There is a lot of speculation about what will come next in commercial real estate and especially in the retail industry. Talking to two of Keyser's experts, Brian Uretzky, Keyser’s Capital Markets Specialist, and Carol Schillne, Keyser’s Retail and Franchise Practice Group Leader, we uncover their thoughts as to what they expect to happen in the retail industry in the upcoming months and how tenants should prepare as they enter into this season of uncertainty. Check out the video or read the transcription below!
What are your expectations for commercial real estate—and more specifically for the retail industry in 2021?
Carol Schillne, Keyser's Retail and Franchise Practice Group Leader
In 2019, we had to refute the claims of the retail apocalypse. The expansion of chains like TJX companies and ALDI really helped to debunk that theory. So COVID unleashed an exponential acceleration of transformation already in progress in the world of retail. We saw the demise of the department store, mall vulnerability, growth of e-commerce, and adaptive reuse, given the U.S. Is already oversupplied in retail stock per capita. So looking into the future, the footprints of most retail locations will shrink. Retailers are going to become more efficient with their space. We see this with the emergence of ghost kitchens to serve restaurants and the shrinking footprints like Best Buy's new 15,000-square-foot stores and urban Target locations. In addition, we'll see the expansion of internet-based concepts into brick-and-mortar locations. Stores like Amazon Go and digitally native brands like Warby Parker, Indochino, and Allbirds for retailers competing on price is no longer a winning strategy.
Competing on products is also challenging because the new innovative product and services can easily be copied. So that leaves customer service as the best playing field; companies that embraced that with creativity and customer service will be the winners in the future. We're also going to see some additions of other uses like medical education, coworking, and residential to fill the vacant space in retail centers. I think that will be the biggest impact.
Brian Uretzky, Keyser's Capital Markets Specialist
I think those are some great points. I think you know, from my perspective, I'm much more negative on the retail sector. I'm really negative based upon four main factors, one, the weaker economy. Two, the growth of e-commerce. Three, ongoing social distancing measures. Four, rising vacancy rates.
If I were to unpack each one of those, just starting off with the weaker economy, we've lost 10 million jobs since the start of COVID, that's a significant number. Additionally, the labor force participation rate has fallen back down to 1970s levels, so a lot of people have left the workforce completely. Spending has been propped up by stimulus and stimulus has certainly helped, but we're still below trend on the spending side of things. And until we see improvements in the job sector and improvements in spending without the help of stimulus, I'm just going to be more negative on the economy.
Additionally, when you think about e-commerce, it's grown as a percentage of retail sales from 12% to 14.3% since the start of COVID. That's an extreme jump. It may not seem like a lot, but it's really pulled forward a lot of online shopping that was expected to happen over the next couple of years. That's had a really negative impact on the brick-and-mortar sector. Third, when you think about social distancing, from my perspective, it's not just about the economy reopening it's the economy reopening at full capacity. Even after much of the country gets vaccinated, it seems to me as though we're still going to be in a social distancing environment. What that means is that most businesses are not going to be able to maximize revenue like they were able to prior to COVID. When you look at some of the data out there, the numbers are pretty startling.
You hear about hundreds of thousands of businesses that have permanently closed since the start of COVID. If you look at chain store data permanent closures, which hit 12,000 in 2020, (that's 30% higher than the previous record). Those are stores like JC Penney, Macy's, and Gap. Finally, I like to take a look at the CMBS market and look at some of the loan data. If you look at that platform of lending call it 12, 12,000 properties almost 12% of loans in that sector are in some stage of delinquency. So there's just a lot of problems throughout the business community, in the brick-and-mortar community. That's all led to rising vacancy rates. I have vacancy rates around up 13% since the start of COVID and given the high negative correlation between vacancy rates and rents, I just expect rents to fall over the coming months and years.
Now, if you look at rents right now, they've taken a dip in a lot of cities across the country, but they haven't fallen, fallen significantly. Now, what people need to understand is that commercial real estate tends to operate with a lag. If you go back to the global financial crisis, as an example, back in 2009 we didn't hit the end of the recession till Q2 2009. But when you think about what happened with rents across commercial real estate, we didn't hit a trough till 2011 and didn't start coming out of that trough till 2012. So for those that say, we haven't seen rents fall much, I would say that history shows that we're going to see rents fall. We're going to see rents fall over the coming months and years. And I do think it's important to be patient in this environment.
What are some of the things tenants should be considered as they take into account today's environment? In other words, how can they be proactive in protecting themselves?
Carol Schillne, Keyser's Retail and Franchise Practice Group Leader
So to be proactive, retailers need to be omnichannel-focused. The customer is demanding experience and relationship with their brands. They need to reach their customers across multiple platforms. They need to have a web presence, whether that's through their own website, Facebook or Instagram, also tenants need to be using robust analytics and AI capabilities to determine the best markets for their expansion, and when evaluating specific new locations. That's going to avoid costly mistakes and time delays. Tenants need to be utilizing representation and preferably representation by a tenant rep advisor — so there aren't any conflicts of interest. A tenant rep should be armed with information to qualify the landlord. For example, are they current on their loan? Are they conscientious about property management and keeping the CAM charges in line? Do they embrace social media marketing on behalf of the shopping center, COVID has also spurred lease provisions like protections from government mandate shutdowns and operational demands like areas for buying online and pickup in-store. And of course the extension of outdoor dining spaces.
Leasing activity is robust here in Arizona, but it obviously varies from market to market depending on how open an area is brands are opportunistically looking to capitalize on potential rent compressions and second-generation spaces in particular restaurants and drive-throughs are hot commodities. Retail is alive and well. Franchising is going to be a huge avenue for growth. Retail is a sector that rewards creativity, entrepreneurism and innovation, and perseverance. I 1:00 AM excited to see how it develops
Brian Uretzky, Keyser's Capital Markets Specialist
Again. I think those are, those are very great points by Carol. I firmly agree with her when it comes to information and using all the tools at your disposal to market yourself and also build your business the right way. I also think it's really important just given the fact that there is a lot of uncertainty out there, and there is a lot of negativity out there, to make sure that you stay as informed as possible when you're entering a market. What are the demographic trends? Right? That's one question that I think every user of space needs to be thinking about. Additionally, what else is available? What are the commercial real estate trends in those areas? I think that staying informed is the number one thing that you can do as a tenant to make sure you're making sensible decisions.
Additionally, given the weakness that I'm seeing in commercial real estate, I also think it makes sense to be patient, you know, the economy can turn in multiple different directions here. And I think that we are, yes, we are recovering. And yes, there's a lot of stimuli out there, but there's also a lot of problems out there as well. A lot of businesses have been struggling and are barely holding on. So it's, it's hard to see the direction in terms of how extreme the recovery is or how extreme the downside potentially is. I do think that that range is the range of outcomes that you're, that we're all looking at right now. So I think it's important for tenants to be patient here, especially given the fact that commercial real estate operates with a lag because a lot of the weakness that we have yet to see in commercial real estate fundamentals historically takes time to play out. So instead of locking in a long-term commitment today, I think it makes more sense to sit there and really gather as much information as possible to really understand your market and then make your informed decision based upon all the factors you have at your disposal.
What are your thoughts? What are your expectations for your business in the upcoming months? Join the conversation on LinkedIn!
