Few topics make for a “better” story in business media than reports about the demise of an industry sector such as brick-and-mortar retail, or the fall of a dominant retail brand. Stirring the pot with simplistic analyses about the how and why, and the future implications of such paradigm shifts is an easy way to grab eyeballs.
But guess what? These paradigm shifts aren’t as broad-reaching as the sensationalists would have you believe. Plus, some changes throw the door open wide for investors shrewd enough to read between the lines. Such is the case with those who are looking at the significant opportunity presented by commercial real estate investment in today’s retail market.
Why do we, at CrowdStreet, believe retail continues to be an integral constituent of a diversified portfolio? Here are four reasons to ponder.
Retail still has muscle.
According to the venerable Urban Land Institute’s (ULI’s) 2018 Emerging Trends in Real Estate report, “The total size of the U.S. retail market in 2017, as estimated by SiteWorks, is $4.65 trillion, and the largest online retailer has less than a 1% share of the market.”
The study acknowledges that e-commerce is on a 10%+ growth trajectory. It also notes that some analysts see the e-commerce S-curve hitting its saturation point soon, with peak market share at just 15 – 20% of all retail.
There’s no doubt that the still-growing power of e-commerce reflects, in part, the shopping patterns of digital natives who are becoming a greater consumer force. That said, there are scores of products and services that a website or app won’t soon replace (e.g., we don’t see “Get a haircut.com” catching on).
Plus, Millennials are especially drawn to experiential shopping experiences. Thus, urban/high-street retail, neighborhood/community shopping centers, and lifestyle and entertainment centers all present a rosy outlook for investors. Holes left by defunct big-box retailers are now being filled by fitness centers, supermarkets, restaurants, and other businesses that create a “destination”–one that buoys the retail establishments in its proximity.
Many brick-and-mortar chains are also still coming up roses. Retailers ranging from the Dollar Store to H&M to TJ Maxx expanded with up to 200 additional locations in 2016. As with other market contractions, we see natural selection at work–brands that have leaned into the wind to find survival strategies are thriving.
So, as the ULI study states, “Physical stores have evolved as the most efficient–and profitable–distribution channel in both the commodity and specialty segments.”
Online brands are embracing brick-and mortar…. and vice versa.
You know the saying: Everything old is new again. Many smart online retailers are now extending their reach via brick-and-mortar presence. Amazon made headlines a few years back by opening brick-and-mortar locations.
Other online-born retailers have followed suit. Many use the opportunity to provide a “hands-on” experience with the merchandise paired with personalized services while keeping overall inventory at a minimum. Examples include M.Gemi’s apparel “Fit Shops,” Warby Parker’s eyeglass “Try-on” locations, among others.
On the flip side, traditional brick-and-mortar are finding success in the new “click-and-collect” model, which marries online purchase with the follow-on gratification of quick in-store pick-up. Once consumers visit the store, some data show they often make additional purchases. The spending also spreads to adjacent retail shops.
Geo-location also creates an unprecedented ability for physical stores to provide special offers and other incentives to consumers who live within a certain distance–or even in real-time with push notifications sent to consumers who stroll or drive past a location.
The market has adjusted to contraction in retail.
Above realities aside, it’s still a given that e-commerce has helped contribute to overcapacity in retail real estate in recent years. The good news is that financial markets have already had time to digest this transition. Thus, associated risk is generally priced into individual asset valuations, multiplying opportunities to source assets priced at attractive discounts.
The capitalization, or “cap”, rate is used in commercial real estate to indicate the rate of return that is expected to be generated on a real estate investment property. The calculation is based on the Net Operating Income the property generates divided by the Purchase Price. Lower cap rates (3-5%) generally point to safer / less risky investments and are... More compression in the retail sector should shift in investors’ strategy away from asset appreciation to focus on current income. Low yields often signal the market is expecting future appreciation (growth in the property’s Market value is the price an asset would fetch in the public marketplace. In commercial real estate, market value can be impacted by the location of the property (major market versus rural), demand for that asset type (multifamily, office space, storage, etc), installed amenities and more.... More) to be more important than current income (cash flow from operations, such as rent).
In today’s retail CRE environment, however, rents have matured, meaning the market has broadly arrived at a range of prices per square foot that both tenants and managers agree is fair. Therefore, without additional scope to ratchet up rents and increase Net operating income (NOI) equals all revenue from the property minus all operating expenses. In addition to rent, a property might generate revenue from parking and/or service fees such as laundry, housecleaning services, pet rent, and more. Operating expenses include the costs of running and maintaining the building and its grounds, including insurance, property management fees, legal fees, utilities, property... More (a primary driver of cap rates), properties generating stable cash flow under experienced asset management would be best positioned. Investors exploring the retail sector should look for triple-net properties (i.e., the tenant pays all real estate taxes, building insurance, and maintenance in addition to rent and utilities) secured by credit tenants, or those rated as “investment grade” based on size and financial strength by one of the major rating agencies (e.g., Fitch Ratings).
Quality In commercial real estate, the sponsor is an individual or company in charge of finding, acquiring and managing the real estate property on behalf of the partnership. The sponsor is usually expected to invest anywhere from 5-20% of the total required equity capital. They are then responsible for raising the remaining funds and acquiring and managing the investment property’s day-to-day... More make all the difference.
Every real estate investment requires faith in the operator who manages and administrates the deal. This can be especially true in the retail sector, given the set of complexities that can accompany a successful development.
Welcome to the CrowdStreet advantage. Our rigorous qualification process for project sponsors helps ensure that your retail investments are in the hands of companies with proven track records of success in the industry.
Ready to dig in?
For more depth on this topic, please see our article, “How to Invest in Retail Real Estate”.
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