CREJ - Retail Properties Quarterly - February 2018
The morning of Aug. 28 marked a new paradigm for retail real estate when Amazon announced its purchase of Whole Foods. E-commerce’s menacing effects on brick-and-mortar retail had been discussed for years. However, this was the decisive tipping point for the industry to take notice. Prior to this event, retail investment sales in Denver of large-format shopping centers were in the sub-7 percent cap range, a phenomenon first realized in 2013 with the sub-6 percent sale of South Denver Marketplace and, more recently, the sale of Aspen Grove at 6.2 percent. In September, soon after the Whole Foods transaction, Sam Zell said on CNBC, “Investing in the (retail) space right now is like catching a falling knife.” His reasons: Excess inventory and the effect of e-commerce. Zell highlighted U.S. inventory as 4 to 5 times more per capita than in Europe. Additionally, the U.S. Census will show that retail space in the United States grew 180 percent from 1970 to 2010, while the population grew 52 percent. Zell’s comments are bold given the nature of the national economy. The national gross domestic product has been growing for eight years, and unemployment is under 5 percent. According to JLL research, the national retail vacancy rate in the third quarter, just after Zell’s statement, was 4.5 percent – decisively healthy. Bolstered by an 18-month build up in positive wage growth, 2017 holiday sales were excellent. According to Mastercard, the holiday shopping season for in-store retail in the U.S. was up 4.9 percent as compared to 2016. This is more consistent with what we are experiencing in Denver as evidenced by retail fundamentals. Since 2009, there has been a clear positive trend. Overall, vacancy has stayed under 5 percent and 2017 ended at 4.5 percent. Rental rates continue to rise, quoted at $17.81 per square foot at the end of 2017, a 5.95 percent increase from 2016. The market also had nearly 1 million sf of absorption in the fourth quarter alone. The most meaningful statistics for the health of Denver’s retail is new construction. In the last 35 years, Denver has experienced an average of over 3.5 million sf of annual construction. This number has been contained in recent years. For a five-year period, including 2010 through 2014, the average annual construction was 1.2 million sf. In 2015 and 2016, the average was 1.7 million sf, and 2017 ended at 2.2 million. This number likely will increase in 2018 as 1.9 million sf was under construction at the end of last year, but the upward trend likely will taper. The 2017-2018 projects are largely made up of occupied buildings with tenants such as Scheels, Sam’s Club, Walmart and King Soopers. The current market is disciplined, operating at a fraction of the historical base. Given the demeanor in retail and its tenants, controlled expansion will continue. Despite the positive trends, there is no denying that the landscape in retail is changing. Building on past bankruptcies, several retailers with stores in the Denver market filed for bankruptcy in 2017. These include The Limited, Gordmans, RadioShack, Gander Mountain and Payless ShoeSource. Given the positive fundamentals and the controlled expansion, what is the lasting impact of e-commerce? According to eMarketer, 90 percent of purchases remain in stores. Additionally, retailers are adapting to customers by blending the online and in-store experience. In fact, Amazon opened its first bookstore in 2015 and now has dozens with plans to expand. Other e-commerce companies are opening their first physical stores as they experiment with omnichannel distribution, some examples being IndoChino, Bonobos and Warby Parker. As some retailers disappeared, others are finding equilibrium. The face of retail is changing, but the need for it is not fading. Since 2014, 17 malls across the country simply took the word “mall” out of their names to start catering to the changing marketplace. The fact remains that convenience and visibility are inherent in retail and it represents the best real estate in a marketplace. “Main and Main” has tended to last for generations and this will continue even if the signage and services provided change for the next generation. This will apply in Denver where the economy is more diverse than in past generations, and employment and population trends are robust. In contrast, retail sales volume has been consistently down. According to our research, national volumes declined 21.4 percent last year; CoStar statistics shows a similar 20 percent for Denver using a yearly third-quarter comparison. The emotional reaction to e-commerce has pushed buyers to hedge risk into core offerings consisting of urban or grocery retail where cap rates will continue to compress. Given the historical lack of urban retail and grocery operators’ tendency to own their stores, these types of deals are difficult to find in Denver. Debt also remains favorable for this class, enticing owners to hold assets. Value-add and opportunistic assets are uncommon as a result of the elongated performance of local retail trends, contributing to the continued decline in the sales volume. As emotions settle, the supply/demand imbalance will favor sellers. Buyers will widen their scope, creating new opportunities for owners in Denver to maximize proceeds.