Commercial real estate is in an awkward place right now. Between store closings, bankruptcies, and a new president the market is not what it used to be — especially in the retail industry. In the article below Mark Dufton, a real estate exec, gives his take on retail real estate and the market right now.
Q&A: Gordon Brothers Real Estate Executive Weighs in on Challenging Retail Real Estate LandscapeMark Dufton Leads Specialized Restructuring Firm Involved in a Hefty Amount of Resizing, Repurposing, Renegotiating and Relocating RetailersMay 4, 2017
With retailers and shopping center owners heading to Las Vegas later this month for RECon, the worlds largest retail real estate convention, we asked Mark Dufton, CEO of the Real Estate practice of Gordon Brothers, for his take on the evolving retail real estate market.
Gordon Brothers is among the handful of retail restructuring specialists capturing the lion’s share of restructuring work involving store closings and dispositions. Dufton has more than 25 years of real estate and management experience. He is also a managing director for Dinosaur Capital Partners, a Boston-based real estate investment and development company, as well as a member of the International Council of Shopping Centers and the Turnaround Management Association.
Q: Weve seen at least nine major retailer bankruptcy filings this year alone. How much restructuring may be going on below the surface at other retailers that the market is not seeing?
Actually, it’s not as prevalent as people think. It has become very difficult to conduct out-of-court restructuring. It used to be much more commonplace, but now the vast majority of retail restructurings are done through bankruptcy. Its essentially become the accepted standard practice, and banks dont seem to mind.
Q: While a lot of news on struggling retailers has been focused on major anchor tenants, inline retailers face the same challenges as anchors, but they are also dealing with the decreased foot traffic those anchors are expected to bring in. What adjustments are they making in their real estate decisions?
The impact on inline retailers can be viewed through two angles: new store openings and lease renewals.
The number of new store openings has slowed dramatically. And when new stores are opened, they are being scrutinized in a way we havent seen before.
Thats largely because lease deals take twice as long as they used to. It used to take six months to close a deal on a new store, now its a year-long process.
Another reason why these deals are taking longer is the added importance being put on the decision. New store decisions used to be made by an internal real estate committee, but new store decisions may now go all the way up to the board for input.
This level of thought and scrutiny for new stores is a good thing for the industry, its important to have greater discipline when adding new locations.
As for lease renewals, we’re seeing a much greater focus on the timing of lease renewals, and determining if that lease is at market value. Retailers now want to know what other factors are associated with the lease and whether they should renew or close. They are paying much more attention to this decision than in the past.
Previously, if a stores sales were mediocre and the renewal came with a nominal rent increase, most retailers would renew. Now, retailers are looking at every detail. For marginal stores they’ll go out and look at the market and try to restructure the lease to make it more profitable. There is more attention to overall occupancy expense than ever before.
Also in the current retail environment, lease renewals are no longer a secondary consideration. It is now the biggest expense for retailers after their people.
Q: When it comes to store closings and lease cancellations, retailers are increasingly choosing between Class A properties and Class B and C properties. How is this showing up in efforts to find new tenants for vacated space? And how is it showing up in the renegotiation of leases?
There is a clear bifurcation between Class A retail properties and Class B and C. Owners of Class A properties actually like having vacated spaces. They have leverage because everyone wants to model Class A traffic. This also means owners at those centers have the power when renegotiating rents.
However, malls no longer publish traffic numbers, which in itself is telling. Owners of B and C centers have little leverage with retailers for vacated spaces and are willing to renegotiate rents. We expect to see Class A properties continue to do well and Class B and C struggle. The divide between A and B and C will simply become greater.
You will see more and more vacancies and lower rents at these properties as retailers are desperate to restructure. There may be many unknowns, but retailers and landlords will choose to repurpose and restructure to improve cash flow, which impacts debt restructure and has an overall cascading effect on the property.
The future for the bottom market B and C retail space is going to look like repurposed quasi-retail, we’re talking schools, churches, call centers, gyms and medical clinics.
All this is part of the big shift going on in retailing – instead of the 1,200 malls we see in the U.S. today, I expect that number to shrink to 800 or 900.
Q: Beyond closing under-performing stores, retailers are trying to become more efficient in their current space allocation and occupancy dollars, as well as selecting new locations. Not counting closures, where is this additional shrinkage coming from and how much are you seeing?
One area where we are seeing retailers conserve capital is in lease mitigation. Instead of spending capital on a lease buyout, more retailers are deciding to ride out the remainder of the lease and then close and maybe relocate.
For many retailers, downsizing is an easier-said-than-done proposition. Some big box retailers dont lend well to splitting up. With challenging configurations, the cost to split and utilities, they may not get the return on investment (from downsizing) without certain rent levels.
Downsizing is much more challenging to execute. More likely it is easier to relocate and downsize when the lease comes up for renewal.
Q: We tend to associate retail troubles with real estate and blame downsizing on an ‘oversaturation’ of retail space. But how much of the trouble in the retail industry is associated with real estate? What other forces are at work?
The way I view it is real estate is the cart and slowing sales is the horse. The oversaturation in the retail market was caused by lagging sales in stores. This only became a real estate problem when sales did not keep up with the market and leases became unprofitable.
The other forces at work that are affecting retailer sales, and eventually retail real estate, include: income stagnation, which continues to put a damper on the mass consumer; the growth of online retail and increasing preference for the channel over bricks and mortar, and the preference among millennial consumers to spend on experiences instead of retail goods.
As I mentioned, those factors have led to lower sales, which in turn has resulted in the sheer size of the retail footprint being too large and the store count too great.
Shoppers’ needs and wants have evolved, and retailers have struggled to keep pace with the trends of younger generations. Also, not all retailers have done a good job integrating their online presence with their brick and mortar operations. We see some retailers who do this exceptionally well and others who have not kept pace.
Q: Even as Class A properties seem to be thriving, there has also been a rise in the number of discount retailers and outlet stores. These arent the type of tenants associated with Class A space. How are they doing in the current environment?
Yes, value shopping has become prevalent at every level of the market, including luxury. We see Nordstrom Rack, Saks Off Fifth and Last Call by Neiman Marcus exceeding margins and (sales) levels never anticipated.
However, even though value retailers like TJX concepts have held up reasonably well, outlets and Class A properties are not performing as they once were. The former darling of the retail industry, outlet stores and Class A are now reporting downturns in their traffic, which makes it more difficult to terminate their leases.
Historically, outlets and high streets like Fifth Avenue in New York and Newbury Street in Boston were minimally affected by industry shifts. But now were seeing more softness among outlets and high streets. In both categories there are more vacancies than we have seen in years.