Trends & Tips For Those Heading To RECon 2018

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In advance of the 2018 ICSC RECON expo in Las Vegas, it’s an opportune time for our annual “Analysis Without Paralysis” retail market predictions. As we’ve done in the past, our analysis takes a qualitative view of the unique insights we’ve obtained with over 90,000 commercial properties placed in our marketplace. 

The Year of the Hippo Market – Not Quite a Bull or a Bear

2018 is what we’re calling a “Hippo Market” – not quite bull or bear but a massive animal that can charge when an opportunity arises or shy away when danger approaches. Primitively put, two factors directly affect value: yield (cap rates) and net income. 
Yields are expanding with interest rates, and the resulting costs of capital are pushing both bonds yields and cap rates up with them. Increasing yield requirements bring deflation: to get the greater desired return at the same income, you must pay less. However, net incomes – often a function of the economy (occupancy, rates, inflation/operating expenses) – are still growing in this low vacancy environment, which offsets some of the yield-driven deflation. 
The net result is flat value, and in many instances, modest deflation. We’ll see deflated values up to 15% (an approximate 100 bps of cap yield expansion) or more in some secondary and tertiary markets. Values for secure assets in strong markets will remain stable, and in some instances up, as a glut of sidelined capital continues to chase good deals.
 

Transaction volume is down, but healthy.

Here’s a dirty little secret: transaction volume is down (but still healthy). A widening bid-ask gap of buyer vs. seller value perception is coming from buyers reacting in real-time to changing conditions and seller’s expectations tending to lag until a trend becomes the norm. Following a long and active expansionary cycle, deals are becoming more challenging and timely to complete. 
While the market commentators still declare the market, “hot, hot, hot,” sellers with property see slowed timelines and slightly softer pricing. There was cooling from 2016 to 2017, and there will be some more cooling in 2018. That said, pricing is still stable, and plenty of transactions are occurring for well-priced and well-positioned assets as we softly land from the last cycle. We recommend sellers hire expert brokers to navigate the changing environment, push their deals over the finish line, and capture what are still very strong asset values.
 

When everyone is zagging, is it time to zig?

Overreaction to the Amazon effect is causing retail to be product type non-grata. Retail is not changing; it has already forever changed. As many seem to be zigging away from the product type, there is yet opportunity. Consumer behavior and preferences have changed, yet high-performing centers still boast full parking lots, grocery sales are strong, and some goods and services can’t be obtained virtually. 
Retailers selling homogenous products (ex: paper towel, books) could struggle from the Amazon effect. However, retailers selling heterogony and experiences instead of goods (restaurants, gyms, luxury) or convenience will continue to prosper, and successful landlords and investors will learn to optimize their tenant mix better. 
Creative landlords and opportune investors will backfill vacant boxes, creating value-add opportunities for entrepreneurial investors. Who will they backfill those boxes with? How about industrial users, who are increasingly seeking centralized locations near population clusters, becoming desensitized to double-digit rents, require loading docks and large parking fields for truck aprons, and can use storefronts for hybrid retail distribution? Why not?
 

High-street isn’t retail – here’s a holistic view.

We’ve said this in the past: well-known luxury retailers are often writing off their high-street rents as showrooms and advertising costs, and the stores aren’t always viewed as direct profit centers. Many high-street retailers recognize that their retail location is a branding vehicle and a place to get customers to try on products before buying them online. Additionally, the store serves as a return-outlets where a customer can return something purchased online and often ends up buying more. While rents are typically high, footprints are small and staffing needs are usually low. 
Assuming a well-thought-out brick and click solution, many high-street retailers are poised to adjust to the changing environment. Once exclusively online retailers like Warby Parker (who once professed they would never have a store), Toms, All-Birds, and Amazon are recognizing the value of a physical location and rolling out stores. Analysts, investors, and landlords should take a holistic view of their tenants and also analyze corporate health.
 

Sell your clothes or die.

Selling other brand’s products – especially apparel – can be a dangerous game. If a customer tries on a pair of Nikes at a Nike store but then purchases them online, Nike will still realize the revenue. If a customer tries on a pair of Nikes at Sports Authority but then buys them at Nike.com, Sports Authority will not achieve the revenue despite paying the rent and human cost to service that eventual non-customer. While Nordstrom and other department stores have done okay, Sears, Macy’s, and others have been challenged for a myriad of reasons. This includes selling other people’s products, which are tried on and then bought online directly from the brand.
 

Private equity supercharges company debt.

Yes, the retail landscape has changed, and sales are down for many concepts, but often the deathblow to a struggling chain that could have otherwise recovered is their corporate ownership structure. Leveraged Buy-Outs (LBOs), now more-politely called Private Equity, have resulted in many companies’ balance sheets being loaded with debt.  
When a private equity firm buys a business, the debt used to acquire the business typically goes on the acquired companies balance sheet. If a PE firm buys a retailer for $1B with 80% leverage, the retailer now has to service a $800MM loan. 
Servicing that debt is expensive, and there is little room for error. A decrease in sales, which could have once been recoverable, is now catastrophic. Many of the high-profile Private Equity owned retailers have taken their medicine, but there are more out there.

Retail must follow the people.

Urbanization is as real as southern migration. Study the demographics. Populations are moving from the iconic northern cities to younger southern cities to find opportunity, escape taxes, benefit from more business-friendly environments, find better weather, and to retire and service those retirees. 
Many of these markets are young and raw and still require some essential development to infill grocers and other basic needs. We love growing warm-weather markets with some physical barriers to prevent sprawl, and we believe the rise of the small city will continue.
 

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Paul Cohen
Paul Cohen

National Sales Director

Paul is the US Director for CREXi where he utilizes his experience in assisting brokers in getting deals done. Paul is widely recognized as a market expert in Commercial Real Estate and has represented numerous private owners with underwriting and developing marketing strategies and has over $1 Billion in total transaction valuation.

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