Our newsletter focuses on what I am seeing on the ground, reading and thinking about, and synthesizes those trends for the "so what." I question conventional wisdom, reframe the usual premise and aim to ask unvarnished, thought-provoking questions about (sometimes) under-the-radar issues that drive opportunity and risk. Expect the issues to vary, from time to time, as dynamically as our industry does.
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I hope you've enjoyed the summer. Welcome to the third issue of The Voice of Retail of 2024, where we'll explore a growing trend of retailers becoming more property-type agnostic; why investors need to avoid complacency despite record low vacancy; how changing yields and a zero-sum approach to lease negotiations is roiling the triple net lease market; how effectively leveraging generative AI is similar to the way we get the most out of so many other exchanges; a wild look at the impact of credit card income on retailer economics and more.
A More Property-Type Agnostic Approach to Expansion
Location, location, location is the prime directive of real estate. For at least a decade, retailers have been relying more heavily on location analytics for decision-making. But even as they deployed better and better analytics, retailers continued to gravitate to familiar property types and place their bets on co-tenancy.
More recently, we see tenants breaking out of traditional mindsets around location, as the wonderful Todd Caruso first pointed out to me. As consumers have shifted where they spend time — and concomitant consumption — retailers are becoming more flexible to capture those dollars, and thus more property-type agnostic.
The mantra is convenience: Can I access the shopper? Do I have the visibility I need? Is the location and parking easy to navigate? As a result, we see some traditionally mall-oriented tenants moving outside the mall, even to grocery-anchored centers, as we saw with Lululemon entering a Whole Foods center in Franklin, TN. Co-tenancy is becoming less of a hard requirement for some so long as intel and data back the decision and provide confidence that customers and sales will be there.
How Investors Will Evolve
As tenants lean into this new dynamic, some investors are using data to position themselves to capture the benefits of this evolution in retailer thinking. This is helping to push the trend over the threshold. For their part, investors can deploy analytics (and powerful storytelling) to explain why their property — although perhaps atypical for that retailer — is a great fit, given the consumer traffic, demographics, psychographics, etc. More than ever, owners must understand the landscape of brands and invest in access to relationships they might not yet have.
Some developers are deploying analytics (always balanced with human insight) to drive a thoughtful blend of formats, weaving elements of lifestyle, neighborhood and community centers into a unique mix of uses. Rather than replicate other formats, these developers are reverse engineering. They figure out what the dirt wants to be based on real needs and then merchandise categories to that plan.
Complacency vs. Continued Growth
Just because a property is fully leased (as so many are these days) doesn't mean your work is finished as an owner or leasing team. The work of driving activation, traffic and sales remains just as important, if not even more important, especially as opportunities to continuously move the needle with leasing are fewer and farther between.
As always, owners and their leasing advisors must have a clear, asset-level north star — with buy-in throughout the capital stack, management teams and service providers — along with a merchandising plan tied to underwriting. This strategy provides a strong lens through which teams can align decision-making and ensure each new tenant (and each decision between) is accretive to the ultimate goal. Start courting those ideal tenants today, so that when lease roll comes up, there’s an opportunity to fill the slot with the retailer that will be most productive and/or have the greatest impact on traffic and sales.
Meanwhile, owners must continually examine ways to make their brand experiences memorable, so they don't fall behind. Constantly thinking about how to bring more consumers to a project, increase visit frequency and drive greater sales will position owners to harvest growth when space becomes available.
As always, owners and their leasing advisors must always have a clear, asset-level north star—with buy-in throughout the capital stack, management teams and service providers — along with a merchandising plan tied to underwriting.
Evolving Sales Dynamics in the Triple-Net Lease Market
Readers are likely familiar with triple net lease properties, in which a merchant developer seeks out a chain-store retailer to build out a pipeline of their sites in a particular region, allowing them to expand. The cost of land and construction are amortized into the rent; and the tenant also pays for utilities, insurance, taxes, property and common area maintenance (CAM), and repair and replacement. The developer sells the property to an investor seeking a passive, fixed-income stream, and moves on to the next site. Historically, about two-thirds of these deals have involved a 1031 exchange, with capital coming out of other real estate trades.
Will Pike
, Vice Chairman and Managing Director at CBRE Capital Markets, shared that developers have been creating these opportunities to a particular yield and selling them for, say, 100 to 150 bps inside of that number. But in the recent era of sharply higher rates, tighter capital availability and spiking land and construction costs, that figure has dropped substantially. With more and more assets falling short of the spread needed to sell them, sales have slowed significantly. Our investment teams are seeing a logjam of product — from 2X to as much as 6X of supply, compared to long-term averages. Meaning that a given retailer who previously had 10-12 units on the NNN sale market might have as many as 60-70+ today!
Although the issue is primarily yield-driven, Thomas Carr
, Associate Vice President at CBRE, adds there's another factor at play: Leases have become increasingly one-sided in favor of tenants. The tougher terms for investors include a range of tenant termination options; pandemic-related language allowing tenants to pay zero or far less rent in the event of Covid-19 repeat; and tax reassessment clauses, in which rising taxes cause some slippage to NOI. Historically, when the market was humming, investors tended to overlook these issues. But when supply and demand balances change, imperfections loom much larger, and give buyers a reason to pass — particularly when they can go buy a bond for essentially the same rate of return.
Our investment colleagues tell us that at the moment, the market is biding its time, patiently waiting for the Fed to cut rates, hoping things will turn around and product will begin to move. But developers are more hesitant to continue growing their pipeline for these tenants. We're watching for two scenarios: A lack of new supply could dent retailers' expansion plans; or retailers will drop the most onerous clauses. There have been a few instances of landlords and tenants convening to revisit existing lease terms in the toughest situations, which underscores the uniqueness of retail as a sector, and the ways unbalanced terms can lead to long-term challenges for everyone.
How AI Can Better Train Our Thinking
Speaking of evolving dynamics, some commented that generative AI and Large Language Models (LLMs) will take the thinking out of the work we do. I would argue just the opposite: The better the thinking that goes into the tool, the more powerful the output, and that improvement isn't linear.
On that front, crafting the right prompt is a crucial component of AI interactions. A well-engineered prompt elevates the accuracy, effectiveness and relevance of results from engines such as Open AI's ChatGPT, Google's Gemini, and our own internal AI platform. Essentially, if given a thoughtful prompt, one can extract a more detailed and precise response in return. This yields responses that more closely align with expectations — and power better problem-solving. Users seeking to make the most of these tools need to develop a disciplined approach to formulating queries.
This is no different from the art of seeking the best feedback from whomever you report to: your CEO, investors, board, clients. You can better serve those people if you know what they want and need, even if they haven’t perfectly articulated it. The better the questions, the better the feedback you’ll receive, both direct and between the lines — giving you the necessary intelligence to create ideal outcomes for them. In short, the quality of the response or output is directly proportional to the quality of the prompt. Generative AI is powerful, but only as powerful as the user “inspires” it to be.
Beyond Real Estate
In this section, I share recent readings that have piqued my interest and delve into insights sometimes beyond, but always somehow relating to, commercial real estate.
Within department stores and airlines, credit cards — rather than retail sales — now generate a surprisingly large portion of profits. Customers who hold department store credit cards are more likely to make purchases, while creating almost zero overhead for the store itself. Credit card income accounted for about 47 percent and 66 percent, respectively, of Nordstrom’s and Kohl’s operating income last year, according to Bank of America Global Research. At Macy’s, the figure was about 55 percent in 2022, according to Citigroup. The Points Guy shared on a recent
episode of The Weekly Take that $7 billion of Delta’s $55 billion revenue comes from credit card income alone, which he argues, “...is a huge portion of their actual EBIT."
If you haven’t taken the time to read this report, I highly recommend it. Page through the written insights and explore the interactive graphics. There is a lot of new content which answers questions many have been afraid to ask that are relatively baseline for any regional or national thinking on retail property investment or brand expansion. Topics include the arc of suburbanization and urbanization in the U.S., comparing growth across groups of cities and the more nuanced evolution of commute times in major cities.
If you look at only one thing, check out the interactive District Analysis. Our research team designed a mapping framework to identify clusters of vibrant urban characteristics and studied their effect on real estate market fundamentals. We have a retail deep dive, building on this piece, in the works. Stay tuned.
And if you’re craving more, the key points in Mary Anne Tighe’s 5-minute take on New York’s future applies to far more than just New York City.
In the last issue of The Voice of Retail, we touched on the role of stores and how the ways we account for their value must shift. As use-types evolve for retail space, it is all the more important to be clear on how to measure success.
As Rachel Wein wrote in a very thoughtful piece
, healthcare and medtail tenants can’t solely rely on traditional measurements of success, such as impressions and sales when one patient could spend thousands of dollars on oncology medication while another is picking up a 99-cent prescription. With reimbursement rates changing (sometimes rapidly) in a matter of months, the 99-cent prescription might even be reimbursed at a higher rate than the cancer medication. Other challenges include recruiting and retaining physicians and physician assistants, especially for newer groups aiming to enter the space and contextualizing a particular space's need in the broader demands of a given health system. Prioritizing transparency into the operating model (reimbursement rates) and focusing on picking the right health system is crucial. And so is asking the right questions as a better gauge for success: What is their plan? What value do they see in a property along with their ecosystem of care? Why do they need your
property and for what services?
Drop-shipping, the e-commerce model where sellers fulfill orders without owning or managing an inventory (more relevant with the increasing rise of retailers like Nordstrom adopting a marketplace model accepting 3rd party sellers), has become intensely competitive. Some companies are building AI-powered drop-shipping platforms that help users automate processes, find sellable products and quickly track their orders, making this low-margin model much less risky. Grandview Research is
predicting an average increase of 23.5% CAGR from 2023 to 2030 with 30% of online stores using drop shipping for fulfillment. But how will this lack of control square with a growing demand for quality client experience?
Drop shippers need to treat their businesses like a brick-and-mortar store to be successful — paying close attention to layout design, the quality of suppliers, competitive pricing and effective marketing. Especially where quality and client experience is paramount, drop shippers should also weigh the challenges: highly competitive, lower margins; lack of control over inventory quality, errors, quantity and shipping times since they don’t control suppliers; customer service and returns challenges.
