“The reports of my death are greatly exaggerated.” – Mark Twain
As e-commerce continues to expand and consume more of the retail market share, a certain narrative has emerged: the brick-and-mortar model is on its last legs; the future of retail real estate is bleak. But the data tells a different story.
The Big Picture
E-commerce accounted for approximately 8.8% of total retail sales in 2017, which may not seem like a high percentage, however when compared to years past there is an undeniable upward trend. In 2015 e-commerce accounted for 7.2% of retail sales, and in 2011, the number was as low as 4.8%. In addition, pundits will point out that “retail sales” include categories that aren’t typically purchased online, including food, alcohol, and even gasoline, effectively diminishing the optics of e-commerce as a percentage of total retail sales. Within the next ten years, some predict that e-commerce will make up as much as 35% of total retail sales.
Category Winners and Losers
Much of the “retail apocalypse” storyline revolves around department store, sporting goods store, and electronics store closings, which is a very concentrated sample size limited to a handful of brands. According to a report by the IHL Group, 16 retailers accounted for 48% of reported store closings in 2017, with RadioShack alone accounting for over 1,000 of such closings. While these specialty and oversized department stores did suffer from over 3,000 store closures in 2017, as a whole the retail sector actually produced over 4,000 net store openings nationally.
On top of that, the future retail outlook is positive, as even more stores are projected to open in 2018 (5,000+). This boost in retail construction stems from strong demand for categories such as dollar stores and other discount specialty stores, quick service restaurants, and beauty supply stores, to name a few.
It’s no secret that America’s middle class, the undisputed driver of domestic retail sales, has been shrinking since the 1970’s, down from 62% of U.S. household income in 1971 to 43% in 2015 (see chart below). The Great Recession and housing market crisis only accelerated this trend – from 2001 to 2013, the median wealth of middle-class households fell by 28%. Consumers emerged with less disposable income, and consequently purchasing power and preferences changed as a result. Enclosed malls and certain brands that historically thrived off of the disposable income of the middle class are now struggling to stay relevant, while off-price retailers are expanding at a rapid clip.
Right Sizing and Reuse
Since 1975, malls have been built at four times the rate of total population growth, and to this day the U.S. has more retail space per capita than any other country in the world. Part of the story of this moment is that retailers have begun to realize that they don’t need so much physical space — in fact, excess space can cannibalize a retailer’s existing footprint — and as a result, are downsizing. But that does not necessarily mean that existing stores are simply closing their doors; in many cases, retailers are strategically “right-sizing.” Kohl’s, for example, has recently tapped grocer Aldi as a partner to sublet part of its space. These two brands will now feed off of each other, with Aldi able to locate in markets that would otherwise be unavailable, and Kohl’s better able to control its margins and occupancy costs in the long run. And according to a 2018 report by NREI, despite a rash of store closings, retail vacancies haven’t significantly spiked. Users such as gyms, discounters, and emerging brands are absorbing much of this excess real estate due to the attractive economics of second generation options versus new construction.
Synergies Between Digital and Brick-and-Mortar – Optimizing the Omni-Channel
Across the retail categories, we are seeing steady sales channel growth through mobile and desktop e-commerce, and retailers who are not investing in IT tools to capitalize on these platforms are being left behind. Embracing the omni-channel, meaning providing consumers with a platform to purchase items both in-store and online, is critical for traditional retailers’ long-term success. According to Business Wire, 84% of shoppers prefer a brick-and-mortar store experience or a combination of online and in-store retail experience, versus online only. This gives a shopper the flexibility and convenience of making a purchase electronically, while still testing and acquiring the item in real time. For beauty supply retailer Ulta, this combination has been key. Since 2012, Ulta’s net sales, earnings per share, and store count, have all increased consistently, and much of this success can be attributed to their commitment to the omni-channel model. According to research conducted by IHL, omni-channel guests spend 2.7x as much time and shop 2.5x more often than in-store only guests. In a given year, an omni-channel guest will spend $465 on beauty products through nine separate transactions, while an in-store only guest will spend just $175 across four separate purchases.
Digital Natives Get Real
As these trends play out across numerous sub categories of retail, they are challenging the zero-sum notion that physical retail is becoming obsolete. In fact, “digitally native” brands have started tapping into the brick-and-mortar space to capitalize on these competitive advantages. Companies that were once considered to be the grim reapers of physical retail now find themselves with retail stores around the country, and with ambitions to continue expanding. Amazon, Bonobos, Warby Parker, and Monica + Andy are four diverse brands that come to mind when thinking about traditionally e-commerce only retailers entering the brick-and-mortar space. And all signs point to further expansion in years to come, whether it be through acquisition of existing physical retailers (Amazon purchasing Whole Foods), or simply opening stores in strategic locations. A new concept that has emerged out of this mashup of online and physical is “showrooming,” where consumers can try on or test out a product in-person, and then ultimately make that purchase online. At the end of the day consumers do value and prefer to visit stores, not only to feel the product, but engage with knowledgeable customer service representatives. The future of retailing will continue to be the phenomenon of physical and digital working in concert with each other, as opposed to having an either-or situation that many feared. With the showroom concept, a consumer can be treated to a “white glove” service from an employee, try on and test out a product so that there is certainty prior to a purchase, and ultimately make that purchase through a mobile app or web browser. For the retailer, there is a material benefit from avoiding unnecessary overhead since inventory is kept to a minimum. For the consumer, the likelihood of having to return an order is all but eliminated, ultimately saving time and resources for both parties. Given recent successes in entering the brick and mortar space, Warby Parker aims to eventually have 1,000 physical stores, and Bonobos plans to operate over 100 locations.
Retail Investment Real Estate: Opportunity or a Falling Knife?
As retail is evolving, different property subtypes are emerging as popular investments. On one hand, deal volume for regional malls and larger shopping centers was down considerably in 2017, yet on the other, the market for single-tenant and grocery-anchored assets has surged, enjoying double-digit year-over-year transaction volume growth. It is no secret that ecommerce is challenging the retail market, changing the way consumers shop for goods and services. However, the sky isn’t falling on physical retail. Overall, retailers are adding square footage and remodeling existing space. The landscape is simply changing as legacy brands struggle to adapt, and new players enter the scene; for every J.C. Penny store that closed in 2017, nine Dollar General stores opened. For every tired business model and product offering that a struggling company fails to effectively reinvent, several new concepts emerge. And as the data and recent industry trends demonstrate, these modern, multi-channel brands need physical retail space just as much as their predecessors – perhaps not to the same extent and in the same way – but need it just the same.