Author Mark Twain is famously quoted as saying, “The reports of my death are greatly exaggerated.” Similarly, the retail industry continues to defy expectations and stand the test of time, regardless of long-term trends or the short-term impacts of the COVID-19 pandemic, inflation and recessions.
While retail trends shift based on the economic and political environment, investors continue to add shopping centers and malls to their investment portfolios. As a commercial mortgage originator, understanding the current and forecasted retail trends allows for a more profound discernment of which investments will be fruitful and which investments are likely to falter.
It is true that shopping malls of today may no longer resemble the malls from years past, which were filled with trendy, high-end clothing stores and massive food courts. The malls that have survived, however, offer consumers a diversity of options. In a similar vein, lifestyle, community and neighborhood shopping centers also have continued to transform and diversify their mix of tenants to remain viable and competitive.
Over the past two years, retailers have had to adapt to the continuous shifts in the economy caused by the pandemic — and to the ways consumers have responded to these shifts. During the early stages of the pandemic, consumers were hesitant to spend money on items deemed unnecessary. Some were reluctant to even leave their homes unless it was absolutely necessary. At the same time, stores, restaurants and the travel industry were virtually shut down.
Fall and rise
These various factors caused a sharp decline in a variety of sectors, including tourism, hospitality, entertainment and restaurant dining. Conversely, purchases of goods deemed necessary (including groceries, home improvement supplies, electronics, home fitness products and meal delivery services) skyrocketed.
The retail environment changed drastically when pandemic-era restrictions eased and people could return to work, go for a trip, venture out for entertainment and start shopping in person again. Additionally, more funds were available for consumers from built-up savings accounts and government stimulus payments.
Over the past two years, retailers have had to adapt to the continuous shifts in the economy caused by the pandemic — and to the ways consumers have responded to these shifts.
The result was a rapid acceleration in consumer spending from late 2020 through 2021. These indicators had retailers and retail investors believing the sector was revving up for an incredible comeback. Overall, the U.S experienced a 7% increase in retail sales in 2020 and more than 14% growth in 2021, according to the National Retail Federation.
The increases in retail sales drove higher demand for space in shopping centers, as evidenced by a 1.1% increase in shopping center occupancy for the year ending in second-quarter 2022, according to the International Council of Shopping Centers (ICSC). This improved state of retail allowed shopping center owners to stabilize their assets and cash flows, and it brought increased demand from investors looking for good retail projects to add to their portfolios.
Changing consumer habits
Retail investment sales in the U.S. returned to pre-pandemic levels with a 32% increase in total sales volume from 2020 to 2022. Capitalization rates moved down as well, from an average of 7.06% in 2019 to 6.58% in 2021, according to real estate analytics company CoStar Group.
The strong rebound in spending that the sector enjoyed in 2020 and 2021 provided the basis for an economic reversal in 2022 that forced consumers, retailers and shopping center investors to adjust once again. The heady demand from consumers gave way to shortages of products and accelerated inflation in the prices of gasoline, groceries and other necessities.
The reaction by the Federal Reserve in driving up interest rates to slow inflation caused a return to spending hesitation among consumers as the cost of necessary purchases limited discretionary spending. Additionally, increased borrowing costs put a damper on major purchases such as homes and vehicles. In fact, ICSC recently reported that 86% of consumers are changing their purchasing habits due to rising prices.
As a result of these fluctuations, retailers are recalibrating their sales forecasts for the year while retail investors and loan originators are becoming more cautious in their investment and financing decisions. Notwithstanding the return of caution, investors must still actively operate their properties and position them to survive in the ever-changing environment.
Commercial mortgage brokers must continue to see the value in retail centers and be able to interpret which retail plans will be successful. To keep shopping centers viable and vibrant, here are some key aspects to consider.
Diversify to survive
The first aspect is that retailers need to diversify to survive. Not only must investors consider overall retail activity in their plans for shopping centers, but they also must consider which types of tenants are going to be needed and wanted by consumers.
In 2021, ICSC reported the closures of 768 apparel stores, 186 footwear stores, 46 grocery stores and 20 discount department stores, indicating that some of the retail types and services usually found within shopping centers no longer met consumers’ needs the way they once did. To be successful, investors must consider the current needs of consumers and meet these needs with diverse tenant offerings.
The key to a successful brick-and-mortar retail center lies in continued diversification of the tenant mix to meet the changing needs of the community in which the center is located. This includes being considerate of uses that traditionally may not be found in shopping centers, as well as new and emerging services and experiences that will likely be utilized by these communities.
In today’s current economic climate, the goal is to provide consumers with shopping centers that conveniently meet all of their needs in one place. As investors consider their tenant portfolio and mortgage originators consider proposed retail plans, they must account for the needs of the consumer. By incorporating needs-based services, experiential offerings and future-thinking companies in shopping center plans, investors can find success that will stand the tests of economic fluctuations.
Needs-based services
When consumers leave the house, it’s often because they need something. Whether they’re buying food, visiting their doctor or purchasing medicine, consumers will head out the door to meet their basic needs.
Stakeholders in neighborhood and community shopping centers must consider the factors that bring people out of their homes and which basic needs can be met within a shopping center. Seemingly, the current key to success is a grocery store anchor. Regardless of economic fluctuations, consumers need to purchase groceries. When simply considering the frequency of visits for any one consumer to a grocery store, retail centers that already have or plan to include a grocery store will see long-term success.
Shopping centers have found success with other types of big-box retailers, such as Costco, Walmart and Target. These centers have thrived as consumers choose to visit a big-box store, then make additional purchases at other needs-based services within the center, such as a pharmacy, an urgent care center or a hair salon.
Experiential offerings
The pandemic forced the world to remain indoors and separated people from their friends, families, hobbies and social activities. As COVID-19 regulations loosened, consumers excitedly returned to group settings.
Businesses such as gyms, restaurants and breweries have regained their popularity. Experiential offerings like axe-throwing centers, cocktail-making classes and concerts are thriving. Humans are social creatures who will always require a level of interpersonal connections.
While needs-based services may initially attract consumers to retail centers, experiential offerings will likely keep them within the centers for longer periods of time. A 4.4% rise in the nonfood and nonretail share of gross leasable areas in shopping centers from 2016 through Q2 2022, according to ICSC, indicates a notable shift in consumer interests. Investors are taking notice.
Future-thinking retail
Certain long-term factors will continue to impact the retail industry even more profoundly than the pandemic, inflation and a possible recession. Federal and state governments control policies that directly impact consumers on a day-to-day basis, and in certain markets are forcing rapid changes in consumer behavior. The phase-out of gas-powered vehicles, along with bans on certain consumer products and containers (such as plastic bags), are just a few of these recent policy initiatives.
The popularity of online shopping and home delivery services is likely to continue increasing, thereby impacting the demand for certain products from brick-and-mortar retail stores. The shifting demographics of the U.S. population will change consumers’ needs and the locations where they’re needed.
Future-thinking retail investors and mortgage originators should keep these factors top of mind when considering retail center tenants. Consumers will increasingly demand products from future-thinking companies, such as emerging technology-based medical services and device providers; vegan and ethnic food restaurants; zero-waste grocery stores; and product refill stores. These and similar future-thinking companies should be considered as potential tenants in response to conversations happening at both a micro and macroeconomic level.
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While the retail industry will continue to adapt to consumer needs, investors can plan for these shifts by continually reviewing and adjusting their retail portfolios. Some products and services to be found within shopping centers are relatively new, which may cause hesitation among commercial real estate stakeholders as they consider the resale values of these properties. Investors who are willing to embrace change and make decisions that look to the future of shopping centers, based on where they think consumer preferences are moving, are likely to see continued success regardless of the economic environment. ●
