virtue acknowledged that store closures could bring more than 150 million square feet of retail space to the market. However, “there will not be anywhere near perfect alignment of vacated space and demand,” she said.

For example, on the “eating out” side of retail, casual dining brands have gone out of business in recent years. Unfortunately, “these building sizes are often not convertible for a fast-food brand,” according to Mike Philbin, Northmarq senior vice president and co-founder of National Restaurant Group.

On the other hand, if the QSR developer has enough capital to work with, a larger casual dining restaurant could be demolished, replaced by a fast-food restaurant. “The advantage of the larger lot size is the ability for a larger drive-through stack or even multiple drive-through lanes,” Philbin said.

The Takeaway

The experts agreed that retail demand and supply depend on consumer demand. This isn’t really news, but it does add complexity to the retail decision-making process when dealing with size and location. “It’s not a one-size-fits-all scenario,” Unsell commented. “Brands need to know their customer base, and they need to stay competitive in the market they’re in.”

Hence, it’s important to keep an eye on consumer behavior. “In times of great uncertainty, consumers tend to stick to necessities and value-oriented retailers,” Virtue commented. “Hence the demand for less expensive restaurants and the emphasis on grocery.” Meanwhile, the demand for beauty has outgrown in other areas, including social media influencers.

In short, “the fast-food, grocery and beauty sectors have demonstrated resilience and adaptability in response to the pandemic’s challenges,” Rizika said. “By evolving with consumer preferences and strategically remerchandising stores, these retail sectors continue to grow.”

Retail real estate is a study of opposites. At one end, there is a lack of space and very low vacancies. At the other end, there are bankruptcy cases and more bankruptcy cases.

However, retail encompasses many uses, products, services and space requirements. Metrics differ depending on the sector.

For example, according to Mark Sigal, Datex Property Solutions CEO, the strongest merchant categories in retail based on sales growth since the pandemic are:

• Fast food: 42%

• Grocery: 20.1%

• Beauty products: 130%

Sigal and other retail experts shared their insights with Connect CRE, explaining the situation behind these three retail areas.

COVID, Grocers and Fast Food

But first, a little history.

In the years before 2020, e-commerce was starting to come into its own. Then the pandemic struck. While the subsequent lockdown imposed hardship on much of the retail sector, quick-service restaurants (QSRs) and grocery stores performed well.

“During the onset of the pandemic, grocery stores were deemed essential businesses, and we experienced panic buying products like meat and toilet paper,” said Sean Unsell, associate principal with RDC. People in quarantine were also more interested in buying food at the “deemed essential” grocery stores to cook at home.

At the same time, fast-food restaurants operated their drive-throughs as normal. “People wanted to get out of the house but were cautious about exposing themselves to COVID,” said Stephanie Skrbin, a retail broker with Axiom Retail Advisors.

Still, QSRs and grocers had to adapt to the changing situation. “Chipotle, Panera Bread, Starbucks and others all pivoted and primarily focused on drive-through locations,” Skribin commented. Added Coreland Companies’ Vice President Chris Premac: “Both grocers and QSRs had to adapt quickly and developed new delivery models and mobile pickups.”

According to Sigal, COVID ended up being a resurgence in grocery stores. “Many forget that when Amazon announced their plans to acquire Whole Foods in 2017, the market caps of the major grocery chains cratered overnight,” Sigal said. “The category was written off by many as the latest retail segment to get Amazon’d.”

However, JLL Retail Research Manager Keisha Virtue painted a somewhat different picture. In 2019, grocery chains experienced robust year-over-year sales growth. During 2020, pandemic quarantines put pressure on QSR growth. However, “as consumers prepared more food at home, grocery sales jumped 9.4% above 2019,” Virtue explained.

She added that fast food and beauty sales increased by 18.8% and 22.0% respectively in 2021.

And, Speaking of Beauty . . .

The beauty sector—cosmetics, spas, hair salons—faced numerous challenges during the pandemic. Beauty stores weren’t considered “essential businesses” at the time. In addition, “there was reduced demand for cosmetics due to remote work and social distancing,” explained Richard Rizika, partner and co-founder of Beta Agency.

Meanwhile, salons and spas were ordered to shut down to stop the coronavirus spread. “Some businesses risked fines for staying open and taking care of customers in the short term,” Unsell said. As a result, consumers took self-care into their own hands. “They ordered products online and learned techniques from online tutorials,” he said.

Today’s Situation

JLL’s Virtue explained that demand for the three categories remains healthy, even as yearly sales gains are shifting the further away we move from the pandemic. Both grocery corporations and QSR companies have announced massive expansions, while health and beauty operators plan to open more than 300 new stores.

“During the fourth quarter of 2024, demand in these sectors reflects a blend of pre-pandemic consumer demand and a shift in consumer preferences and economic concerns,” Rizika noted. Along those lines, demand for affordability combined with busier lifestyles are driving consumers to retailers that can offer value and convenience.

Northmarq Senior Vice President and Co-Founder of the National Restaurant Group Mike Philbin pointed out that the intrinsic value of QSR keeps demand high. “They’re able to survive on smaller lots with adaptable footprints,” he said. “If a tenant does vacate, hundreds of replacement tenants are available because of advantageous locations with drive-through access.”

Furthermore, the casual dining appetite has cooled as chains struggle with labor costs, paper and food. “The cost to build has made it all but impossible to develop new restaurants, rather than growing through acquisitions of vacant restaurants,” Philbin observed.

While grocery chains are performing well (despite inflation and supply chain shortages), they’re also facing a fragmented demographic, with discount options (Aldi) and unique offerings (Trader Joe’s). “In some cases, people want high-quality products that offer healthy alternatives to fast food,” RDC’s Unsell observed. “Single-ingredient whole foods have also gained popularity on social media as more people cook at home.”

Meanwhile, hair salons and spas are operating. Furthermore, beauty products benefit from social media influencers and a general desire for self-care and well-being. “There’s been a resurgence in demand, as consumers return to social activities and seek self-care merchandise,” said Rizika with the Beta Agency.

Unlike grocery stores and QSRs, beauty retailers tend to face higher competition from e-commerce merchants. Datex’s Sigal explained that such supplies need to “thread the needle” between commodities that can be purchased online versus lifestyle delivery. Still, “the outcome of looking one’s best and feeling beautiful is worth that something that only brick and mortar can provide,” he said.