The retail space saw substantial volatility in 2018—and this uncertainty has carried over to 2019.

In the second half of 2018, Moody’s Investors Service turned positive as retailers benefited from the strong economy. This was the first upgrade since July 2015.

Shortly after that, retail sales fell 1.2% from November to December 2018—the worst drop in nine years. This drop is even greater—at 1.8%—if the automobile and gas sector is excluded from the calculation. Factors contributing to the decline include the government shutdown as well as the continuing rise of e-commerce and overall weaker readings for consumer sentiment.

On the investment side, real estate is generally out of favor because there’s uncertainty among institutional investors. While some expect capitalization rates will increase, others think they’ll stay steady.

Factors Impacting Markets

Even though e-commerce sales are skyrocketing, physical spaces remain important with 85% of retail still taking place in stores. That means many offline brick and mortar stores aren’t disappearing, but they’re downsizing and reevaluating locations. This is especially true for big-box and mall spaces, which are too large for retailers’ current needs. 

Malls, Big-Box Stores Suffering

There are an estimated 1,200 malls in the United States today, and a quarter of them are at risk of closing by 2024, according to Credit Suisse. The commercial real estate research firm CoStar also estimates that nearly 20% of malls have a high risk of losing an anchor store.

Anchor store closures have several effects, including a decrease in customer traffic, low sales productivity, and an increase in building vacancies.

Big-box retailers have had their challenges as well, but for certain retailers in need of well-located space, the increased availability has enabled them to seek more strategic locations or those more preferable for space consolidation. While retailers are driving the absorption, some big-box assets are good candidates for redevelopment into other asset classes, such as multifamily and medical office—although there’s been an increasing trend in industrial conversion.

While e-commerce is partly to blame for the increased store closings, the main driving factor is the country’s oversupply of retail space. There are an estimated 26 square feet of retail space per person in the United States versus 2.5 square feet per person in Europe.

Innovative Uses of Space

Developers are now tasked with figuring out ways to convert high-vacancy and low-performing malls into spaces that will provide consumers with a better experience as well as fulfill community needs besides commerce. For example, some closed department stores are converting into medical clinics, churches, offices, public libraries, schools, and fitness centers. These services are also a strategy to attract traffic to smaller businesses. Carwashes are also an increasingly popular service-based use of space, as building owners look for retail uses that are relatively immune to e-commerce trends.

Amid these changes, lease structures are shifting away from typical five- to seven-year leases in favor of two- to three-year or pop-up leases. These shortening lease structures are not only related to the changing dynamics and uncertainty in retail markets and growing technology trends but also reflect a response to new lease accounting standards, which could benefit certain lessees. A wave of shorter-term leases will likely have an effect on property values due to increased vacancy and leasing costs.

Looking Forward

Here are some of the emerging trends on the horizon that investors should keep an eye on­­­­.

Convergence of Retail and Living Spaces

For all retail types, more bankruptcies and store closures are expected as companies try to realign physical footprints with e-commerce, striving to keep only stores that are in high demand markets and convert space to its highest and best use.

Developers have traditionally built retail spaces in areas where there’s a significant residential community—a phenomenon reflected by the common trend, “retail follows rooftops.” Now, developers are taking this trend further by building under the rooftops, converting apartment lobbies in high foot traffic areas into public retail space.

Changes for Offline Retail

Offline retail continues to experience a cultural shift. Although human connection and personalization for many retailers—and shoppers—is essential, many larger brands still need a strong identity for successful omnichannel execution. Artificial intelligence (AI), machine learning, and data science will continue to help bridge any gaps. AI will continue to allow retailers to predict future customer purchases as well as enable fluid pricing based on the day of the week, while data science can help retailers determine how they can win customers and drive loyalty.

We’re Here to Help

To learn more about these trends and how they might affect your business, or if you’re an investor, fund manager, or play a role in your firm’s financial reporting space, contact your Moss Adams professional.