20Jun 2016

Andrew Gibbs

Senior Analyst, Property Multi-Manager

Shopping for growth with urban retail

Shopping for growth with urban retail

“Anyone who believes the competitive spirit in America is dead has never been in a supermarket when the cashier opens another checkout line.” A newspaper columnist noted that in 1954. For better or worse, time has shown that consumption is ingrained in Americans. While Americans’ desire to consume has been preserved, where we shop and go to spend our dollars is constantly evolving.

With the closure of more than 400 malls over the past 10 years, it appears America is in the midst of a transition. What does this mean for property investors?

As real estate investors, we need to pinpoint where we are in this evolution. This helps reveal where we should be investing capital. With the reemergence of urbanization, some of these opportunities lie where they were over 60 years ago: back in the cities.

Developers can build vertically in urban areas, but there is a finite level of ground-floor retail space. As these areas densify, storefronts could demand premiums because they have marketing potential.

Luxury urban retail, in particular, has been a strong performer. On prominent luxury streets across the U.S. – including Rodeo Drive in Los Angeles, Fifth Avenue in New York City and Lincoln Road in Miami – increases in net asking rent ranged between 20% and 100% during the years 2010 to 2014, according to CBRE.

Although most urban retail districts have benefited from rent growth, there are many variations. For example, over the past eight years, rents in the most established “destination” districts of New York City grew by 11.4% per year. This is nearly five times higher than non-destination districts that primarily cater to local residents. Destination shopping is a retail industry concept for malls and shopping centers where shoppers make specific trips to a designated area for certain types of goods or services, such as luxury or entertainment. Retailers also create “convenience” shopping districts to house grocery, pharmacy, personal and food and beverage stores.

In some high-growth markets, retailers are making significant profits, and the new rents appear sustainable. We believe investors should focus on these profitable destination and convenience retail districts in high-growth urban markets. Among expensive destination streets, neighboring fringe areas could continue to benefit from retailers that are priced out of prime streets but still want to ride the coattails of the successful areas’ foot traffic.

We also look for attractive opportunities in emerging neighborhoods that we believe are poised to become prime destination districts. Transformation may be difficult and slow. It will also require significant investment. But as long as these districts are underpinned by strong demographics, the downside can be minimal.

Demographics are one among many factors that should be taken into account when investing in urban retail. Consumer shopping habits are always changing – from catalogs to malls to the Internet – and this unpredictability can make investing in urban retail a challenge.

Investors must be cautious when investing in areas experiencing rapid growth but yet untested by cycles. For instance, in the early 2000s, rents in the Meatpacking District grew from $75 to $400 per square foot. Between 2008 and 2015, median market rents in the district declined. Some of these concerns have been raised in more established New York shopping districts like SoHo, given the recent increase in rents.

Retail districts are dynamic, and as rents increase in certain areas, it is likely that shopping districts will evolve and expand along the fringes. Unlike malls, most urban retail districts are not controlled by one owner. This could reduce the leverage landlords have and give retailers alternative options to expand.

As technology improves, retail could face yet another shift. Urban retail investors must be mindful of the impact of e-commerce and shifting supply chains. Retailers are constantly thinking about how to minimize distribution costs. Paying for storage space in urban environments might not be the best way to use prime space. As retailers expand into cities with new concept stores, they will likely change store formats in an effort to determine the best use of space.

Retail is always changing, and so are trends. One thing is certain: the newspaper columnist was right about the American competitive spirit.

Ref: 23211-160616-1