Shopping Center Owners Brace for More Downsizing

RETAIL OUTLOOK: Shopping Center Owners Brace for More Downsizing as Space Rationalization Still in Early Stages

Retailers Could Shrink Brick-and-Mortar Space by 10% or 1 Billion SF

by Mark Heschmeyer, CoStar 

Even as holiday shoppers were hunting for bargains and exchanging gifts, news began leaking on the latest expected big store closures.

Sears Holding was quietly closing another 50 or so stores, and The Limited was closing several stores or letting inventory dwindle so much that store employees worried they were next in line to close. More store closings and downsizings no doubt are still to come in 2017. (Editor's note: at the time of this article being shared, The Limited has now completely closed all stores.)

Having recently analyzed the oversupply of retail stores and the growing market share of e-commerce sales, Costar’s Portfolio Strategy group is making a bold call going into the new year: Retailers need to rationalize nearly 1 billion square feet of U.S. store space in order to reverse the trend in declining sales per square foot. This could take the form of store closures, converting unused retail space to other uses, or rent roll downs.

“Simply put,” said Suzanne Mulvee, director of US research, retail for CoStar Portfolio Strategy, “it all comes down to productivity. Retailers on average are generating fewer sales per square foot than they did during the decade leading up to the recession.”

Mulvee said there are a variety of reasons for the lower sales productivity among retailers. But at the bottom line it means that fewer stores are economically viable–the sales generated by the stores don’t justify the costs of operation. Therefore, more retaiilers are closing locations or seeking rent relief, Mulvee notes.

Historically, retail sales were far higher on a per square foot basis at the beginning of the last decade. A basket of publicly traded retailers produced retail sales of more than $350/square foot, CoStar Portfolio Strategy analysts reported. Today, the same retailers are generating sales of less than $330/square foot.

The decline in average sales per square foot from 2000 to 2008 among retailers coincided with an aggressive expansion in store space. During that same timeframe, annual totals of new retail space averaged 160 million square feet per year. 

The recession finally put an end to the retail construction boom, and annual retail space completions bottomed out at 35 million square feet in 2011. New retail construction has only gradually crept up during the current recovery.

Last year, developers completed approximately 60 million square feet of new retail space, still 100 million square feet below the peak of the cycle.

However, the reduced construction levels may not be enough to address weaker store productivity, Mulvee said. The share of spending by consumers on online shopping continues to grow by about 15% annually. Therefore, pressure on retailers’ sales productivity in their stores may continue.

“To counter these pressures and return store productivity to a band more in line with historical averages, more than 10% of retail space, or nearly a billion square feet, needs to be rationalized,” Mulvee said. “We expect store closures to increase in 2017 and rent roll downs to remain commonplace for the bottom 50% of centers.”

While store rationalization will no doubt be painful for shopping center owners and will likely result in higher loan defaults, especially in the CMBS arena, Mulvee said it’s a necessary process to bring retail sales in balance with retailers’ operating costs.

 

Searching for a Silver Lining

While painful, the store rationalization process, will likely have different impacts on different shopping centers, with “higher-quality” centers continuing to attract top retailers, achieving rent growth and accelerating productivity. At the same time, the process should expedite the sale of underperforming centers to new investors capable of converting the properties to more profitable uses.

Retail REITs are expected to continue shedding more of their secondary and tertiary assets in 2017 while holding onto core grocery-anchored and urban retail properties, according to Cushman & Wakefield. Perhaps sensing an investment opportunity, C&W also reports there is still no shortage of investors with plenty of capital chasing retail real estate heading into 2017.

“We are still seeing a lot of interest in the retail sector, but investors are having trouble finding quality product in the market,” noted Brian Whitmer, retail practice lead of Cushman & Wakefield’s Metropolitan Area Capital Markets Group. “They have been increasingly more selective, targeting core markets, urban street retail and grocery-anchored shopping centers with strong credit.”

In a bit of a disconnect, most of the product coming online is located in secondary or tertiary assets, or non-core locations. Still there are investors going after that product at slightly higher cap rates.

Meanwhile, retailers are likely to target store growth rates in the mid-single-digit range, providing support in 2017 for sustained high occupancies and solid same store-NOI growth, along with selective upside from value-added redevelopments for REITs, said Paul Morgan, a REIT analyst with Canaccord Genuity Inc.

Among the successful retailers that are driving net shopping center demand area the TJX concepts (TJ Maxx, Marshall’s, HomeGoods), ULTA Cosmetics, Ross, Costco, and certain food/coffee chains such as Shake Shack, Potbelly, BJ’s Roadhouse, Jamba Juice, Panera Bread and Starbucks, Morgan noted.

Meanwhile, Morgan said, some retailers that had previously been struggling now appear to have stabilized.

“We find increasing stability among retail concept leaders such as Best Buy, Bed, Bath & Beyond, Barnes & Noble and Dick’s Sporting Goods, who have benefitted from their competitors’ demise in recent years,” he added.

Dollar stores are again expected to be among the top-performers in 2017, as cash-strapped consumers look to save money on multiple fronts, according to Mickey Chadha, a Moody’s vice president -- senior credit officer. Home improvement stores such as Home Depot and Lowe’s will also benefit from the continuing recovery of the housing market.

Apparel and footwear sellers, on the other hand, will be squeezed as consumers continue to spend more on health care, rent, home-related products, electronics and cars, Chadha added.

And then there are the beleagured department stores, which again are expected to face weak traffic trends and competitive pressure on their operating performance.

 

Article reprinted courtesy of CoStar and Mark Heschmeyer | www.costarmanager.com

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