In WMRE’s 2023 Market Outlook, X Team’s president, Dave Cheatham believes that retailers will continue to tap into their resilience and ingenuity in the coming year, to meet the market. Whether through upgrading older spaces, small-format store concepts, or creating new business models, he proposes that those wishing to expand will need to be flexible, creative, and most of all, efficient.
Retail Sector Continues to Evolve Post Pandemic, New Concepts Redefine Thriving Consumer-Oriented Real Estate Model That’s Emerging
Disruption to retail caused by the pandemic, upended the way in which merchants sell to customers. The need to pivot, almost instantaneously to e-commerce took customers off the selling floor and riveted them to their touchscreens, completely redefining the buyer’s journey. As we emerge in fits and starts from pandemic isolation and confinement these last three years, omnichannel and experiential retail concepts have become increasingly sophisticated to meet a new society’s changing needs.
Retail experts predict the redefinition retail will prove the sector hasn’t died and in fact is simply undergoing a transformation, albeit a rather massive one. The retail industry is being reinvented as consumer-oriented real estate that incorporates all of the elements of retail but eschews some traditional tenets of retail. Tenant mixes are changing and the over-retailing that’s occurred over the last decade is being corrected via a thinning of the herd. The market is seeing smaller concepts emerge as retailers balance and right-size their oversized footprints, even as others continue to pivot to online and hybrid models. It all adds up to exciting times ahead for the retail sector.
As retail grapples with ways to stay profitable and reach the Americans consumer, big questions around retail space and land use are being asked and little is assumed. The last decade saw the acceleration of the un-malling of America. In a decades-long run up to the Great Recession, the market was overbuilt and oversupplied with big boxes centers and shopping malls. David Larson, X Team affiliate and Owner and Partner at Legend Partners, LLP, a retail brokerage firm based in Denver, Colorado, represents an extensive variety of national retailers with a focus on large box tenants. Larson believes that the retail sector is ripe for a redefinition of itself. He explains, “What is true, in my belief and experience, is that retail is certainly not dead, nor is the American consumer. Retail is changing and evolving. I would suggest that instead of referring to “retail” we need to rephrase it as “consumer real estate”- because in essence that is where the sector has evolved. Explaining this nuance Larson offers, “Many retail sites are currently occupied by a service—whether that is a fitness center, office suites or medical clinic. These tenants have the same market dynamics as a traditional retail tenant. They are consumer-oriented, must be conveniently accessible, possess branding and identity needs. In short, they present all of the elements of retail, but they aren’t retail in the traditional sense.”
Changing Tenant Mixes
The change in tenant mix can be traced back over a decade, leading up to the 2008/09 economic downturn. Larson explains, “Around eight to ten years ago, vacancies were hitting the market due to the Great Recession. At that time, everyone in the business was trying to figure out how to backfill all the empty boxes. Shopping centers and other retail developments had restrictions in place to prevent certain types of businesses from leasing. It is a greatly different story today. If you want to discover who is doing the biggest deals now, you need to examine those old lease restrictions. It is precisely those excluded tenants who are the drivers of retail leasing today."
Covenants, Conditions, and Restrictions (CC&Rs) in commercial real estate leases, spell out exclusives and radius clauses determining the types of businesses who can operate in a particular development within a certain location. CCRs are implemented to protect the interests of tenants and the development. These lease clauses are one of the more contentious issues between commercial property owners and tenants. Certain types of businesses that affect parking requirements were undesired, such as theaters, fitness centers, entertainment venues, as well as other non-retail uses, such as educational or medical. Achieving the correct retail mix often meant outlining a series of restrictive lease covenants to prohibit undesirable uses of the development. Ironically, it is these same fitness centers, entertainment arcades, bowling alleys and even marijuana dispensaries that are leasing large footprints, revitalizing an old anchor or vacant big box hardware store.
One of the more significant changes Larson has witnessed over the last ten years, has been the move toward consumer-oriented, interactive use for retail space. He states, “Although the end use may have changed, retailers have not gone away.”
According to Statista, the United States had the highest square footage of retail space per capita worldwide at 23.5 square feet per person in 2018. Canada and Australia followed behind with 16.8 and 11.2 square feet, respectively. COVID-19 has accelerated a trend of consolidation and closures that had already been underway. As Larson points out, there simply was too much retail space built in the last decade. “There needed to be some fallout. It was inevitable because in many cases there were three or four competitors occupying the same retail category within a given market. That level of saturation wasn't sustainable. There were just too many malls and centers that were underperforming—we were over-retailed.”
Today, prime retail space is commanding record rents, and assets within the top tier are not in distress. Along with rising rents, a record number of properties traded hands. CoStar Analytics reports that more than $105 billion of retail assets were bought and sold across the nation in 2021. Activity was 65% higher on a year-over-year basis. Today, Larson sees the biggest challenge facing retailers who want to grow is the lack of affordable space.
“In Denver, Colorado, where I am based, you'd be hard pressed to find a decent 20,000-square foot box that's available. And a 40,000-square-foot space can’t be divided and make good fiscal sense anymore. The expense incurred to install an additional loading dock, and rework utilities and so on, is prohibitive,” Larson explains. “So, I see this as an ongoing challenge to retailers over the next five years, or so.”
Small But Mighty
On the other end of the spectrum, there is hot demand for smaller retail spaces, particularly in the urban core and in other densely populated areas. Traditional large retailers and nascent digital brands are looking for smaller footprints to re-invigorate the shopping experience or move their online brand into the real world. Downtown store fronts are popular choices, offering street level visibility, pedestrian engagement and easy access.
Smaller concepts may also play a key role in enticing pandemic-weary customer back into what they perceive to be a safe and controlled environment. Last year, IKEA opened its first urban store in the hip Tokyo, Harajuku neighborhood. The 27,000-square-foot store sells curated merchandise for small spaces and urban living, offering novel interior design ideas to customers. The new concept store is far smaller than a standard IKEA 300,000-square-foot expanse and may pave the way for future expansion to other urban centers.
Online retailers Warby Parker, Allbirds, Everlane, Casper, Bonobos and Million Dollar Shave Club have expanded to bricks-and-mortar in the last few years, enjoying great success. The flow of pixels to places and spaces is expected to continue. Research suggests that by 2025, a physical location will fulfill 30.5% of all digital transactions. Larson confirms that most digital brands lease within the 1,200-square-foot to 5,000-square-foot range, with the majority of new retail space consisting of freestanding single-tenant properties.
Technology Lends A Hand
As larger retailers look to strike a balance and right-size their oversized footprints, many are relocating to smaller retail spaces to downsize their stores. Merchants are devising more engaging ways to leverage technology to extend beyond their four walls and bolster sales. Larson explains, “Retailers are trying to figure out how to generate the same sales volume from a smaller footprint. Technology is often a way to accomplish this, which is where omnichannel retailing comes into play. The integration of online sales makes perfect sense to reach sales goals without having to carry the expense and overhead of a large physical retail space.”
The pivot to online and hybrid continues with many of the largest public grocery chains investing heavily in their online infrastructure. Other retailers have partnered with popular social media apps to create a frictionless and interactive retail experience. WhatsApp has joined with several major retailers as part of an ecommerce strategy called, Shops in WhatsApp, rolled out at the end of 2021. The Meta-owned platform will introduce new technologies like Instagram visual search and AR Dynamic Ads to create an engaging intelligence-driven experience. China’s App-Powered stores are linked with WeChat to blend livestreaming and instore shopping. Viewers on the app can comment and interact with each other during retail events, bringing the shopping experience out of the physical box and onto the screen. Increasingly AR and VR is being used to virtually “try on” apparel or project a piece of furniture into your living room.
Today’s retail sector is rebounding from the disruption experienced during the pandemic and new concepts and models are earning a place on consumers shopping lists. The blending of retail, e-commerce and technology is creating a world in which omnichannel and experiential retail concepts are working hand-in-hand to deliver products and services consumers want – and that’s music to any retailers ears.
Pre-COVID, ask any investor what kind of retail they were looking for and the answer would be experiential retail with elevated service offerings. Operators were undergoing aggressive leasing campaigns to attract direct to consumer tenants into bricks and mortar spaces and the key conversations were around activating spaces in order to maintain foot traffic throughout the day and night. Class A mall operators completed these renovations and activation programs and were positioned to lead the way into the new wave of retail. Since March of 2020, what we consider to be the best retail investment has changed dramatically, and it has left owners and investors in a conundrum that has come to a head in the past weeks.
What’s Happened?
A catalyst can be found underlying a mega-deal involving one of the largest Class A mall owners in the United States. Unibail-Rodamco-Westfield (URW) announced in their Investor Day presentation on March 30th that they would be disposing of their U.S. assets by the end of 2023. It appears that the primary motive here, beyond switching to pure-play European, is deleveraging their overall portfolio; exiting the U.S. market will bring LTV to below 40%, assuming the portfolio can be disposed of at a 30% discount on 2021 valuations. Last month, URW Westfield sold the former Promenade mall in Woodland Hills for $150 million, a 60% premium on its appraisal, and CEO Jean-Marie Tritant, cited that example and the overall quality of the U.S. portfolio as factors in their confidence of getting good returns, good being a relative term. X Team Retail Advisors’ Jim Bieri, of Detroit based affiliate Stokas Bieri, is skeptical of URW’s statement and timeline, citing a similar statement that was retracted last year.
Long Term Challenges & Shifting Mall Trends
Prior to the sale to Unibail-Rodamco, Westfield was owned by the Lowy family, an Australian developer with pension fund capital. The family sold to Unibail-Rodamco at a good value prior to the pandemic, but there were long term challenges brewing before COVID graced our lips. Bieri noted that super regional centers were redeveloped and made too large, an example of that being Garden State Plaza in New Jersey, which added a second level and two further additions that created more retail losers than winners. Neiman Marcus was added, and capital was expended in an ill-fated attempt to attract luxury retailers. Another example is Annapolis Mall, which was expanded to five anchors and too much GLA. The market could not support the space, and today the center has two anchors and significant vacancy. Similar stories occurred at Topanga, Roseville, San Diego’s UTC, and Santa Clara’s Valley Fair, with the biggest challenges occurring at the World Trade Center. Hindsight is of course 20/20, but upon reflection, the expectation for re-tenanting and growth through redevelopment was miscalculated. COVID acted as an accelerant for all things related to retail and commercial real estate as a whole, shifting how people work, where and how they spend their time and impacted the “third place,” something that URW was banking on as they planned the expansion and asset growth.
Newport Beach based X Team board member Rick Chichester sees the macro-retail impact on URW’s decision. Chichester says, “Customer demand has changed significantly and as such malls need to reposition themselves to align with these changing expectations and demands. For the best located malls, this repositioning entails redesigning spaces into more of a mixed used (Live, Work, Play) densified development, and in most cases includes reducing the existing “retail” footprint. Redevelopment is expensive and time consuming, and as such, many owners and investors are looking to balance their risk adjusted costs and returns, as well as capital allocations in an effort to strategically determine which assets they will invest in, and which they will dispose of.” Ultimately URW has already engaged in the redevelopment of assets and hasn’t been able to see the returns expected. Bieri further points out URW’s strategy during the pandemic, as centers were closed and URW was initially aggressive to chase rent payments, served to alienate key relationships at a time when flexibility and mutual understanding was key.
URW’s Disposal and The Bigger Challenge
Unibail acquired Westfield in 2018 and took on considerable debt in order to make the acquisition and began selling off properties. URW allowed lenders to take back five underperforming malls in the United States last year. Tritant took the helm as CEO in January 2021 and made it clear “Our investment should be in Europe.” Chichester sees some strategic merit to the disposition strategy. He says, “The U.S. market hosts the largest retail footprint per capita, thus the associated property repositioning costs probably do not provide Unibail with the returns they can achieve in markets outside of the U.S. Finally, the market demand for good real estate is compelling and, as such, this could be an opportune time for URW to monetize its U.S. portfolio.” The upcoming disposition of the U.S. assets, and the proclamation made, however, may provide potential buyers with an opportunity to capitalize on even lower prices.
X Team’s Tim Miller of Chicago-based affiliate Great Street Realty sees the long-term challenges of sustainable rents in Class A malls. Citing URW’s Old Orchard Mall in Chicago’s North Shore, “tenants are paying double the price per square foot to be in 4,000 square feet in the mall. They can pay up to half that rate to be in the best outlot of the best power center across the street. It doesn’t add up. Mall rents need to come down, and the value of the malls needs to be reset.”
URW isn’t the only owner seeing a massive reset in their Class A mall portfolio. Brookfield announced April 5th that Chicago mall Water Tower Place was being handed back to the lender. Brookfield Properties spokesperson Lindsay Kahn said Water Tower Place “will no longer be part of Brookfield’s portfolio.”
“After many discussions to carefully assess and identify all available options to move forward, we’ve determined that it is best to focus Brookfield’s resources on other opportunities within our portfolio,” Kahn said. Ownership will be transferred to lender MetLife Investment Management, a unit of MetLife Inc.
Establishment owners like URW and Brookfield disposing of U.S. based assets is not emblematic of larger retail challenges as quick service retail, grocery anchored centers and community retail thrive. It does however signal a massive reset in the Class A mall space as owners have to adjust to new strategies, rents, values, and approaches in a post-COVID existence. Bieri sees positivity in the market for those who are willing to be patient. “Mall traffic is generally back to 2019 levels. Department stores remain a key component to any mall retaining fashion and luxury stores. Simon and Brookfield have adjusted their portfolios by focusing capital and resources on their best properties. They also propped up their malls by purchasing J.C. Penney and several other retailers. Rising construction cost and supply chain issues make new construction difficult. Key centers will continue to attract new concepts. Failing centers will become mixed use and or be torn down for warehousing, medical, civic, or educational uses.” Once again, we will see a reset of the best use in Class A mall space for years to come, black swan interruptions aside.
The grocery industry, one of the most competitive and market reactive in the retail sector, faces a critical moment. Pandemic shopping habits changed dramatically by force, and operators had to pivot and adapt quickly as customers curtailed trips to the grocery store in favor of online shopping and delivery.
Revenues rose as much as 35% from the previous year as home-cooked meals, stress baking and panic buying ensued during 2020. The coronavirus elevated fiscal sales by $4.6 billion. As events unfolded, e-commerce platforms, store operations and supply chain logistics were figured out in real-time. Profit margins in the grocery industry have always been thin because of intense competition, and operators often sought promotions to entice customers into their stores. Industry analysts are wondering if consumer habits, developed out of necessity, will carry forward as we move past the pandemic era. Will we stay glued to our phone apps and Instacart? Or will the visceral experience, and possibility to pick our own fruits and veggies, entice us back into the grocery aisle?
Doug Munson is the founding Principal at MTN Retail Advisors, a national primary grocery retail research and data collection firm that works with major grocers to help retailers, developers and investors determine the best locations for grocery stores.
Munson says, “I do see a demarcation between publicly-traded and privately-owned grocery companies and their business focus. The large publicly-traded grocers are investing heavily in e-commerce and online fulfilment to support that segment, which averages 8-10% of total store sales. To that point, the physical store is not going away. There are approximately 8,000 exclusively-online retailers looking to establish brick and mortar locations.”
High land and construction costs and a heavy-handed entitlement process is slowing down development. Darren Pitts, Executive Vice President of Velocity Retail Group in Phoenix, Arizona foresees an environment that favors a large amount of built-to-suit and small development, along with value-add opportunities that redevelop existing shopping centers.
Moving toward a period of normalcy, leading chains will need to reinvent themselves in order to preserve and sustain additional sales they achieved from the pandemic. Other headwinds include the inflationary environment, supply chain hiccups and a constricted labor market exacerbated by the “Great Resignation.” Munson sees the latter as a pain point that is not going away any time soon.
“Grocery is essential to the economy, as we quickly realized during the pandemic. While supply chain disruptions have eased somewhat as we move away from the crisis, we still face considerable challenges in hiring. The labor market is very tight, and grocers are having a tough time finding employees. I feel this will continue to be an issue for retailers for some time to come.”
Emerging Trends and Technology
Store-within-a-store concepts will continue to emerge as large grocers strike deals with retailers in alternative categories to create new segments of merchandise under their roof. Consumer brands in popular categories such as clothes and household goods will create interest, differentiation, and expand margins.
Kansas City-based Ball’s Food Store has introduced a CBD store-within-a-store in its Price Chopper supermarket through a partnership with American Shaman, a provider of high quality CBD tinctures and beverages. The store environment features botanical prints, a small seating area to test products and consult with brand representatives, and wood-toned finishes to reflect the brand’s focus on natural ingredients.
Darren Wood, Principal of The Providence Group of Charlotte, North Carolina, spoke at the recent X Team annual meeting about the integration of grocery store technology, both in and out of the store. Wood is a U.S. tenant representative for Aldi Foods, the German family-owned discount supermarket chain with 200 stores in 15 states domestically. They are currently testing frictionless checkout technology in Utrecht, the Netherlands as a pilot to implement on a wider basis. That parent division, Aldi Nord operates 500 stores throughout the country. The technology was developed by Trigio, an Israel-based computer vision startup.
Wood cites Nourish + Bloom, as an independent grocery retail innovator, based in the States. The organic market and bistro integrate cutting-edge technology and maintains a fleet of friendly mobile robots for grocery delivery. The company’s first store is located in Fayetteville, Georgia, an underserved community 22 miles south of Atlanta.
The 1,500-square-foot store is the brainchild of married entrepreneurs Jamie and Jilea Hemmings whose autistic son and his food-related issues, sent them on a mission to provide fresh, healthy food for the black community—often lacking in poorer neighborhoods. They plan to expand their concept further into Georgia and Florida. Partnering with Microsoft, who helps offset the cost of technology investment, the store promotes itself as the first African American-owned autonomous grocery store, with robotic delivery in the world. The shopping journey is frictionless and minimizes contact. Shoppers download the store app, input their payment information, and scan a QR code to enter through an automated gate.
“Smart shelves” subtract the weight of each item picked and records its purchase in a digital cart. Thirty ceiling cameras track shopper’s physical movement throughout the sales floor. One caution—if the customer fails to return any rejected item to its original shelf, it stays charged to their account as a purchase.
Store guides are on hand to help customers, and a quick phone scan checks them out. The app tabulates the order and pays electronically. The receipt is emailed. There are no lines to wait on, just a seamless experience which ends with an exit through an automated gate.
Amazon Fresh, who currently has 19 stores across six states and Washington, D.C., according to their website, was one of the first small-format grocers to introduce this technology to consumers. The grocery chain’s deep-pocketed parent absorbed the considerable R & D technology costs as a loss leader. Wood notes, “It will be interesting to see how many companies can buy this technology in the future.”
Advances in the fulfilment center are improving efficiencies, managing inventory, costs and reducing waste and energy-use. The need for large warehouses and smaller, localized-sites to create micro-fulfillment centers, has transformed the industrial sector into the reddest hot and most active in commercial real estate. Ocado Group, a U.K-based online grocer, builds automated customer fulfilment centers (CFCs) using sophisticated AI-powered, demand-forecasting engines, high-speed picking bots and a 3D grid of crates packed with items. The company has partnered with Kroger, the largest U.S. grocery chain, to build several automated giant CFCs to meet the demand for online grocery. Ocado’s solution, the Ocado Smart Platform (OSP), offers grocers an end-to-end e-commerce, fulfilment and logistics platform.
Kroger’s e-Commerce online delivery earnings outperformed during the pandemic. The company will dedicate significant resources to accelerate e-Commerce under its strategic growth plan. Currently Kroger operates 45 warehouses. They have partnered with Ocado to build 20 super warehouses. The first of these debuted mid-April 2021 in Monroe, Ohio. The $55 million, 375,000-square-foot facility contains over 1,000 robots alongside 400 human employees to pick, sort and move items controlled by a proprietary air-traffic control system to fulfil customer’s orders. Algorithms regulate the pick-and-sort process and robots pack groceries intelligently, balancing bag weight to reduce plastic use and waste. The center is forecast to process as much as $700 million in sales annually, equivalent to 20 brick-and-mortar stores.
Omnichannel Retail Strategies
Omnichannel retailing enables consumers to interact with brands through both online and offline channels, enjoying a unified experience. Grocers are incorporating this strategy to allow shoppers to order online and pick up at the store, providing choice and flexibility. Shopping habits may be permanently changed, considering the popularity of OGP (Online Grocery Pickup) and BOPIS (Buy Online Pickup In Store). During the pandemic almost half of the top 500 retailers with brick-and-mortar operations were offering BOPIS, a rise from less than 7% pre-pandemic, according to a Digital Commerce 360 survey taken August 2020. Amazon at Whole Foods, Walmart and Kroger offers a BOPIS option to customers.
Pandemic-driven services like curbside pickup and same-day delivery are expensive for retailers to operate and eat into profitability. The BOPIS model helps offset delivery expenses and benefits grocers as it gets consumers into the store—reducing online cart abandonment and capturing brand loyalty.
Major markets have begun to roll out omnichannel grocery store prototypes that function as both a physical store and online fulfilment center. Workers quickly pick items with hand-held inventory guns identified by wayfaring signage. Inventory is restocked speedily by moving merchandise from the back-end fulfilment area to the sales floor, allowing consumers to get their essentials faster.
Community Partnerships
Grocers are partnering with nonprofit and government entities to meet the needs of “food deserts.” A food desert, or healthy food priority area, has limited access to affordable and nutritious food. The USDA’s Economic Research Service previously identified more than 6,500 food census tracts in the United States that equates to approximately 13.5 million people with low access to sources of healthful food. In early 2021, H. R. 1313 (Healthy Food Access for All Americans Act) was introduced to stimulate investment and healthy nutrition options in these communities.
However, the most viable and agile solutions seem to be emerging from grass-roots organizers, civic leaders and business partnerships. For example, when Buy For Less, suddenly shut its doors in northeast Oklahoma City in 2019, its primarily black community lost its only full grocery option. Working closely with community nonprofit, RestoreOKC, Homeland Stores was able to open a 6,800-square-foot grocery store in April 2021. It is about one-third of the size of an average store, and will sell a seasonal supply of fruits and vegetables grown at the nearby RestoreOKC urban farm by local middle and high school student interns. Corporate suppliers with food assistance programs can sell grocery items with deep discounts to the store. This particular Homeland Store will provide an invaluable resource to the community, and include nutrition, cooking and shopping classes.
Consumers and competition will continue to modify the grocery industry environment, as we move into what’s next. Technology will continue to play a major role in shaping every aspect of the industry, however the demise of physical stores is largely overblown. The U.S. Department of Commerce census bureau news reports that while 2021 e-commerce sales did increase 14.2 percent year-over-year, it still accounts for 13.2 percent of total retail sales. There is a sense that consumers like the convenience of their phone apps, but also are beginning to welcome the communal experience of shopping after a long and isolating pandemic. Chains and independents will have to willingly embrace innovation, as different choices, challenges and opportunities present themselves.