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Risk-Averse Strip Mall Landlords Seek 'Internet-Proof' Renters in Smaller Spaces


By Neil Axler

“You can’t get your nails done online, you can’t get dry cleaning done online and you can’t eat the Internet.” These are the dominant themes from retail clients (property owners) over the last few years. Today’s shopping center acquirers are looking for “necessity centers” with a stable rent roll. These centers consist of restaurants, nail salons and other destination retail that is not competing with e-commerce.

Twenty years ago, property owners would acquire large shopping centers with big box tenants. That’s not the case in 2015. The risk of one large tenant vacating a property can significantly adversely impact its net operating income (NOI) and lower property value. The bigger the tenant, the harder it is to lease up the space or re-purpose it, as exemplified by large vacancies left by Circuit City, Borders and other large retailers that filed bankruptcy. The big-box space left behind by these bankruptcies is much more difficult to re-lease or re-purpose than smaller spaces, often leading to extended vacancies, decreased NOI and lowered valuations of properties.

Retail clients today are buying properties with specialty grocers, discount apparel and dollar stores, which provide steadier cash flows and often serve blue collar markets. These clients are also seeking shopping centers with shadow anchors such as Wal-Mart, Target and Home Depot.

According to McGladrey’s chief economist Joe Brusuelas, the pace of economic growth and hiring accelerated during 2014, creating conditions for modest wage growth in 2015. Consumer spending is rising due to lower gasoline prices. The 60% drop in oil prices has led to a 40% decrease in the cost of gasoline since mid-year 2014. Lower gas prices are expected to give U.S. consumers an additional $150 billion in purchasing power.

This additional purchasing power should be good for the health of the retail real estate market. However, it is still perceived as the lowest of all major property types for investment and development because consumer preferences are volatile, and obsolescence occurs more quickly than other asset classes. While some obsolete retail properties are transitioning to other uses, often times the cost is prohibitive. It all comes down to location and tenant mix.

Despite forecasts of the ‘demise of retail’ predicted by some at the outset of e-commerce, e-commerce currently accounts for approximately ten percent of consumer sales, while brick-and-mortar accounts for 90%. Retail landlords (and others) understand that while e-commerce has hit certain parts of retail, it hasn’t hit everywhere. The majority of consumers still enjoy congregating and touching products prior to buying. Even Millennials, who are highly technical and use their devices to research products and services to make purchasing decisions, often use those devices to compare prices and features while in stores. In fact, reportedly 80% of consumers now use their devices to research and compare products and services – either before or during their visit to a store.

Not only that, but according to Carol Lapidus, consumer products industry practice leader for McGladrey, Millennials use technology to share their experiences with family, friends and work colleagues. They are highly likely to use social media to tell others about their recent purchases or visits to restaurants or entertainment venues. In fact, reportedly 80 percent of all consumers now use their devices to research products and services and compare either prior to or during their visit to a store. Therefore, it’s understandable why “internet commodity” stores are performing more poorly than necessity stores. In addition to nail salons, dry cleaners and restaurants, other necessity stores include grocery stores, hair salons, dollar stores, liquor stores, check-cashing and pawn shops also provide NOI stability.

Another shopping habit of Millenials: they have a strong preference for boutiques, trendy restaurants and coffee shops – all unattainable on the internet. Understanding the technology habits of shoppers who tend to share their experiences with family and friends via social media is imperative for the landlord’s tenant selection. The tenants who use technology to connect with this demographic often build and maintain customer relationships more than the tenants that do not.

And while there is no discounting the importance of millennial consumers, it’s also important for landlords to think about tenants that cater to baby boomers and their interests, as well. Just one example of how landlords are considering this still important demographic: shopping centers across the country are being repurposed into medical offices, as health care tenants are increasingly becoming another internet-proof tenant that is helping stabilize properties, increase NOI and increase value.

On the other end of the spectrum, major national retailers searching for smaller spaces, since it’s not as important for them to house vast amounts of physical inventory. So the lines between e-commerce and shopping centers are becoming increasingly blurred. Traditional retailers are now relying more on their websites and social media to connect with customers, while e-commerce retailers are opening showrooms to allow customers to embrace products in person. This shift in dynamics has been quick. Landlords who can identify the right tenant mix are likely to be rewarded with high occupancy, low vacancy, high NOI and higher valuations.

Neil Axler is Director, McGladrey LLP, a national provider of assurance, tax and consulting services.

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