Current Recession Creates More Challenges for Retail
During the previous economic expansion, retail faced an uphill battle. The current recession tripled down on that struggle. The current pessimistic view among panelists in the latest Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey is that retail properties will be generating significantly lower, if any, returns in 2023 compared to the end of 2020. Overall, the level of new retail property construction is expected to significantly decline from 2020 through 2023; and some existing space, lacking sufficient demand, will be converted to other uses.
Retail market industry leaders, El Warner of Colliers and Jonathan Lorenzen of Allen Matkins, discuss what lies ahead for this sector of the California commercial real estate market.
1. EVEN PRIOR TO COVID-19, BRICK-AND-MORTAR RETAIL FACED AN UPHILL BATTLE AGAINST ONLINE SHOPPING. WHILE MANY RETAIL DEVELOPERS HAVE ALREADY TAKEN STEPS TO ATTRACT MORE BUSINESS, WHAT NEEDS TO CHANGE MOVING FORWARD TO NOT ONLY STAY AFLOAT, BUT TURN A POSITIVE CORNER IN 2021 AND BEYOND?
Warner: I believe it is really important to correct this misconception and update the narrative surrounding retail. While online sales have increased, brick-and-mortar retail isn’t in an “uphill battle against online shopping.” In reality, online sales have helped to drive brick-and-mortar revenue by increasing product awareness and becoming a distribution center for online orders.
Prior to the pandemic, retail cap rates had seen a steady decrease year over year, and while transaction velocity was down 62 percent post-COVID-19, cap rates have remained stable. Entertainment centers were performing very well pre-COVID-19 and while cinemas, fine dining, and gyms have been the hardest hit by the pandemic, there is full belief that the pent-up demand over the last 10–12 months will quickly restabilize these tenants by year end 2021. Whereas neighborhood centers, including grocery stores, pharmacies, hardware, sporting goods, and discount stores, etc. have been thriving and are expected to continue to do so.
Some of the development trends that have transpired from COVID-19, including larger outdoor spaces, outdoor dining, drive-throughs, pick-up windows, etc., will remain for the foreseeable future and the owners who have the flexibility to adapt to their tenants' needs will fare well.
From an investment sales perspective, retail is not overpriced like many other asset classes and as owners and investors get off the sidelines, we’re expecting continued growth and success in the retail space.
Lorenzen: Retail developers will need to implement strategies to draw shoppers out of their homes and away from their phones, by focusing on the physical retail experiences that cannot be replicated in a virtual environment. This move toward online shopping is a trend we certainly saw prior to COVID-19. In response, developers have been implementing very effective strategies to attract shoppers, by focusing on so-called "experiential" retail. For example, many developers have had great success at centers with ample dining options, boutique fitness uses, and outdoor gathering spaces for community interaction. The pandemic has increased our sensitivity to social interaction, but I'm confident that this is only a temporary sensitivity, and that people will return to shared spaces and experiences as soon as it feels safe to do so. People yearn for these experiences and have increasingly missed them as the pandemic has continued, so the most successful developers should be the ones who are able to cater to these needs. In response to the retail naysayers, people have become more accustomed to online retail options during COVID-19, but I see this as a matter of necessity, and not as a permanent exclusion to retail development. We all share an innate desire to gather with each other and share experiences, which has been brought into much sharper focus as a result of the pandemic. Retail developers who position themselves best to serve this need should be the most successful in coming years.
2. MULTI-FAMILY DEVELOPMENT AND HOMEBUILDING HAVE REMAINED RELATIVELY STRONG EVEN DURING THE PANDEMIC. WHY AND HOW WILL THE HOUSING SECTOR HAVE ANY IMPACT ON RETAIL’S SURVIVAL?
Warner: Multi-family housing has always been and will continue to be a viable partner for retail but “retail’s survival” is not dependent on multi-family development, especially as the housing sector becomes oversaturated. The biggest impact I see is the transition of some older retail sites into mixed-use projects to lean into the trend of live/work/play and people’s travel spheres becoming smaller.
Retailers’ footprints have decreased in recent years and since retail is considered a “low-density” development, it offers developers the opportunity to build mixed-use sites in which retail will be a main component of its success. While the retail industry may have been overbuilt, there is plenty of opportunity to combine the asset classes moving forward
Lorenzen: Changes to where people want to reside may translate to changed locations for the most successful retail centers. People have sought larger living spaces and more room as a result of the pandemic. This has caused residential demand to shift from densely populated urban centers to suburban areas and developments on the periphery of our established cities. As a result, retail developments that are located near these areas of increased demand may be the most successful in the near future. This demand for services will include experiential retail options such as dining and fitness, but also core necessities such as grocery stores, home improvement, and discount shopping. One caveat, however, is that we need to consider the overall number of people in a given area. If urban centers permanently lose residents to other urban centers or entirely different states without replacing those residents, then we may see little real growth in those centers, but instead only a shifting of demand.
3. HOW MUCH OF AN IMPACT WILL THE MOST RECENT STIMULUS PACKAGE HELP RETAIL, BOTH THROUGH CONSUMER SPENDING AND ANOTHER ROUND OF SMALL BUSINESS LOANS?
Warner: The new stimulus bill will certainly continue to help. While retail tenants have resumed paying rent or catching up on back rent, the majority of small businesses have seen a drop of more than 25 percent in revenue in 2020. Business loans will continue to help keep small, family-owned retailers in place and should create a small spike in sales, assuming the retailers can remain open in the near-term. Whether it will be enough to help stores from closing, time will tell. Certainly, the speed to getting the vaccines administered and businesses re-opening will all play a factor.
Lorenzen: The next round of stimulus checks and small business loans should provide a much needed boost to retail spending. Retail sales were somewhat disappointing during the 2020 holiday season, declining by approximately 0.7 percent in December 2020 when compared to retail sales in November 2020, as reported by the Wall Street Journal. This is a highly unusual drop and certainly dismal, especially when considering that November 2020 was also a particularly weak month for retail sales. However, this is not at all surprising when considering the COVID-19 surge that we saw at the end of 2020, and the corresponding increase in restrictions that discouraged retail activity. The stimulus should help encourage shoppers to increase their retail spending, particularly if shoppers delayed purchasing discretionary items in 2020. With additional funds in hand, people should be more likely to make these purchases in the near-term.
El Warner is Executive Vice President of Capital Markets, Retail for Colliers International. El specializes in the disposition of large institutional assets across the country, and has background as a Certified General Real Estate Appraiser and deep-seated knowledge of the industry.