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A Private Credit Perspective on Understanding &

Embracing the Evolution of American Retail

JUNE 2018

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RRA’s Private Credit Perspective on Understanding & Embracing the Evolution of American Retail

THE EVOLUTION

Main Streets of America At the height of their existence, malls were once considered the “new Main Streets of America.”55 Consumers had only one option for their retail shopping: the local mall.39 Whether indoor or outdoor, these retail centers were the gathering places for locals, from adolescents scouring the food court or frequenting the movie theater, to the window shoppers, mall walkers, or the families shopping for back-to-school clothes, all could be found occupying the same space and at the same time: the shopping mall.

In 1995, a typical mall was home to 142 stores taking up 1.2 million square feet on average.24 During the 1990s, investors and retailers overbuilt and oversaturated the market with retail outlets. The US became overstocked as a result of investors pouring money into commercial real estate.70 Experts always assumed, or rather hoped, that market demand would catch up to the supply, but this never happened.50 The US has the highest amount of retail space per capita in the world16 at 23.6 square feet53 (which is 50% more sq. ft. per capita than Canada),45 more than Australia’s 11.1 sq. ft. and the U.K’s 4.6 sq. ft. per capita.53 Anchor stores were also competing with their own brand due to proximity. Roughly 60% of Macy’s stores that are closing are within 10 miles of another Macy’s, as an example.55 The older malls were being overshadowed by their newer, more attractive counterparts. Of the 73 malls nationwide that have closed, 23 were redeveloped into different retail and 18 properties were turned into multi-use properties with residential and businesses taking up the vacant real estate.23

Adding fuel to the fire was the emergence of and the buyer’s shift towards e-commerce or online shopping. Experts all but guaranteed the demise of retail as it was once known. The e-commerce giant, Amazon, was poised to change the market forever, but would it be the doomsday the experts were predicting when writing the headline grabber “Retail Apocalypse”?

“The key is not to predict the future, but to prepare for it.” - Pericles

2017: The Year That Brick & Mortar Retail Died?

The Retail Apocalypse, written about in 2017, promised to be the end of brick-and-mortar malls via the disappearing anchor stores that, until recently, drove foot traffic benefitting the surrounding smaller retailers. In 2017, approximately 7,000 stores closed their doors for good.70 Mall vacancies were up 10% through the end of 2017; and experts were predicting that a quarter of American malls would be closed within five years, roughly 300 out of the 1,100 that currently exist.55 56

Not everyone was to be victim of this Apocalypse. Of the top three classifications of malls, A, B, or C, “A” malls, for the most part, remained unscathed by the Retail Apocalypse. It was the smaller and older malls, mainly “B” & “C” malls, that were being ravaged by the anchor store closures. The three major culprits being JCPenney, Macy’s, and Sears/Kmart.56



The mall classification breakdown depends on the sales per square foot. The typical “A” mall will have greater than $500 per square feet in sales. These malls tend to be high-end with anchor stores like Nordstrom or destination stores such as Apple or Tesla, as well as an entertainment component such as a movie theatre. They are also considered “destination properties” because the consumer seeks out the location specifically for what it has to offer. “A” malls make up 20% of the locations and bring in 75% of total volume.12

Department store closures are hitting the “B” and “C” malls particularly hard. “B” malls are a more blue-collar version of the “A” counterpart. The anchor stores are typically Sear’s or Macy’s mixed in with discount retail. “C” malls are an even more watered-down version that has more vacancies and may even be affected by crime. The future of these malls will be determined by the ability of the owners and tenants to evolve with the changing retail market.12

“The best performing malls and shopping centers will continue to attract tenants and retain value. Average and lower-performing properties will continue to lose value and

eventually close or be repurposed…” - TH Real Estate Report, CoStar17

The Elements Eroding the Retail Market E-Commerce & AmazonAccording to one popular theory, the main cause of the “Retail Apocalypse” is the emergence and dominance of Amazon in online retail. The doomsday preachers were convinced that Amazon was going to be the death of brick-and-mortar malls and all the market could do was watch. But did this happen? Interestingly, Amazon was responsible for 44% (38% in 2016) of the e-commerce sales, and only 4% of all retail sales in 2017 according to a study done by One Click Retail. Best Buy still has three times the market share in electronics that Amazon has; Costco has 85 million members to Amazon’s 100 million Prime subscribers;57 and finally, Walmart and Kroger account for $330 billion in sales, compared to $20 billion by Whole Foods, recently acquired by Amazon.39 It is not to say that the market should ignore Amazon’s presence and influence in the retail market. Companies like Bed, Bath & Beyond missed huge opportunities by totally disregarding the online marketplace.19

Devastating DebtDuring the last “great recession,” businesses were refinancing to buy time, going more and more heavily into debt. These debts became unsustainable and businesses are now being forced into bankruptcy. The debt service on these loans had the added consequence of diverting free cash flow away from investing in improvements needed to stay competitive. Long-standing retail chains have billions in borrowings on the books and are succumbing to the debt.70 More than half of all store closures in 2017 were due to bankruptcy.40 Toys ‘R’ Us is the 3rd largest retailer in history that has been forced to file for bankruptcy due to mounting debt.4 At least another 300 retailers filed for bankruptcy in 2017.56 Some of the other big-name retailers to file for bankruptcy include RadioShack, Sports Authority, and Payless Shoe Source with more likely to follow.4 39



Interest Rate Increase

Also factoring into this scenario of debt-caused closings, is the anticipated increases in interest rates. Even though there were stronger-than-expected numbers reported for the fourth quarter of last year (2017), Real Estate Investment Trusts (REITs) shares still fell. Investors anticipating this raise in rates have consequentially been reluctant to put new money in retail real estate.22

The Changing ConsumerConsumers of today do not behave the way their predecessors did. The modern consumer is more likely to purchase an experience than a “thing,” making them more discerning in their purchasing.50 Buyers are demanding flexibility and personalization in their retail shopping experiences. With the internet at every consumer’s finger tips, shoppers can now do all the researching at home with the help of mobile apps and websites. Consumers can price shop from the luxury of their couch, eliminating the “impulse” buy because customers are no longer going into stores to look for items to buy or comparison shop. American consumers are spending less on apparel and more on experiences such as travel or dining out. In 1977, the average American household spending on clothing was 6.2%, now it is half that (3.1% in 2016). Apparel is being displaced by travel, dining out, and activities. These experience-based purchases have grown to 18% of consumer spending.54

The Social Media Significance

Snapchat and Instagram have also had their hands in the “Retail Apocalypse.” Millennials want to share, and they are more likely to share a photo of a gourmet meal they have just been served, the masterpiece just finished in a wine painting class, or a luxurious spa experience, rather than a picture of an outfit they just purchased at JCPenney. People want to share their experiences, not things.

Millennials

According to a report published in April 2018 by Retail Dive, Millennials are expected to surpass Baby Boomers as the largest living spending generation in the United States; and currently, they contribute $200 billion in spending power. Millennials are influenced less by advertising and more by the shopping experience delivered via convenience and customer service integrated with the most current technology.

Bifurcation Due to Income LevelsAn article in the March 2018 issue of Deloitte Insights, entitled “The Great Retail Bifurcation,” pointed out that in the last 10 years “the lower 40% income group has found itself struggling



to keep up with expenses, while the middle 40% has seen its income shrink. Thus, for 80% of consumers, the last decade has generally represented a dramatic worsening of their financial situation.” This means that “for the 80% of the shoppers who face strained budgets with limited disposable income, price sensitivity is paramount.” Deloitte’s finding is that “low-income consumers are 44% more likely than their wealthier counterparts to shop at discount retailers, and also more likely to shop at supermarkets, convenience stores, and department stores. High-income consumers, on the other hand, are 52% more likely to shop online (based on self-reporting).”38

A Shift in PriorityAs costs soar in other areas of life, the money spent on consumer goods is always first to be sacrificed. With healthcare now a huge part of the average American’s budget, discretionary spending is taking a hit. Technology is an ever present and necessary element in today’s society, most jobs/tasks/projects today cannot be performed without some form of advanced technology, consumers are making these larger, more often expensive purchases their priority. Ten years ago, consumers spent a fraction of their disposable income on cell phones. Apple now does roughly $100 billion in i-goods sales in the U.S. (roughly two-thirds are iPhone sales).36 Education costs are also at an all-time high and are another reason why buyers are not spending like they used to at a traditional brick-and-mortar store.24

Differing OpinionsDepending on who is consulted, the interpretation and understanding of the actual state of retail and brick-and-mortar shopping centers vary. Mall owners may feel that this is an exciting time for retail, investors might say that the future of retail is dire and to make investments elsewhere, tenants and retailers fall somewhere in the middle.

The Optimistic OwnersExecutives from CBL, JLL, and PREIT are all making the case, and with supporting evidence, that malls are in an exciting transitional period and are not dying at all. These three top executives contend that this “doom and gloom” is grossly overstated.49 With this transition, yes, there are growing pains, but in the end well located malls will survive and thrive. Because of the over-building during the 1990s, there had to be a market correction. Underperforming and otherwise challenged malls will close, and those with potential will be restructured and renovated. Mall owners and landlords are approaching this market shift as an opportunity to reinvent the mall as it was once recognized. Owners of “B” and “C” malls are repurposing their locations into multi-use developments.12 With this shift, tenant demographics are also evolving.

Tenants and landlords are renegotiating leases and filling the spaces left by the once-popular, now irrelevant large retailers such as Sears or JCPenney with well-performing, relevant, and adaptable anchors like HomeGoods, Target, or Home Depot. A direct result is found in the evolving landscape of the brick-and-mortar malls. One mall owner, GGP CEO Sandeep Mathrani, says, “One of the key tenets of our business plan is capitalizing on the embedded opportunity with our portfolio to redevelop anchor boxes.”63 The loss of the underperforming anchors has been embraced by mall owners as an opportunity to bring in new, more profitable tenants or to repurpose the entire center into a multi-use development.12



The Realistic RetailersThere are retailers that are succeeding, and there are retailers that are not. Depending on which retailer is asked, one would hear very different opinions on the health of retail and brick-and-mortar stores. Those retailers that have kept their heads above water and are making a profit have realized that new strategies are vital to the survival of the Retail Apocalypse. These retailers have embraced the shift to e-commerce and have incorporated modern technology into their shopping platforms. Walmart is adding the option to pay with a mobile device through the Walmart “Scan & Go” app, offering online grocery pickup and even installing “Pickup Towers,” that work like high-tech vending machines that facilitates online orders for in-store pick up.8

Retailers are experimenting with smaller real estate footprints and are choosing to focus on the consumer experience.58 Retailers must adapt, and quickly, in order to keep pace with the evolving habits of the consumers. If they are able to embrace the shift, they can survive.

The other retailer is having a liquidation sale and/or filing for bankruptcy. Toys ‘R’ Us has become the poster child for how not to manage the Retail Apocalypse. The main contributing factors of the Toys ‘R’ Us’ failure to succeed in today’s retail market are unsustainable debt, ignoring the e-commerce market, no major store improvements/modifications in 60 years, and underselling their baby business, Babies ‘R’ Us which is emblematic of almost all leveraged buyouts in retail.29

The Apoplectic InvestorsUp until recently, investors were not jumping back into brick-and-mortar retail. What investors hate most is uncertainty and the current evolution is shrouded in uncertainty. Investors, for the most part,

have embraced a negative narrative surrounding brick-and-mortar retail.62 Even when retailers posted better-than-expected numbers for the fourth quarter last year following negative returns in the first two quarters, REIT shares still fell as investors remained unconvinced that this “apocalypse” was temporary.22 Redevelopment is costly and the idea of pursuing redevelopment has investors asking: how much capital will it take to renovate the older malls, and how quickly can the process unfold?67

One, if not the only, area of the retail real estate industry that is still successful in attracting investors is the grocery-anchored shopping center, which rose more than 5% in 2017.18 But is this growth sustainable or is confidence overly optimistic as it was in the 1990’s? There has never been as much retail square footage dedicated to selling food/groceries as there

is today – and some would say it is too much.28 Grocery square footage per capita was the highest it has ever been in 2016, setting a record at 4.15 square feet of food retail per person (30 times the amount in 1950).28 Some large-scale grocery retailers have taken notice and are decreasing their footprint. Kroger planned to only open 55 stores, down from 100, in 2017.28 Online grocery delivery services are a rapidly growing industry and could account for 20% of sales by 2025.15 Millennials are



the main driving force merging e-commerce and grocery shopping opting to combine convenience with quality and the flexibility that online shopping provides.15

Interest rates are a continuing factor affecting short and long-term investing, and it is no different in commercial real estate, particularly with struggling malls. If interest rates do not rise significantly in the coming year, the upside will be that the cost of borrowing and the value of properties should remain stable.51 If the opposite proves true, then rate hikes could create a bubble by removing lender incentive to tighten lending requirements.51

“To get it right and survive, today’s retail must focus on experience and convenience while incorporating food and entertainment with a diverse merchandising mix.”

- Joseph Williams, Senior Vice President of Woodmont Co.16

Embracing the EvolutionThe businesses that are succeeding have turned this retail “crisis” into an opportunity to expand their horizons and the retail shopping experience. Three companies that have been weathering the storm are Home Depot, Target, and Ross Stores. There are varying reasons why each is managing the struggle better than those that have not adapted to the evolution of retail.

Home Depot At the publishing of this report, Home Depot and others in the home improvement industry are gearing up to hire 133,000 seasonal workers, nearly half of these will become permanent employees. While other stores are closing doors, Home Depot is opening theirs and hiring.32 During an economic upturn, such as the present one, the home improvement sector typically benefits. With more disposable income, buyers are looking to put that money into projects specifically in-home upgrades and repairs. Home Depot grew their employment by 3% while the rest of the retail sector lost jobs.32 E-commerce has had a minimal impact on the home improvement retail industry because of the goods that it sells. When a consumer wishes to repaint a room or update a bathroom, it is not possible (at least not advisable) to make these selections online. It is necessary, rather, to make the final decision in person in the store. Brick-and-mortar stores are successful when that is what they actually sell: brick and mortar.32

Home Depot’s challenge, and one it seems they are very willing to take on, is incorporating technology into their shopping experience. A customer can go online, find the item/materials they wish to purchase, locate in the store by aisle/shelf/dock, and easily go in-store to make their purchase. Keeping this system streamlined and current is the key. Home Depot has also explored partnering with Google Home and utilizing the voice-activated shopping experience to compete with Amazon’s Alexa platform.11

Target Target has been implementing a strategy that seems to be working: opening smaller format stores. These smaller stores, often referred to as “flexible-format,” cater to the demands of the local community and will adjust to what the community requires. Target sales are $600 per square



foot in the smaller format stores versus $300 in the larger traditional Target stores.48 According to multiple analysts, Target is on track to have 130 small-format stores operating in the U.S. The first small-format store in the country was in Minneapolis with stores opening in selected markets throughout 2017 and 2018. The Phoenix small-format store opened in 2017 in a space vacated by Sport’s Authority. Target’s innovative flex-format stores are located in more densely-populated neighborhoods, urban areas, even college campuses.27 The downside of this strategy, for the real estate owner, is that it results in a reduced future demand for square footage by Target.

To remain competitive with the e-commerce industry, Target is partnering with Google and Shipt, lowering prices in-store, offering drive through pick up, or (eventually) same day in-home delivery. By aligning with Google, Target is positioning itself to compete with the home-activated shopping service of Alexa, through Google’s Home smart-speaker technology.11 With the acquisition of “Shipt,” a grocery delivery company, Target is venturing into the same-day grocery delivery service that Amazon has taken a bite of by its takeover of Whole Foods.52 This presents some challenges that Target will have to overcome to continue to be profitable. Currently, Target has significantly fewer distribution centers than either Walmart or Amazon and will need to solve the issue of having the right goods on hand to fulfill shipping commitments.52

With the bankruptcy and ultimate closure of all Toys ‘R’ Us stores, Target and Walmart are set to be the big winners.72 Target alone could scoop up more than $600 million in additional sales as a result of Toys ‘R’ Us’ closure.37 Roughly 90% of Toys ‘R’ Us stores and 96% of Babies ‘R’ Us store are within five miles of a Target, poising the large retailer to draw in about 15% and 5% of the sales, respectively, from each location, according to one analyst from Credit Suisse.37 In addition to gaining market share, Target is also considering on bidding on Toys ‘R’ Us locations to be auctioned.66

Ross Stores Ross plans to open almost as many locations as Macy’s plans to close.71 In a climate where large retailers are closing their stores, Ross and other discount retailers are going in the opposite direction. Discount retailers such as Ross benefited from the economic downturn. When consumers were counting every dollar, they were looking for affordable, but quality merchandise as provided by the discount retailers. Even after the economy improved, consumers did not abandon their more cost-conscious shopping habits keeping discount retailers relevant and profitable.50 Discount retailers like Ross are also benefitting from the influx of merchandise flowing in from the stores that are liquidating and are taking in that market share. One analyst expects that off-price retailers “will be the primary beneficiary of this brick-and-mortar sales volume up for grabs and benefit from the plethora of close-out merchandise for several years.”59

But will this successful trend endure? Because the essence of the discount retailer is the thrill of finding a bargain or “treasure hunting” for their purchases, these stores will be virtually unaffected



by the e-commerce market, for now. Until Amazon and other online sellers can be competitive with their pricing, the discount retailers will continue to hold a grip on the retail market. Discount retail has been able to offer products for anywhere between 20% to 60% less than Amazon and their full-line department store counterparts.71 Another challenge for the discount retailer is keeping the pace going, even as the market fills up with more stores. Macy’s and Nordstrom have taken notice of the success in off-price retail and have elected to open their own versions, which will no doubt add more competition only benefiting the consumers.59

“The next occupiers of the vacated spaces run the gamut…from specialty retailers to service

providers to entertainment concepts to industrial and office tenants.”

- Diana Bell, National Real Estate Investor5

So…What Now?While the “A” malls are still profitable and attracting consumers for now, it is the “B” and “C” malls that must make major adjustments, if not total reinventions. How do landlords fill the vacant retail space and attract business once again? Densification, or the conversion of retail space into non-retail space, seems to be one, if not the only, solution to revitalizing these underperforming retail spaces. Developers and owners are looking to reinvest into these “dead” malls to turn them into mixed-use properties. Landlords are also looking “to create destinations for the community that might not be entirely focused on buying something.”21 They are also “looking at what appeals to shoppers in the local markets in order to bring in the most appropriate tenants.”5

Landlords, Owners & DevelopersOutdated and vacant malls are being converted into office space, charter schools, community colleges, call centers, last-mile distribution centers for e-commerce, multi-family housing, senior living, fitness centers, hotels, medical space, experiential destinations, and the larger spaces are being converted into smaller retail blocks for new, smaller anchors such as a grocery store.5 Simon, the largest mall owner, currently has $1.3 billion going into 30 redevelopment projects which are adding more restaurant/food options and experimenting with pop-up store concepts.63 In a press release on April 9, 2018, Simon Property Group announced redevelopment plans in 5 different locations, Brea Mall (Brea, CA), Burlington Mall (Burlington, MA), Midland Park Mall (Midland, TX), Ocean County Mall (Toms River, NJ), and Ross Park Mall (Pittsburgh, PA).47

Examples of a landlord/owner diversifying a location with non-retail tenants in previous retail spaces varies by community. In Phoenix, Arizona the first shopping mall to be built there during the 1950s, now considered “dead”, is in talks to be redeveloped into a high-tech office center similar to one already located on Scottsdale Road in Scottsdale, Arizona, SkySong.60 The effort plans on converting the dilapidated Park Central Mall, located at Central Avenue and Osborn Road, into a center for technology and innovation. These similar renovations were made to the comparable mall in Scottsdale with encouraging results.60

In Tulsa, Oklahoma, Eastgate Metroplex, located on East 21st Street, was transformed from a dying mall and redeveloped into a multi-use development featuring a call center among many other businesses.20 The Eastgate Metroplex was a $60 million investment overall for the tenants and owners. As of March 2018, and according to Eastgate’s own website, the list of tenants included, but



was not limited to: Alorica (call center), Coca-Cola Enterprises, Department of Public Safety – DMV, NCO Financial Systems, Oklahoma State University Center for Health Services, Paul Mitchell Beauty School, Tulsa City/County Health Department, and numerous local restaurants.

In yet another instance, two developers had the idea to transform one of their non-retail properties into a conglomeration of boutiques, workout studios, offices, and restaurants. Named “Platform” and located on Washington Boulevard in Culver City, California, one of the requirements to securing a lease is that the proposed tenant must offer a unique experience, something “Instagram-worthy.”42 In this non-traditional mall format, Platform tenants are on course to take in $850 per square foot compared to the national average of $165 per square foot.42 Platform is a refurbished industrial complex occupying 50,000 square feet.42

Redevelopment of these properties is not a cheap endeavor. In west Los Angeles, Hudson Pacific Properties has plans to convert 500,000 of approximately 600,000 square feet of Westside Pavilion into creative office space. The remaining 100,000 square feet will remain entertainment retail space. The total cost of the project will run anywhere from $425 million to $475 million. The decision to install this type of property was based around the lack of current office space in Los Angeles’ westside, exemplifying the need to evaluate and cater to the local needs of the community.33 On the opposite side of the country, Normandy Real Estate Partners are doing similar conversions to vacated retail space in the Flatiron District of Manhattan, recently closing a $133-million-dollar deal to move into the upper portion of the ABC Carpet’s flagship store on 888 Broadway. This is another instance where office space is encroaching on retail’s territory.46

Uber founder and former CEO, Travis Kalanick, has also taken notice of this new commercial real estate opportunity. In March of 2018, Kalanick announced his plans to become CEO of a small, new startup, City Storage Systems. Its goal is to take abandoned and out-of-use locations and convert them into warehouse space for online retail companies or food delivery kitchens.10 Kalanick has pledged to put in $150 million of his own money, acquiring controlling stake of City Storage Systems.10

Retail landlords are also converting old malls into multi-family housing. From San Diego to Maryland, empty or underperforming retail spaces are being converted to a mixture of living, working, and retail. “Residential and retail often serve as complementary property types in contemporary retail developments, whether they involve renovations of historic buildings in urban centers or new mixed-use centers.”44 Experts caution, however, that inventory is close to exceeding demand for housing. Zoning permission is needed to put non-retail properties into retail locations. Because more housing means more people, which means more city services needed, local regulators would rather have offices, industry, or commercial properties in vacant retail space as opposed to multi-family housing.44

Finally, gyms are also occupying the void that large department stores have left behind. In the past, having a gym or fitness center was not seen as ideal, now mall landlords are leasing some of their best real estate to health clubs.2 Gyms are an experiential destination that can often be visited every day in some cases or three to four times per week for the average health-conscious consumer. As a result of the hundreds of store closings across the US and the rising trend of fitness centers and boutique gyms, mall landlords have yet another possible anchor tenant to attract business. Phillips Edison & Company have gyms in more than 44% of its shopping centers, Westfield has them in more than half, and GGP has plans to open gyms in malls in Oklahoma City and Honolulu.2 Owners of



grocery-anchored shopping centers are incorporating fitness into their developments, for example, OrangeTheory Fitness is teaming up with Hy-Vee, an Iowa-based grocery chain, to open studios adjacent to or inside many of its 245 midwestern locations.2

Developers and landlords are not lacking for options on ways to repurpose the stagnant “B” and “C” shopping malls. The challenge is determining the local needs and demands of the community, raising the funds to make costly renovations, and incorporating it into a unique experience. For developers, location plays a significant role and taking advantage of visibility is key. Mixed-use developments are the future for these large properties and those developers that continue to invest and innovate will continue to be successful.9

RetailersRetailers must come up with strategies to entice the customer into the store and keep them coming back. These strategies include creating a unique shopping experience, closing less profitable locations to focus on the successful ones, partnering with other businesses (i.e. Target with Google), keeping up with current technology and social trends, and revamping customer loyalty programs.61 New brick-and-mortar retailers are emerging, companies that once only existed online are now expanding to open physical locations for their product. Bonobos, Athleta, and Warby Parker are some examples of stores that started as online businesses and eventually opened brick-and-mortar locations.

Restaurants remain a draw for customers, but large chains are suffering. Consumers are choosing to frequent small and locally-owned businesses because they tend to offer more unique and better-

quality options. The National Restaurant Association reported a survey in their annual “State of the Industry 2017” that found 61% of adults say they would prefer to spend money on experiences, including eating out at restaurants or other activities, over purchasing an item from a store.” Naveen Jaggi, president of Retail Advisory Services of JLL, reported that 40% of consumers today will pick a mall to visit primarily based on the restaurants located there. And that the mall can capture 12% more sales revenue and 35 extra minutes of time in the mall from people who stop and eat versus people who don’t.64

Today it takes more for retailers to attract customers into their stores. Potential shoppers are looking for something that is unique to a particular shopping experience, one they cannot find online. This “emotional fulfillment” is

seeing, touching, smelling, and testing the product prior to purchase.45 A way entrepreneurs are accomplishing this is incorporating the online aspect with the in-store shopping experience, they are embracing the e-commerce world.

The business owner must make patronage attractive, both physically and experientially. Retailers that are performing well have made the investment in store upgrades and renovations to create a “more compelling store experience.”25 Retailers that have focused on “delivering convenience, operational efficiency and remarkably value-priced merchandise, along with those retailers that



differentiate themselves on unique product and more remarkable experiential shopping (including great customer service, vibrant stores and digital channels that are well harmonized with their store)” are experiencing that retail is not dead, and, in fact, it is quite healthy.13 If the experience is superior, and photo-worthy, then the client will want to share on social media. Restaurants in particular have benefited from this Instagram-era, with sales growing twice as fast as retail since 2005.68 Leveraging social media, both in promoting and maintaining customer loyalty is key to surviving in the new retail world. The point of purchase is a powerful moment for the retailer: by creating a rewards program for every in-store purchase or “check-in” on a social app like Facebook, the customer is given incentive for visiting the brick-and-mortar store.41 Social media can also create customer loyalty, providing both access to new products and keeping an open line of communication with the customer play another huge role in the success of retailers who are embracing the evolution.41

Large retailers are also closing underperforming large-format stores and converting them to showrooms, which showcases their products but sells nothing.30 Consumers can search for the product online, price-shop, and then go into a physical location to make their final decision, creating the need to maintain a physical presence in the retail world. Nordstrom is experimenting with the showroom concept. Called “Nordstrom Local”, the new store footprint will feature eight dressing rooms where shoppers can try on merchandise from the options on display. Assisted by personal stylists or a style-board app, shoppers make their selections, then ultimately order from the website. These locations also offer a variety of other services such as manicures and on-site alterations, or they may have a coffee shop.35

Showrooms also alleviate the need to have a full inventory at all times, requiring less time to manage and less physical space.30 Bonobos, a men’s clothing company recently acquired by Walmart, is another perfect example of how the showroom retail concept operates. Given the moniker “Guideshops”, these retail locations also offer appointment bookings, alcoholic and non-alcoholic beverages, and personal sales assistants. Bonobos has been successfully operating since 2012, with more plans to expand.30

“Brick and mortar infrastructure has historically evolved based on the needs, utility, and technological innovation of the populations it serves.”

- J. Derhake, National Real Estate Investor 15

Many retailers are using the latest technology to further grow their businesses. Nordstrom (the Nordstrom mobile app), Target (with Google), Home Depot (with Pinterest) have all taken advantage of the technology used by today’s consumers. Consumers see it, they like it, they click on it and buy it. Ease of shopping can be as simple as having a user-friendly app that complements the physical store. Through these apps, companies can track customer data and preferences, target marketing, streamline product development, which keeps businesses relevant and evolving with consumers’ changing preferences and habits.31 It is “crucial for both mall owners and retailers to embrace the new technology that’s able to gather more data than ever on consumers.”49 Retailers that have the greatest success in marketing have combined older, more traditional tactics with newer digital, data-driven tactics.6

One such successful, large chain retailer is Apple. A potential customer could conveniently order their new iPhone or any Apple product online and have it shipped home, but the in-store experience offers so much more that buyers are willing to wait for hours to receive service. (Note: the presence



of tech-heavy stores like Apple, Microsoft, and Tesla can drive a mall’s sales per square foot up by more than 10% and create the same kind of destination effect a department store once did.)3

Companies that started online are now opening physical locations. Two brands that had their genesis online, UNTUCKit and Morphe, are now opening brick-and-mortar stores across the country and now in Arizona. One advantage of starting online is that the business can track consumer data from day one, enabling the most strategic decision-making when opening physical store locations.7

In the past, large anchor stores paid very low rent – and the surrounding smaller stores paid market prices. Now, with those large stores closing, landlords and tenants are having to renegotiate lease structures. The basis for these lease structures is still in progress and will vary from market to market.5 Landlords are filling the empty spaces with tenants based on local community demands which includes anything from dry cleaning services, to dance/fitness studios, to urgent care. The CEO of Starbucks was quoted to say that the retail sector is coming to a point where landlords across the country will need to lower rents.43 The average US retail tenant paid just under $18 per square foot in 2017 which is a slight increase from 2016 ($16).43

Not all locations will be successful at evolving. Those malls located in an already struggling economy will face greater challenges, but for many it will be an opportunity to see the conversion of underused real estate into multi-use functioning community spaces.53

Future is Now Here Brick-and-mortar stores have a future. The latest CBRE report, The Future of Retail 2030, explains this in detail. Shopping centers of the past will be repurposed into mixed-use properties including, but not limited to healthcare, education, and experiential destinations and will be connected to the latest technologies. Retail will become automated.1 “Customers want quick access to goods and services across many channels, and they want meaningful experiences around their purchases…”.26 Businesses will need to start incorporating the technology now, so that they can keep up with consumers changing needs in real-time. As the virtual reality world advances, customers will one day abandon their smartphones for smaller, wearable devices which will become the vehicle they use to access online goods and services. Retailers, like Nordstrom, are already anticipating this shift in their smaller format stores. Check-out lines with human cashiers will be replaced by faster, cashless ways to pay, a feature that many retailers are already implementing.26 Amazon has started Amazon GO Stores, and the response has been positive. The cashier-less stores allow shoppers to fill their baskets and pay at the same time. They can fill their bags and GO.1

By partnering with Target, Costco, and Walmart, Google is trying to break consumers’ Amazon Prime habits.69 Google’s new service will allow buyers to search on their Google Home device and then directly buy from the retailers. “Shopping Actions,” a shopping program, will connect the Google Home platform and major retailers with a universal shopping cart a consumer can add products to, facilitating a smooth check out at purchase time.69 Google is also partnering with Target, Lowe’s and



Pottery Barn by using augmented-reality technology. This technology allows for digital objects to be placed in the real world via a computer or tablet screen helping customers make their most informed purchases.11

Pinterest is expanding its “Shop the Look” feature by partnering with Home Depot. Shop the Look will make it easy to locate and purchase items that are “Pins” and users will be able to tap on an object they would like to find in-store or online to purchase. Home Depot is also incorporating ‘how-to’ videos for ‘do-it-yourself’ (DIY) projects from which a consumer can directly shop.14

Social media has been and will continue to play a significant role in the future of retail. All successful retailers in this recent evolution of retail have used social media to their advantage and will need to continue to do so by attracting the attention of their customers, collecting data, establishing and maintaining brand recognition, establishing a customer loyalty rewards program, and providing superior customer service.34 Social media allows for businesses to really know their customers and to use this knowledge to maintain a relationship which keeps their customers coming back.34

Artificial Intelligence (AI) and self-driving cars are also on deck to change the future of retail. AI technology may actually predict trends, which will increase accuracy in anticipating the demands before they arise. AI will also automate inventory and merchandising decisions, and schedule delivery.73 Self-driving cars will further alter brick-and-mortar shopping. After the self-driving car becomes safe and reliable, companies could create stores on wheels, thereby creating new conveniences, but simultaneously shrinking retail’s footprint in real estate even further.68

“The winning retailers of the future are going to combine great physical assets with the ease that comes along with that digital interaction.”

- Brian Cornell, CEO of Target 65

In this evolutionary period, the challenge facing retailers and mall owners will be to capitalize on consumers’ own measure of their economic well-being, or lack thereof, to offer a value proposition that aligns with consumer needs, to retain current customers and acquire new ones by making the shopping experience unique and personal while also incorporating the latest in social media and technology. This challenge will be met by people who understand this to be an opportunity and who will find solutions born of a full understanding of the path to purchase for the consumer, and who possess the expertise to be able to influence that path, retaining customers with loyalty/rewards programs through store apps and social media, adjusting the store to fit the needs of local consumers by tracking customer data, and keeping technology current and complementary to the shopping experience.



ConclusionRetail is in a state of evolution which has been caused mainly by advancements in technology and changing consumer behaviors and tastes. The retail industry will continue to be in flux as it seeks frantically to find its right place in this century. This flux will cause disruption and will produce winners and losers. Savvy retailers will adapt by maximizing the use of technology to gain customer loyalty, by focusing on unique experience within their stores to make them destinations worth visiting, and by adapting their real estate to capture the right blend of showroom, fulfillment center, food/beverage, etc. Not-so-savvy retailers will find themselves, as so many have recently, out of favor with customers and creditors. And while there is almost surely too much space devoted to retail currently, adaptive reuse opportunities abound (at the right price, of course) for those entrepreneurs willing to reconfigure and reimagine existing retail space. Credit investors will need to tread with caution for the foreseeable future as there are many threats to retail real estate that are still hard to quantify and will only become known over the coming years and decades. However, while taking a red line to the entire retail asset class might save an investor heartache, it will almost certainly cause them to miss out on some exceptional opportunities. Instead, using intelligent underwriting and keeping abreast of the constant changes in this industry, an investor can plant themselves firmly on the winning side of this historic evolution.



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