Anthony Grosso is Co-Founder, Co-Chairman, and Managing Principal of First National Realty Partners.
As a real estate investment firm, we specialize in the acquisition and management of broad, multipurpose commercial real estate assets, but we don’t like to call them shopping centers. Given the ever-changing retail landscape, we believe that this is an overly simplistic term that misses a key point about modern retail tenants. There’s much more than just shopping happening in their storefronts.
While modern retail stores are places where shoppers go to buy things, they’re also storage centers, ghost kitchens, offices, distribution points and medical centers. As a result, these “shopping centers” have become more of a diversified commercial real estate asset. As time goes on, I believe that institutional capital will recognize this fact and the resulting cap rate compression will drive prices higher to valuation multiples that are more akin to industrial or multifamily properties. There are four macro trends shaping this narrative.
1. Adaptive Reuse
It’s true that the continued rise of e-commerce and changing consumer tastes has been bad news for traditional retailers of consumable goods like J. Crew, J.C. Penney, Neiman Marcus and Brooks Brothers. But, the flip side of this fact is that their vacated space — at low single-digit rents — has provided retail property owners with a unique opportunity to backfill and/or repurpose it with stronger tenants who are willing to pay higher rents.
For example, vacant retail space has been converted into churches and used for medical facilities. Or, in more creative projects, vacant space has been turned into student housing or so-called “ghost kitchens,” which are delivery-only restaurants.
No matter the vision for reuse, the important point is that the above projects represent an evolution in retail space meant to meet the needs of the modern marketplace. These are no longer traditional retail shopping centers, but they do inhabit traditional retail spaces. When these types of businesses are present, the property ceases to be a traditional shopping center and is transformed into a present-day mixed-use asset.
2. Omnichannel Distribution
To survive the competition presented by digital-native businesses like Amazon, Casper, Allbirds and Everlane, existing brick-and-mortar retailers have had to adapt. In many cases, this means that they’ve had to do two key things.
First, they’ve had to invest heavily in the digital shopping experience. For example, Wal-Mart, one of the largest retailers in the world, also has one of the largest physical footprints in the world. As traffic to its stores has declined, it has had to invest heavily in its digital presence to provide the same type of shopping experience to its customers online.
Second, many retailers have reduced the size of their sales floor while simultaneously expanding the size of their stock rooms to accommodate the shipping and receiving activities required to fulfill orders that come in through digital channels. This is particularly prevalent for small and mid-sized retailers who don’t have the resources for centralized fulfillment and distribution facilities.
Given both of these activities, the point is this. A retailer may have a physical footprint within the confines of a commercial property, but it’s increasingly likely that they aren’t just a retailer. They may be using their space to sell goods to customers in the local market and to manage the logistics of shipping orders to customers outside of their market. As a result, this space acts as a hybrid of retail and industrial.
3. Experiential Retail
No matter how much of the retail shopping pie shifts to digital, there are certain segments of the retail business that just can’t be replicated online. Think about quick-service restaurants, boutique fitness centers or grocery stores. These types of businesses go beyond the traditional retail experience, and their presence in a property means that they transcend the description of a traditional shopping center.
4. Last-Mile Distribution
One of the reasons that major corporations are particularly interested in the retail space is that they represent a creative solution to the very tricky “last mile” problem, which is the complexity of delivering goods the “last mile” to the consumer.
Because retail spaces are located in close proximity to the customer base they serve, they act as the perfect distribution channel to reach consumers through local delivery or in-store pickup. There’s no better example of this strategy than the combination of Amazon and Whole Foods. So, in this sense, the modern retail space acts more like a warehouse/distribution center and should be valued as such.
What This Means For The Industry
As retail investors, the health of your tenant businesses and their ability to pay rent is a primary risk management concern. To this end, consider looking for properties whose tenants are well-protected against ongoing digital disruption such as grocery stores and other businesses with an experiential component. For example, my company’s West Market Street Station property is anchored by a Whole Foods grocery store and supported by experiential tenants like Orangetheory Fitness, Anthony Vince Nail Spa and Moe’s Southwest Grill.
So, despite the fact that these are retail businesses located in a retail center, “shopping centers” are really more like diversified commercial real estate assets because businesses like those described above aren’t just in the retail business. They’re in the experience, transportation and logistics businesses, and their presence in the center means that it’s closer to a mixed-use asset. I believe that, over the long run, other institutions and investors will realize this fact and valuations will adjust to reflect it.