Nowadays, a mix of realism and optimism permeates the retail REIT sector, with landlords acknowledging the rocky atmosphere for brick-and-mortar retail while touting the rise of “experience” retailers that don’t rely heavily on e-commerce.
On one end of the spectrum are retail REITs with a heavy concentration of older regional malls in secondary and tertiary markets. These REITs face “substantive risk,” says Alan Pontius, national director of specialty divisions at real estate services firm Marcus & Millichap.
On the other end, the outlook is “more positive” for retail REITs operating neighborhood and community centers in markets that are witnessing strong employment growth, Pontius says. The prospects are especially strong for properties attracting retailers that emphasize the experience at least as much as their products and services.
As retail REITs struggle with outdated retail concepts and try to find compelling new retailers, they’re also coping with an overall thumbs-down from Wall Street. Year-to-date, retail REITs have underperformed the broader REIT index by roughly 1,400 basis points as retail woes, namely bankruptcies and store closures, have weighed down their stocks, according to Spenser Allaway, an equity research analyst at Green Street Advisors, a real estate research and advisory firm.
“While headwinds in the retail space are real, the share underperformance has been much larger than the actual asset value at risk,” Allaway says. “Hence, it appears the market is looking beyond the current disruption in the space and pricing in a much further deterioration of REIT fundamentals.”
To executives at retail REITs, that projected deterioration is exaggerated.
“I think it is fair to say that the debate surrounding the death of physical retail is over,” Conor Flynn, CEO of Kimco Realty Corp., declared during the REIT’s July 27 earnings call.
In that call, Flynn noted that despite the challenges confronting the retail industry—namely in the apparel space—off-price, grocery, home improvement, fitness, beauty and other specialty retailers are thriving. Many of these retailers offer “experiences” that consumers can’t enjoy online.
During the earnings call, Glenn Cohen, Kimco’s CFO, called those segments the “shining stars” in today’s retail environment. Kimco’s two largest tenants are off-price retailer T.J. Maxx and home improvement retailer Home Depot.
Flynn said Kimco’s leasing volume so far this year had reached a record level for the REIT, and cited a report from retail advisory firm IHL Group indicating that retailers are opening over 4,000 net new stores in 2017 and are on track to open 5,500 net new stores in 2018.
Likewise, David Simon, chairman and CEO of REIT giant Simon Property Group, said during the company’s Aug. 1 earnings call that leasing activity “remained solid,” with average base rent was up 3.3 percent compared with last year, and malls and premium outlets notched a 12.9 percent year-to-year jump in leasing spreads.
The off-price segment, in particular, is a bright spot for retail landlords, thanks to strong performance by the likes of Burlington, Nordstrom Rack, Ross and T.J. Maxx. An estimated two-thirds of American shoppers make purchases at off-price retailers, whose revenue comes primarily from brick-and-mortar sales.
“The off-price sector has … been particularly successful in driving traffic to stores. Some three-quarters of regular off-price shoppers say they like visiting stores because the constantly changing assortment is interesting and fun to shop,” noted a report released in May by commercial real estate services company Colliers International.
Despite the rosy outlook for off-price retailers, some landlords must still face the reality that older malls—especially those anchored by traditional department stores—and some big-box tenants are suffering.
“Demand for retail space is strong, with vacancy rates at their tightest levels since 2000, but retail center investors must closely consider their tenant composition,” says Pontius. “Each tenant’s ability to draw customers to the center is a critical success factor, and the strength of each tenant’s business model is an important consideration.”
Observers say owners of retail real estate ignore the industry’s headwinds at their own peril.
“However, retail REITs tend to own institutional, higher-quality real estate that should fare better than lower-quality centers, likely much better than the overwhelmingly negative narrative,” Allaway notes.
Over the longer term, Allaway expects tenant churn, anchor redevelopment and capital investments to ramp up for retail REITs and other retail landlords.
“Retailer weakness is certainly something that any retail landlord, REITs included, must actively manage against,” says Chris Wimmer, vice president and head of REITs at Morningstar Credit Ratings. “On the margin, REITs will need to quickly move weaker stores out of their portfolios and replace them with stronger and more profitable ones.”