Retail sales, a measure of purchases at stores, restaurants and online, climbed a seasonally adjusted 0.7% from June to July 2019, according to the Commerce Department. Despite this uptick, retail space continues to see volatility in 2019 in the form of sales weakness, store closings and bankruptcies—particularly in the department store and apparel space.

Market Trends

Store Closures

National retail chains have planned to shutter over 7,000 stores this year, and the number would be over 10,000 if considering all brick and mortar stores.

Factors contributing to the overall retail sales point to a robust labor market and low unemployment rate that’s given households enough confidence to spend at these levels, although the US trade fight with China continues to be a wild card in regards to potential price increases.

Redevelopment Prospects

New retail development at a national level should remain slow, but redevelopment prospects are anticipated to remain strong—with a large chunk of existing properties, particularly strip centers, being converted into mixed-use projects, such as multifamily units with offices or ground floor retail.

Investment Trends

On the investment side, retail real estate is generally out of favor due to the continuing uncertainty among investors. Most believe national capitalization rates will increase, even though, generally speaking, Class A properties should continue to remain stable or even outperform relative to Class B and Class C properties.

Background

Even though e-commerce sales continue to skyrocket, physical spaces remain important. In 2018, over 80% of retail took place in stores, according to the latest US census data. At the same time, many offline brick and mortar stores continue to downsize and reevaluate locations. This is especially true for big-box and mall spaces, which are too large for retailers’ current needs, although there are some markets in which big-box stores are repositioning successfully.

While the rise of e-commerce, as well as consumer interest in unique experiences, are partly to blame for the store-closing epidemic, the main driving factor is the country’s oversupply of retail space. There are an estimated 23.5 square feet of retail space per person in the United States, versus 2.5 square feet per person in Europe.

Amidst 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 relate to the changing dynamics and uncertainty in retail markets and growing technology trends. This trending may also be in response to new lease accounting standards, which could benefit certain lessees when operating leases require recognition of a right-of-use asset and lease liability on a company’s balance sheet upon the effective date of the new standards. A wave of shorter-term leases will likely have a negative effect on property values due to increased vacancy and leasing costs.

Innovative Uses of Space

The term medtail has emerged to describe the trend of mixing medical services and retail. Medical clinic leases at retail centers continue to increase with landlords looking to pull in shoppers and increase occupancy. Often times shopping centers offer providers convenient locations for outpatient care and preventative care centers.

Looking Forward

Retail Divergence

For many 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. On a more positive note, many stores with smaller footprints such as value-related chains, discounters, and health-related spaces continue to look to expand. Certain restaurants and unique grocery options are also anticipated to continue expansion.

Continuing Changes for Offline Retail

Offline retail culture 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. These new technologies and analyses will help retailers predict future customer purchases, enable fluid pricing—based on the day of the week or customer buying behavior, for example—and offer insights to help win customers and drive loyalty.

Next Steps

In the current environment, investors and operators can benefit from increasing due diligence efforts on the acquisition and leasing side, paying particular attention to retail sales history and business viability. Also, tenant quality has never been more important. Detailed tenant interviews are becoming increasingly valuable as are investigations into the identification and quality of lease guarantors.

We’re Here to Help

If you’d like to learn more about these trends and how they might affect your business, contact your Moss Adams professional.