Shawn Massey, CCIM, SCLS

The Sky is NOT Falling; Don’t Believe the Hype…

I have had the privilege to be associated with Garrick Brown this past several years through my affiliation with Chainlinks. The editorial below is one of the best I have read in a long time. Garrick thanks for allowing me to share.

Terranomics Retail Newsline
Week Ending January 26, 2014

The Sky is NOT Falling; Don’t Believe the Hype…

Hello everyone. This week we have a double issue for you. Due to the MLK Day holiday, many of you weren’t in the office and I wasn’t either… so we didn’t release a Newsline last week. But that didn’t mean we weren’t watching what was going on out there and so this week’s issue is a double issue covering the top stories of the past two weeks.

So many of you may be aware of the other weekly news roundup that I do that focuses on all property types but just the San Francisco Bay Area—the Research Rant (drop me a line if you want to receive that one too, though it’s focus is not just retail). And, yes, in that publication I do actually rant at times though I usually try to be a little more reserved in the Retail Newsline. Not this week. This week I am ranting.

I understand some of the gloom and doom I have been seeing in retail stories as of late. We had a disappointing holiday sales season. E-commerce surged once again and if there is anyone left in retail real estate that doesn’t get that it will be a redefining force in the industry… well, they probably shouldn’t be in the industry. And, of course, it is January… so this is the time when retailers start announcing their closure plans. Put this all together with the stock market performance of last week and I can see where someone could start to believe that things are getting ugly. Of course, the holiday sales season wasn’t bad—it was just mediocre. E-commerce is something we have seen coming for a long time and those who think it will destroy bricks and mortar retail are just as wrong as those who didn’t think it would have much of an impact. January is retailer closure month and this year’s slated closures are actually down compared to what we have dealt with in years past. And, lastly, after last year’s run-up in the stock market, a correction might actually be a very good thing.

And so while I get why people in the industry are a little on edge, I can’t say that this justifies some of the gloom and doom I have seen in a few articles in the past couple of weeks.

There is nothing I hate more than fuzzy logic or bad research. And there is nowhere you are likely to see more of that than in television coverage of our industry. I get it that with a handful of 24/7 news networks that they always have to be running with something but there are two things that greatly distress me; the lack of depth of the reporting generally done and the sensationalist nonsense that frequently guarantees coverage. And for an example I have to point to a story that CNBC ran with this past week.

In their story, A Tsunami of Store Closings Expected to Hit Retail, CNBC starts with some basic undisputable facts. In fact, the video clip portion of the story pretty much nails things in terms of what is happening with mall-based REITs and Sears/Kmart and JC Penney. I won’t nitpick too much about the fact that there aren’t an awful lot of Kmart stores in malls—I certainly don’t know of any within Class A or B malls. The fact is that both of those retailers (Sears/Kmart and JC Penney) will be closing more stores this year and remain in precarious positions, though most financial analysts don’t see imminent bankruptcies. For example, JC Penney managed to get financing at the end of last year to give it about $2 billion in liquidity. They still may be able to pull out of their spiral if they can cut costs and reconnect with their consumers. The outlook is a little less rosy for Sears, but they have been boosting their liquidity by selling off assets. Their ultimate challenge is getting sales back on track—otherwise the selloff of assets like Lands’ End or the planned selloff of their Auto Centers and other assets may just be a case of mortgaging the future to survive in the present… but bankruptcy is NOT imminent.

Where I have the real issue is in the text that accompanied this report. The first line sets it all up… “Get ready for the next era in retail—one that will be characterized by far fewer shops and smaller stores.” The statement about smaller stores is accurate; with the exception of sporting goods every big box category is shrinking their footprint. We are also seeing more apparel retailers and other hard goods merchants shrinking theirs as well—but not necessarily by massive amounts (that 4,000 square foot Gap at the mall may be looking to get closer to 3,500 square feet, etc.). Retailers are looking to cut occupancy costs across the board and are trying to boost their sales per square foot numbers even while slashing footprints. And so the statement sounds true on the surface. But I take issue with the statement “far fewer.” And I know that on the surface this is where I may sound to some like I am just a great big whiner, but that word “far” actually means something. In fact, it means a LOT.

The choice of the phrase “far fewer” is clearly not an accident. The article goes on to mention planned store closures by Sears and JC Penney (retailers we all knew were going to be shuttering locations this year) and includes mention of a few planned store closures from Macy’s in the same statement. Macy’s is the clear segment leader in the department store category and remains very profitable but by lumping them in with two troubled brands, this report paints a much more dire picture than what is actually occurring. Macy’s is closing five stores that are underperformers. The move will save them $100 million annually. Is all new growth off the table? No. Are they in trouble? No. If I recall correctly, last January they announced the closure of eight underperformers. In fact, Macy’s continues to expand modestly—in Q3 it opened a replacement store and consolidated a men’s and furniture store into an existing location. In Q4 it opened a new Bloomingdale’s in Glendale. It has closed 14 unproductive locations over the past two years, but these rates of closures are not aberrantly high considering the challenges poised in recent times by the economy and the emergence of e-commerce.

Worse yet, they throw in a move by Target to streamline operations at their HQ as evidence that Target is in consolidation mode when the exact opposite is true. Target is in growth mode and continues to be one of the dominant players in the industry.

The article claims this is only the tip of the iceberg and then quotes someone in the excess space disposition business as saying that overall retail square footage will see an “average” decrease of 33% to 50% over the next five to ten years. Now I deal with the media a lot. Most of the time they get my quotes right and do a great job. I have been misquoted on occasion and every once in a while I will admit, I have misunderstood a question and said something that didn’t make a lot of sense. I don’t like throwing anyone under the bus, but I want you to really think about what it would mean for the “average” decrease of retail space usage to fall by 50% over the next ten years.

Consider this; the office supply category is where we are going to see the tightest contraction in retail in the next few years. The Office Depot/Office Max merger created redundancies, which the new Office Depot will be shuttering (somewhere in the 300 to 400 store range) in the coming 24 months or so. But the entire sector is looking to move away from a typical footprint in the 20,000+ square foot range to the 10,000 square foot range. Assuming Staples, Office Depot and the other active smaller players do this, here is where we will see a 50% to even 70% drop in retail space usage over the next decade.

And, yes, department stores are shrinking both in terms of store counts and footprints. As are many mall or lifestyle center based apparel and hard goods retailers. But none at anything near that rate. Even Barnes & Noble, in the decimated retail book business, is currently just planning on closing about one third of their locations over the next few years as leases on underperforming stores run out. The article goes on to list planned closures from American Eagle, Aeropostale and… Walmart. Yes, Walmart. The very same Walmart that has plans to grow their new, smaller format concepts by as many as 150 units over the next 18 months. Will they be closing some stores during this time? Of course they will. They always do. Retailers are always closing their underperformers and moving on. And the first quarter of the year is usually when this happens. Don’t confuse the normal ebb and flow of retail real estate with longer term trends because they are not the same thing.

My point is this; if you believe that retail square footage usage will decrease just 33% over the next decade you are already essentially a shopping center doomsday prepper. According to the Costar Group, there is just under 6.2 billion square feet of retail space in the United States, of which roughly 5.8 billion is currently occupied. Do you really believe 1.9 billion square feet of that retail space is going to go vacant in the next decade? And remember that would be the conservative estimate listed in this report. Do you really see that happening? Especially considering that this market actually GREW occupancy in 2013 to the tune of 38.5 million square feet? Even during the great big box giveback of 2006 – 2008 when Circuit City, Linens N’Things and a number of other box chains went belly up, the impact on the marketplace was counted in millions of square feet—not billions.

If you do believe this, you need to go down to your local Costco (which is in growth mode, by the way, and will add 30 units internationally in 2014—16 of which will be in the United States), stock up on canned goods and beef jerky, drive over to your local Dick’s Sporting Goods (which will open about 60 new 80,000 square foot stores this year) and get your guns and ammo. Then go hole up in your bunker (which you can outfit cheaply from any number of furniture stores—a category that is slowly returning to growth mode) and then wait for the pending e-commerce apocalypse.

You’ll be waiting for quite a while.

E-commerce is creating significant shifts in the retail marketplace and will continue to do so. Mid-priced, hard goods retailers will be most heavily impacted. Yet, even as those sectors are moving to contraction or no growth mode, we are seeing strong growth from food users (restaurants and grocers), service retail and entertainment concepts. The smart players are adapting and they are who will survive and thrive. But the evolution of the marketplace will hasten the demise of the weakest links. That is a fact.

That being said, the sky is not falling. A tsunami of store closures and failures is NOT coming. A wave is. And there will be plenty more over the next few years. E-commerce is not going away and I am not a believer in downplaying the threat to bricks and mortar. Footprints will shrink for most retail categories in the years ahead and many categories—but certainly not all of them—will be in contraction mode. But it’s not going to be an apocalypse folks.

E-commerce is about convenience. People want that. Shopping is about experience. People want that too. The rising tide of e-commerce is not going to destroy bricks and mortar retail. Like every other major shift in the retail marketplace over the past hundred years (from the emergence of catalog sales to rise and fall of the suburban mall), it will force the marketplace to adapt and evolve. But these are not the “end times” for shopping centers.

We’ll have more useful reading next week.

Thanks and have a great week!

– Garrick H. Brown

Garrick Brown
Research Director, Terranomics
916.329.1558
gbrown@terranomics.com

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