C&W Analyst: New Wave of Store Closures on Deck for American Retail Market

Toys ‘R’ Us carried a heavy debt load when it filed for bankruptcy earlier this year. According to Cushman & Wakefield retail analyst Garrick Brown, the market is likely to see more of these leveraged buyouts as major retail chains continue to close their stores.

LAS VEGAS — Another massive spate of store closures is coming in America, and both retail landlords and operators should expect to feel the strains of an over-retailed market until the next recession, according to one of the nation’s leading analysts of retail real estate.

Garrick Brown, vice president of retail intelligence at Cushman & Wakefield’s Rancho Cordova, California, office, believes that an overall economic downturn will be a key catalyst in alleviating America’s excess retail space, as a recession will push retailers that are eking out a profit over the red line.

The arrival of an economic slump that reduces consumers’ disposable incomes should trigger the next wave of store closures, said Brown. The victims are bound to be retailers that have yet to distinguish themselves from their competitors in terms of either product pricing or shopping experience.

Brown spoke to REBusinessOnline at ICSC RECon in Las Vegas, the world’s largest retail trade show that was held on May 20-23. In addition to laying down some tough realities for American retail, Brown noted that the next couple years are likely to see more leveraged buyouts of struggling retailers as well as a rise in food hall concepts.

Brown’s edited responses to a series of big-picture questions on where the American retail market is headed are as follows:

REBusinessOnline: Beyond consumer preferences and e-commerce, what other factors have led to the American market being so over-retailed?

Garrick Brown: We have a mediocrity issue in American retail. Some of that is Wall Street-driven: As chains got bigger they became commodities. They looked for all these ways to create efficiencies while their customers were experiencing wage stagnation.

Sam Walton’s [Walmart] business model was about value and selection. It wasn’t about service. If you’re a mid-priced retailer that has no dedication to service, you’re suffering right now. People will show up if there’s value involved or if there’s an experience. But if you’re in the middle, you may have fallen victim to e-commerce.

REBO: What are some factors beyond e-commerce that will impact the rate of store closures?

Brown: The first factor is the degree to which we’re over-retailed. There’s about 25 square feet of retail per

Garrick Brown, Cushman & Wakefield

man, woman and child in the U.S. The closest country behind us is Canada with 16 square feet per capita. Great Britain is the most retailed country in Europe with 6 square feet per head, so we’re about four times as retailed as Britain.

E-commerce has been this catalyst that came along and exposed every weakness in the retail market. But there are other factors that are just as disruptive. One practice is known as race-to-the-bottom discounting, and it’s hammering all these mid-price retailers. Yet T.J. Maxx, Burlington, Ross [Dress for Less] — all these chains are on fire. Dollar stores are experiencing ridiculous growth. The top five dollar stores chains have added nearly 6,500 new stores over the last four years. That means a new dollar store has been opening about once every five hours for the last four years.

Disruption is happening, and furthermore, a lot of the retailers that are growing aren’t especially glamorous. Part of our issue with this dark cloud over retail is that when Americans think of retail, they still think of the malls and department stores they grew up going to, and that’s where some of the biggest pain is.

Lastly, there’s the demographic shift, and that applies mostly to millennials. This group spends money differently, less on stuff and more on experience. They spend more on food and dining out and they’re not buying homes, which impacts the furniture market.

REBO: What are some other retail trends we can expect to see in 2018?

Brown: This year is going to be remembered as the year of leveraged buyout, debt-related bankruptcies. Take Toys ‘R’ Us, for example. They were a very relevant retailer for many years, but the company had a massive debt load. With the practice of leveraged buyouts, wherein a company borrows money from a bank or whoever to buy a retailer as a private equity venture, the debt doesn’t go on the buyer’s balance sheet. It goes on the retailer’s books, which means the deal is priced to perfection. It also means that just a moderate decline in sales will kill the retailer.

It’s the same as with a person who makes good money but has maxed out his or her credit card debt. If the majority of the person’s paycheck goes to credit card debt, and then his salary decreases by 10 percent, he’s toast. And that’s what we’re going to see more of in the retail space. Several retailers, including Guitar Center, GNC and Nieman Marcus, are already in this precarious position. So as far as closures are concerned, we’re going to see another wave.

REBO: So to be clear, the worst is not yet over?

Brown: I’m afraid not. We’re about halfway through the current wave, and we’re not going to reach a new normal until we go through a garden-variety recession. What that will do is wash away a number of the retail concepts that are just barely hanging on.

Part of the problem is the tendency to forget that we’re still so over-retailed. When the herd is overpopulated, it’s the weak that die and the strong that survive. This is holding true in the cases of both the retailers and retail real estate.

People like to think that malls are dying, but really it’s the Class C malls that are getting killed. Class A malls are doing fine; their biggest challenge is perception. They have to worry about the fact that the investor class doesn’t understand the nuances of the retail story. Consequently, retail stocks are undervalued right now, even for the best operators.

Food Halls Offer Ray of Sunshine

REBO: Over the last few years we’ve really seen the food hall concept blossom and take root. How did food halls attain this level of growth?

Brown: It’s a variety of things, starting with the rise of foodie culture, which started 25 years ago with 24/7 food television networks. At that time, the American palate began to change and become more exotic. Big immigrant cities always had more exotic food offerings, but now you had this general movement of people in all cities becoming more adventurous with food.

Lincoln Eatery in Miami Beach, Fla., will feature 16 fast-casual restaurants, juice bars and artisanal coffee tenants.

Millennials are unique to this scenario; they value authenticity above all else. So the big chains, especially casual dining concepts, aren’t resonating with millennials quite as much. There’s been a renewed emphasis on authentic cuisine, especially with their generation.

Combine that need for authenticity with what’s happening in the retail industry. A number of major retail categories are in contraction mode and there’s a need to fill space with tenants that connect to consumers and drive foot traffic. It’s within that combination that you started to see the explosion of food halls. The concept has been around for a long time. We just used to call them by other names.

REBO: Where is development of new food halls headed over the next few years? Are we approaching saturation in some markets?

Brown: Over the last three years, we’ve tracked development of about 100 new food halls across the country. At that rate, the market will absolutely hit 300 food halls by 2020. Some might say that even that estimate is too conservative — it could easily be 400. Mall developers want food halls because they drive traffic and really connect with consumers.

In addition, food halls are taking new forms. We’re seeing everything from food halls being created from scratch to celebrity-focused food halls to projects that convert food courts into destinations that look like food halls.

A challenge we’re facing is that so many owners and developers are jumping on the food hall bandwagon, so the definition of a food hall is really being stretched. It’s something the industry hasn’t agreed on. Is it a food hall if it’s just a glorified food court? Is it a food hall if there’s nothing special about the environment or it’s not accompanied by entertainment offerings?

We see so many projects going forward. Once we finally see the first wave of significant failures — which hasn’t happened yet —then we might realize it’s time to clarify what a food hall is.

We’re nowhere near saturation yet. As we build more food halls, we’ll start to see more quality food halls that reflect community, authenticity, experience and entertainment. Those concepts are going to thrive, and the knockoffs that are just glorified food courts in crowded marketplaces won’t do as well. But as of now, we haven’t seen any significant failures.

It’s undoubtedly a crowded marketplace and you have to wonder how much supply it can bear. But like everything else in retail, someone is eventually going to come along with a brighter, better concept. And that’s part of why we’re over-retailed: We can always build new stuff and people will show up. We’re not overbuilt; we’re under-demolished.

Buying/Selling Trends Shift

REBO: Although it is still low by historical standards, the 10-year Treasury yield is up about 60 basis points since the beginning of the year. Spreads are tight for banks. How are these trends going to manifest in the retail market?

Brown: Cap rates are going up on retail properties. But investors are more concerned about the risk that retail assets carry, not interest rates.

In addition, cap rates are not going up equally. The buyer pool has shrunk by about 30 percent. Pension funds have been particularly bearish on retail and are unloading properties. Your typical institutional investors haven’t completely cut out of retail, but we’ve seen them engage in some big portfolio sales and cut the proportions of retail holdings in their funds.

The buyer pool is smaller and most investors who are left are chasing the same thing: core and core-plus properties, Class A malls, occupied Class A urban retail. They’re afraid of Class B malls and nobody is buying Class C malls unless it’s a redevelopment play.

Class A power centers are actually pretty low-risk, but their cap rates are going up. The same applies to Class A neighborhood centers — your neighborhood grocery-anchored centers with restaurants and dry cleaners and e-commerce resistant players. And this is happening because of this combination of investors unloading properties and chasing the same kind of product when they are looking to buy.

However, there is a segment of opportunistic buyers who love retail apocalypse stories. The narrative allows these investors to buy product for cheap. In their view, perception is worse than reality, and sadly that’s not about to change.

REBO: There seems to be a bias among institutional investors that grocery-anchored centers are the most preferable asset class. But in reality, they aren’t all equal. What is your view on this sub-type of retail properties in today’s market?

Brown: A lot of players aren’t looking at grocery-anchored centers in terms of class. But there’s a big difference between a center that’s anchored by a Publix and one that’s anchored by a regionalized small chain.

In addition, investors need to be looking closely at the size of the grocery box. In the past, grocery boxes used to be 50,000 to 75,000 square feet. Now, grocery users run from 15,000 or so square feet for the likes of Trader Joes or Aldi. Then you’ve got Whole Foods at 30,000 to 40,000 square feet and you also have a lot of smaller formats.

The $121 million 360 Market Square is a mixed-use development in downtown Indianapolis featuring 292 luxury apartment units and a Whole Foods Market. Flaherty & Collins was the project developer.

So if you have an old 70,000-square-foot space and a grocer with financial issues, that’s a red flag. But even if you’re talking about a grocer with financial issues, if it’s a good location and a small box, there might be an opportunity.

Whole Foods is an interesting play right now. They’re likely to experience a growth spurt because they’ve been working to lower prices and increase supply chain efficiencies. They want to compete head-to-head with Walmart and Kroger, each of which has more than 2,000 units. So it’s conceivable that they could ramp up store openings, maybe as much as 500 new stores over the next five years. Whole Foods isn’t on the record saying this, but it’s conceivable.

REBO: It seems like whenever a new retail concept emerges and finds success, lenders continue to give them money to build and build and build. Invariably, unless the company is cut off prematurely, they end up overbuilt. How does this keep happening?

Brown: One of the reasons the American retail market is overbuilt is because we have publicly traded chains. With those entities, there are two main ways to boost earnings. The first is to increase same-store sales, which is usually a function of effective marketing or an overall strong economy. The other way is to open new stores. And as long as the market supports it, you will continue to see the emergence of big store openings.

But you start to see a pattern when the market becomes saturated, when those same-store comps start going down. You’d think that would be a red flag that would encourage companies to stop expanding.

Concerns over maintaining and growing market share also factor into this kind of expansion. But in fact, a lot of times this attempt to seize market share results in a company creating a balloon that’s going to burst. The lenders could prevent this, but they don’t.

— Matt Valley & Taylor Williams

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