Navigating a Rapidly Changing Retail Industry

Over 20,000 real estate investors, developers, property managers, retailers and brokers convened in Las Vegas last month for the annual ICSC convention. In the midst of a volatile market, attendees sought answers on how to navigate current challenges impacting the retail industry. Below were three of the biggest themes to emerge.

Retail resiliency amid market headwinds

Just a few years ago, the outlook for the retail industry was grim. Consumers weren’t shopping due to the pandemic, brick-and-mortar stores were closing and many large retailers were filing for bankruptcy. However, the market surprisingly bounced back post-covid as consumers returned to stores with a desire to spend.

As the real estate industry as a whole now contends with new challenges including higher interest rates and economic uncertainty, the silver lining is that retail has been somewhat less impacted than other asset classes. Office continues to face return-to-work challenges and industrial is contending with supply chain bottlenecks and overall supply shortages. While retail has not been entirely insulated, the fundamentals have remained quite sound – leasing remains strong, occupancy is high and companies are continuing to announce new store openings. The consensus at ICSC was that there are certainly challenges ahead, but that the retail industry is well positioned to weather the storm and come out in a position of strength.

Trend toward mixed-use retail

One of the biggest challenges in today’s retail environment is adapting to the growing and changing needs of the everyday consumer. As a result, landlords, retail owners and developers are increasingly exploring mixed-use developments – which blend multiple uses such as retail, residential and entertainment. For instance, a landlord may decide to redevelop an existing retail center by incorporating entertainment facilities, residential apartments and hotel amenities that attract consumers while also helping drive sales and boost profits. Landlords are also embracing a more experiential approach to retail centers by incorporating movie theaters, fitness centers, spas and other lifestyle attractions. Particularly now when ground-up retail development is not the most attractive given the current market, converting existing retail centers into mixed-use sites is a unique way for landlords to maximize value and grab consumer attention.

Sale-leasebacks as a solution for rising development costs

Rising interest rates continue to impact retail development. Developers’ capital costs have increased drastically, and as a result they are demanding higher asking rents from retailers. This is forcing more retailers to turn toward in-house development, which means the development costs are held on the balance sheet of the company. To offset these costs, retailers are exploring sale-leasebacks – where a company sells its real estate to an investor for cash and simultaneously enters into a long-term lease. This enables the retailer to receive a significant cash infusion while maintaining full operational control of the property.
 

Developers can also take advantage of the sale-leaseback model. If they’re developing a building in which a tenant has already been secured, developers can work with an investor on a forward commitment in which the investor funds construction costs and acquires the building upon completion, or the investor purchases the building once complete. This enables the developer to recoup costs while still collecting a development fee.
 

With an interest rate decrease not likely for 2023, sale-leasebacks are expected to continue growing in popularity for retailers looking to expand their footprints and developers, providing opportunity for investors that specialize in these types of transactions (like W. P. Carey!).