How Retail Investors Can Separate the Thrivers From the Survivors

IRVINE, CA—while some might want to paint the whole sector black, there are certainly pockets of opportunity remaining for savvy investors who’ve been around the retail block more than a time or two. High-energy urban infill submarkets and the lack of new construction are two retail bright spots, says Don MacLellan, senior managing partner of Orange County, CA-based real estate advisory firm Faris Lee Investments. caught up with the industry veteran for his late-year (and cycle) investment insights. What are your thoughts on the recent Sears bankruptcy filing and the doom and gloom narrative in the retail sector?
Don MacLellan: Retail is not going extinct, it’s just evolving. Retail is the most dynamic of all property types. Amazon is impacting, not taking away retail. Target is one of the top retailer’s because of their ability to be nimble and react quickly to market changes.  As for the Sears and Toys ‘R’ Us’ of the world, it was a combination of their overleveraged debt and unwillingness to adapt and not solely but in part by the impact of the internet, not sales or the Internet that did them in. Debt strangles; you don’t have the agile capital to adjust. Retail is a function of staying agile.
Instead of seeing Sears’s bankruptcy as an uncertain future for the retail industry, we could argue that this could be an opportunity for retail. The majority of these Sears leases are well below market with long term control thus making it difficult for landlord’s to tap into the upside. This could be an opportunity to increase rent as well as reinvent the space to adapt to evolving consuming styles.
Consumers are changing their shopping habits to omnichannel which allows them to purchase whatever they want, whenever they want, on whichever platform they choose (tablet, mobile, laptop, etc.)  60% of shoppers look up product information and prices while using their mobile phones in stores, making a mobile strategy critical for retailers. Although the physical access to the product is still a necessity, the need for large inventories could be changing. The housing sector is also experiencing some adversity. What effects are you seeing in retail?
MacLellan: Like retail, housing prices have to be justified. The cost of living is so high in California, New York, and other major job growth areas. The housing shortage has led to urban high-rise development geared toward educated young professionals with a massive supply of for-rent product all over the country. As a result, most of the retail development has been urban infill, not the traditional suburban neighborhood centers, because all of the residential growth has been infill and high density (with Seattle as the anomaly).
Also, the young professional demographic is really driving more of the restaurant development. In terms of personal budget, restaurant food is much more substantial than it was for Baby Boomers in the suburbs. There is certainly a lot of talk about how things will shake out in the late stages of this economic cycle. What should retail investors be looking at as 2019 approaches?
MacLellan: Retail depends on GDP, customer confidence and consumption. I don’t see anything changing in retail itself. I think it’s more about the overall economic impact. If there’s any hiccup, it’ll be from the consumer. For example: credit card debt.
I get it, we’re in the 11th hour and emotion always plays into our economic cycles. For example, REIT stock values are way undervalued based on the quality of the real estate because of this whole fear of retail. There’s still opportunity though for savvy investors who understand the sector and know how to reposition assets. The good news for retail is that there’s really no new construction. A lot of our clients have bought these REIT properties in secondary locations at good cap rates and they’re well-positioned because they’re the only game in town.
With the Sears bankruptcy, the closing of thousands of Toys ‘R’ Us stores, the question remains: who will be next? However, capital providers need to stay abreast of the retail industry fast evolution and consider each case individually. In this market, the location, quality of the tenant, and track record are key factors to consider. Moving forward, capital providers might want to pay closer attention to the creativity of the business plans.


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