Despite a spate of recent store closure announcements, industry experts say retail real estate isn't broken — but it is being remodeled, possibly furthering a convergence of real estate sectors.
Retail is one of the four pillars of the real estate investible universe, along with office, industrial and apartments. However, some of the once most-prized tenants for retail properties are in the midst of structural changes as consumers go online, leaving shopping center landlords searching for replacement tenants.
Macy's, J.C. Penney, CVS, The Limited, Wal-Mart, Sports Authority, Office Depot and Sears have all have announced store closures in recent months. Neiman Marcus Group Inc. in January withdrew its registration for an initial public offering after closing stores in 2016.
Observers predict more store closures are to come.
Equity real estate investors are not pulling out of retail in light of the store closures because the retail they own is performing well. But the store closures are changing the way investors view the sector, adding more risk to properties such as department store-anchored malls that had been viewed as safe investments, real estate managers say.
“Traditionally, the safer part of the retail universe was department store-anchored malls, now it will be one of the worst,” said Lee Menifee, Madison, N.J.-based managing director and head of Americas research of PGIM Real Estate, the real estate money management arm of Prudential Financial Inc.
“The right tenant used to be the department stores that drove traffic through the rest of your mall,” Mr. Menifee said. “Now the risk is that the weaker department stores are driving traffic away from malls.”
The way real estate managers underwrite or analyze retail investments is changing, too. In the past, investors underwrote retail by looking at the creditworthiness of the tenants.
“That's not the way to assess whether a retail center is a good investment or not,” Mr. Menifee said. “We don't know who the winners will be ... Whoever they are will want to be located in the best conceived, best-located centers.”
Instead, managers are looking at sales, location and traffic, he said.
Adding to the woes, rent growth in the retail sector is expected to remain sluggish in North America through 2019, according to LaSalle Investment Management, Chicago.
Some retail malls are going out of business, being turned into data centers and office parks while others are being transformed into mixed-use centers that offer apartments above a mix of national chains, boutique shops and service-related establishments such as gyms, restaurants and dry cleaners.
“The way to do re-tenanting is less like-for-like but taking an old space and making it good for a couple of restaurants or a movie theater,” Mr. Menifee said “Replacing a department store with an H&M, which is selling the same type of products, is version 1.0. Version 2.0 is converting mall space from just selling goods to providing services.”
The transformation of retail makes it one of the most challenging sectors, said Ronald M. Dickerman, president and founder of New York real estate manager Madison International Realty.
But there is opportunity in the changing retail landscape, he said.
Madison International Realty executives are bullish on grocery-anchored retail shopping centers, malls in main city locations and fortress malls, which have at least four anchors and sales of $600 to $700 per square foot, Mr. Dickerman said.
Grocery-anchored shopping centers have suffered less disruption from the internet and in an economic downturn, people eat out less, making grocery stores more attractive, he said.