Real Estate's Next Chapter

With the holiday shopping season now underway, the final chapters of 2017 are already being written. While we don’t know exactly how the story will end, we can safely say that this has been a rough year for retailers–and for the retail real estate industry.

As everyone begins to look forward to the new year, here’s a look at what are shaping up to be the most important retail real estate trends for 2018:

Malls

When it comes to America’s struggling malls, I think 2018 will largely be more of the same–but even worse (at least for C malls). I do think we’ll see more clear segmentation among mall categories, with C malls essentially becoming obsolete. B malls will be somewhat bifurcated: some will get the upgrades and improvements they need to move toward the A category, while others will slide further down towards their imperiled C mall brethren.

It’s impossible to think about what comes next for traditional malls without considering the status of iconic department store brands like Sears, Macy’s and J.C. Penney. I think Sears will continue to close more stores (including Kmart stores), and it wouldn’t necessarily surprise me to see Sears close the bulk of its stores by the end of 2018. Macy’s continues to plan to integrate its off-price Backstage concept into existing Macy’s stores. If that move proves to be successful, that could limit Macy’s closures in 2018. My gut feeling is that this is unlikely to work out for Macy’s. There are already so many other established off-price concepts that do a better job (Nordstrom Rack, Marshall’s, TJ Maxx, Ross, Saks Off 5th and Stein Mart). It’s a crowded and competitive segment, as evidenced by Bloomingdales decision to pull back on new outlet openings, and Neiman Marcus’s recently announcement that it plans to close 25 percent of its Last Call outlet stores. Building the Backstage brand seems like a big ask, especially when others have been refining and strengthening their position for so long. I also question Macy’s decision to bring its off-price brand into traditional stores in the first place. This seems like a surefire way to muddy the waters and create brand confusion. As for J.C. Penney, while we may see some additional closures, I think it’s unlikely to be on the same scale as Sears and Macy’s. I expect those closings to primarily be smaller stores in smaller markets, as part of J.C. Penney’s ongoing effort to trim lower-performing locations from its portfolio.

Digital crossover

Online and mobile retail will continue to be a big story in 2018. I think the headline is less about “competition,” and more about the way the lines between traditional brick-and-mortar and its digital counterparts continue to blur. We’ll likely see more retailers following brands like Restoration Hardware, Warby Parker, Bonobos and the new Nordstrom Local concept, by not carrying a full array of merchandise. Instead, these stores use their space to showcase products that can be ordered on the spot and delivered to your home.

Many larger retailers are going to be looking to buy smaller online brands in 2018, in moves similar to Walmart’s acquisition of Bonobos. I’m not sure who it’s going to be exactly, but it wouldn’t surprise me to see more of this from Walmart or Target. Traditional department stores don’t really have the cash required to make this kind of a move–with the possible exception of Nordstrom, who may make a smaller-scale purchase (perhaps acquiring an emerging brand that has already performed well in Nordstrom stores).

Speaking of digital/traditional crossovers, I expect we’ll continue to see more online retailers working to establish a brick-and-mortar presence with mixed success. This “clicks to bricks” phenomenon had led to some high-profile successes, and some equally high-profile struggles. It’s unclear if the latter are the result of concepts that don’t lend themselves well to brick-and-mortar, or if some online retailers simply don’t have the necessary brick-and-mortar expertise to execute that transition successfully.

Soft big boxes

In 2018, the big box market will likely continue to soften. Power centers are continuing to see some sluggish performance, with an abundance of vacant space and a limited number of concepts available to fill those spaces. Home Goods has a new concept on tap, but it’s still in testing mode. We’ll certainly see some new TJ Maxx, Marshalls and Home Goods locations, but we are beginning to max out on those. Continued softness in the office supplies segment isn’t going to help, with Office Depot taking over more Office Max stores and closing others, and Staples closing more stores. Best Buy and other consumer electronics seem to be somewhat stabilized and holding steady, but the Sporting Goods segment was decimated in 2017. With Gander Mountain closing stores, and Sports Authority and MC Sports now defunct, the category winner is Dick’s Sporting Goods–but there are only so many of those stores to go around. The bottom line is that this category is shrinking, and I expect that to continue in 2018.

Supermarkets

The supermarket segment has been an industry bright spot for some time now. However, a combination of international competition and an influx of new concepts has left the grocery landscape very much in flux heading into 2018. Competition between two German brands–the established Aldi, which is expanding significantly stateside, and relative U.S. newcomer Lidl, which is opening an eyebrow-raising five to 10 stores per month–has driven prices down and created serious market share issues for traditional supermarket brands. Those traditional concepts will also be pressured by the continued expansion of specialty markets. Sprouts continues to open 40-60 stores a year, and names like Earth Fare and Natural Grocers occupy a growing share of the organic and specialty market. Trader Joe’s is also a significant player in this increasingly segmented category. One wild card is Whole Foods, where questions remain in the wake of its acquisition by Amazon. There seems to be little doubt that the iconic organic brand will gain market share, but Amazon’s strategy of lowering prices will almost certainly bring down profits in the process.

Bottom Line

Every retail format will feel the impact of the ongoing challenges that have emerged or continued in 2017. Malls will continue to struggle, power centers will face some headwinds, and–with the grocery market in flux–it’s possible that even neighborhood centers will face some rough air.

Here’s the good news: if 2017 was almost exclusively bad news, 2018 will likely be more of a mixed bag. Yes, we will see closures, but there are creative new concepts that are growing, changing and emerging. It may be a bumpy ride for retail real estate in 2018, but with turbulence comes innovation and creativity–and the prospects of clearer air ahead. It will be fascinating to watch it all unfold.

Will sales clauses in leases soon become obsolete?

The retail landscape today looks different than it did just a few years ago. Brick-and-mortar retail is becoming more diverse. Brands are embracing different operational models and integrating more closely with online and mobile channels. Retailers like Bonobos, Warby Parker and Restoration Hardware are using physical locations purely as showrooms, a new trend that appears to be gaining significant traction.
 
The implications of these changes are varied and profound. For now, I want to focus on one particular issue. That issue centers on a single question: when a retailer reports sales numbers, what exactly are they reporting?
 
To put it another way, in a world where the clear lines between online and brick-and-mortar sales are blurring, how do we determine which channel gets the sales “credit” for any one transaction?
 
Consider these real-world examples from my own experiences. I recently ordered some Restoration Hardware bathmats through a brick-and-mortar location. I subsequently returned them for a different color, an exchange I conducted online. Is that a brick-and-mortar sale or an online sale? In a different scenario, I placed an online order with Bonobos, and ultimately wound up making an exchange at a brick-and-mortar Bonobos store where the item came from their warehouse. What kind of sale is that?
 
Those are just two examples in my own life – there are countless other permutations. Even if we determine which of those transactions is recorded as an online sale or a brick-and-mortar sale, it doesn’t begin to account for the true unknowns. For example, an online purchase prompted from a consumer walking past a storefront earlier in the day could be a questionable sale, or the opposite, someone using online or mobile tools to get a sense of what’s available and where the best price might be, then visiting a physical store to make a purchase.
 
It’s complicated, right?
 
The real question is why does any of this matter? It certainly provides some fodder for media writing dramatic headlines about the demise of brick-and-mortar and the ascendance of online and mobile sales. But does it matter to the retailer? Does Old Navy care whether the dollars on their bottom line got there through an online funnel or an over-the-counter transaction in a physical store?
 
On one level the answer is no, not really. A dollar is a dollar is a dollar. However, it does matter – potentially quite a lot – once we start thinking about the impact on leases and what gets reported to the landlord. Some rents are calculated based on sales, and many leases have sales-based provisions, incentives or kickout clauses that are triggered by a specific sales figure. While the retail landscape may be evolving rapidly, leases don’t change nearly that fast. Unless a lease has been signed fairly recently, it almost certainly doesn’t account for the online/inline nuances and gray areas that have emerged. Think about a retailer in the eight year of a 10-year lease. Consider how much has changed during that time. Ten years is a long time in the world of retail, and an even longer time in the world of online tools and mobile technology. To put it into perspective, the first iPhone had just been released a decade ago.
 
A new retail taxonomy
So what options do landlords have? How do they know that what they are getting from their tenants is an accurate reflection of brick-and-mortar sales? How do they address that “channel uncertainty” in their leases? Can they stop retailers from what amounts to creative reporting of sales to trigger opt-out clauses or to suppress rents? Auditing might be possible if both sides agree, but if it isn’t clear to the retailer how to categorize a sale, how can landlords be expected to monitor such a thing?
 
For sales-based leasing language to be meaningful and enforceable, the retailers and landlords would have to stipulate/agree to meticulous transaction tracking and categorization. Furthermore, to address the complexities and uncertainties I mentioned above, the industry would likely have to develop a kind of standardized “taxonomy” for all the different categories of retail transactions in a multichannel world.
 
I suspect what is more likely is the leasing language will change. Leases will, by necessity, become much more simplified. With sales figures becoming malleable to the point of being meaningless, sales clauses in leases will be somewhere between irrelevant and unenforceable, and will likely go away. We may see conditional clauses based on different metrics (co-tenancy specifications, for example), or we might just see the industry move toward a simpler leasing structure. Perhaps something more akin to a residential lease, where breaking the lease early incurs a financial penalty. Even now, some retailers are not required to report sales. So we certainly could be moving in that direction.
 
That’s all in the future, for leases that have yet to be written and negotiated. The difficulty right now is that landlords have no leverage, and retailers have no incentive to renegotiate existing leases. This is a challenging time for landlords trying to adjust to an evolving and increasingly multichannel industry.

Retailers in control at RECon

For retail professionals, the International Council of Shopping Centers’ Spring RECon Convention in Las Vegas is the highlight of the year. There’s always so much to take in, and every year comes with its singular storylines. Here were some of the more dramatic ones at play convention floor:
 
Food-focused foot traffic
The overall volume of traffic seemed light to me, and I can’t help wondering if the 37,000 attendance figure cited by ICSC is a realistic one. What seemed more interesting than the raw numbers, however, was the distribution: not so much how many folks were there, but where they were. To some extent, the ebb and flow in the world of brick-and-mortar retail can be reflected (or even perhaps predicted by) shifting traffic patterns at RECon. The fact that the foodservice section of the exhibit hall was by far the busiest is very interesting. Given that restaurants represent the fastest-growing segment of the retail marketplace, it might not seem too surprising. Still, I was still impressed by the sheer volume of people there getting deals done. Restaurants seemed to have an abundance of open-to-buy opportunities.
 
Mixed-use is still a hot topic
Mixed-use development isn’t going anywhere. No matter which REIT or development company you visited at the conference, all seemed to have joint ventures going with hotel and residential developers. I still find it remarkable how many residential and hotel developers are now attending the industry’s premier retail conference. Their presence affirms (or reaffirms) the degree to which they have become part of the retail equation.
 
Leasing dynamics have shifted
We have gone through periods in the not-too-distant past where a lack of quality retail space meant that rental rates were on the rise and landlords had more control. Today, it’s clear that the supply-and-demand curve has flipped, and that dynamic was clearly evident in Vegas. With retailers cutting back on new stores, there is less demand on the retail side and more demand on the development side. Plenty of space is available in most markets, and retailers have the control in the shopping center leasing arena. Right now, the developer needs the tenant more than the tenant needs the developer, which is resulting in lower rental rates and more favorable terms for retailers.
 
A (surprisingly?) upbeat mood
Given some of the underlying currents of uncertainty (underwhelming sales numbers, high vacancy rates in some markets, high-profile store closings) the overall mood at the event was more positive than I had expected it to be. Brick-and-mortar retail is not expanding very much at the moment, and the industry is going through some significant structural transitions, which could result in turbulence and uncertainty for years to come. This makes me wonder why investors (more specifically, private equity firms) still seem so eager to invest in retail in the current climate. I don’t want to overstate the issue. The current challenges in the retail marketplace are certainly nothing like 2008-2009, when retail wasn’t expanding at all. No, today’ challenges are not driven by the economy, but by structural shifts in consumer expectations and changing patterns in how people shop. While we might not be in a recession, these changes are possibly a much bigger long-term issue for the industry. They raise worrisome questions about what will happen when another economic downturn comes around. The industry simply cannot absorb that kind of a hit right now – not without significant damage.
 
Experiential 
The passion for experiential retail was everywhere at this year’s RECon convention. I was especially fascinated by the extent to which traditional ideas about what constitutes “experiential” seem to be expanding. Retailers are really coming around to the notion that experiential isn’t limited to the experience of the consumer while they are in the store, but to everything about how the store is set up as well as the retail transaction. A great example is Restoration Hardware, which now has no back room and no stock. Even if you want to buy a towel, they type your order into an iPad and it’s sent to you directly. That kind of showrooming seems to be a big trend. It’s been expanding for years, but it was really on display this year in Vegas. 
 
The customer experience mandate also raises big questions, and I’m troubled that the industry may not have fully thought the answers through. For example, what does showrooming – and the blurring of lines between brick-and-mortar and online sales – mean for calculating and classifying sales and other sales-based numbers? The discussion doesn’t seem to be changing as quickly as it should, and retail professionals need to be searching for answers and pondering the implications for their brands and businesses. I suspect we’ll be hearing much more about these issues in future RECon conventions!

The Squeeze from Bottom-Up, Top-Down

At a time when store closings and consolidations are dominating the headlines, understanding the underlying industry dynamics also requires paying close attention to new store openings. Brands that are expanding their footprints are providing a revealing look at how consumer shopping patterns, priorities and preferences are evolving. In turn, this shows what might be in store for the retail industry ahead.

Regardless of what the volume of coverage or casual media narratives might suggest, there are a significant number of new store openings to talk about. We are in the midst of a turbulent (and fascinating!) time for the retail industry, and that period of transition is ripe for both consolidation and new additions.

The vast majority of new store openings are taking place in two major retail categories. The first is the discount sector, where off-price concepts are expanding at an impressive rate. The TJX Companies’ discount brands, including T.J. Maxx, Marshall’s and HomeGoods, continue to grow at an impressive rate. In another indication that discount concepts are thriving, TJX recently announced an upcoming HomeGoods spinoff–a new home concept store that will be rolled out sometime next year. Ross Stores is continuing to roll out their deep-discount format: dd’s Discount, which offers bargain-priced fashion and home goods. Dollar General–and the entire dollar store category–continues to expand nationally. Further down the discount chain, in a category you might call “off off price,” brands Ollie’s Bargain Outlet are also opening a large number of new stores.

This strong growth and activity in the discount and off-price sector is more interesting when you consider the other retail sector that is currently opening new stores: high-end specialty retailers. Specifically, the online-only retail concepts that are relative newcomers to the brick-and-mortar space. Brands like Warby Parker, Bonobos, Birchbox and Brilliant Earth are occupying new spaces and new markets, and they are doing so with strategic precision. They are following a pattern perfected by groundbreakers in this space like Apple and Amazon, who have leveraged their online information to great advantage. When online retailers have accumulated extensive information about who buys their products and where, site selection becomes less of a guessing game. Online brands moving into brick and mortar can zero in on ideal locations in ideal markets–in some cases even micro-merchandising a location–a clear advantage over their brick-and-mortar-only counterparts.

With most growth located on both ends of the pricing spectrum, discounters at one end and higher-end specialty retail at the other, the result is a kind of barbell-shaped expansion curve. Middle-market brands are treading water (and in some places sinking) while discounters and specialty/online concepts gain ground. To some extent, we see that same barbell dynamic reflected in the grocery sector. The success of discount brands like ALDI and Costco, and the proliferation of grocery offerings from non-traditional sources like Walmart and Target, has pushed traditional middle-market grocery stores from the bottom-up. On the other hand, gourmet, high end or organic-based markets like Whole Foods and Sprouts have applied similar pressure from the top-down.

I think it’s noteworthy that one end of that barbell is being supported almost entirely by formerly online-only concepts. If you remove these retailers from the equation, then the barbell becomes be even more lopsided. This speaks to the dominance of the discount sector right now. Value and affordable pricing remain top consumer priorities, even with the lean times of the 2000s recession behind us. The recession may have ended, but it seems that the shopping patterns remain. I would have thought that an improving economy would help full-price and upscale stores bounce back. To some extent, it feels as if we have been “taught” to shop this way. Members of the influential Millennial demographic are clearly motivated to a large extent by value, but they are hardly alone. When T.J. Maxx first came on the scene, conventional wisdom was that it would be popular for middle- and lower-income individuals­–but discount shopping turned out to appeal to a universal demographic.

There is no better testament to the power of discount retail than the fact that upscale and luxury brands all seem to have their own discount counterparts as well. Nordstrom Rack, Last Call by Neiman Marcus, Bloomingdales Outlets and Saks Off Fifth are all evidence of the fact that not only is discount at the top of the retail heap right now, but it looks to stay that way for quite some time.

Store closings are part of the business, but is this business as usual?

2017 is just two months old, but we have already experienced what feels like a year’s worth of major store closing and liquidation announcements from national brands. This spike in store closings seems to have rattled retail industry professionals, and has gotten retail analysts and observers talking about big shifts – and thinking not only about what comes next, but how painful the transition might be in the meantime.

 J.C. Penney just announced it will take out 140 stores by June. Over  the past few weeks The Limited has closed its doors, liquidating its assets and filing for bankruptcy, American Apparel is closing all of its 110 stores, BCBG is closing stores and restructuring, The Andersons is closing down its stores and going out of business, Wet Seal is closing down all of its locations, Macy’s announced the closure of 68 more stores, and Sears announced that it will be closing 150 Sears and Kmart locations.
 
To be fair, the first few weeks of the new year are always a turbulent time, when post-holiday closing announcements come out in a flurry of activity. But the dramatic uptick in closings feels different this time, and there seems to be an air of concern – perhaps even bordering on panic–across the industry. The topic is dominating conversation in and around the industry. What’s happening with Macy’s? What’s next for Sears? This seems to be all that people are talking about. It’s almost as if, for the first time, these announcements have prompted a broad-scale realization of the fact that shopping patterns are changing in fundamental ways.
 
This is hardly a new development, but it does feel like we might be at a tipping point: where big-picture trends come into sharper focus and events that have taken years to unfold are beginning to pick up some critical and game-changing momentum. Part of the reason for that sense is that there is such a large number of store closings and liquidations all at once, but it’s also that these aren’t small players, these are national brands (in some cases iconic names) that are consolidating or going out of business. We have been talking about the challenges facing brands like Macy’s, Sears, Kmart, and JC Penney for years now, but as closures pick up steam, the reality of what the implications of those challenges might be is sinking in, and those theoretical discussions are turning into conversations about how to deal with the real-world ramifications of these changes. It’s also worth remembering that this is just the beginning for Macy’s and Sears, both of which will likely be announcing more store closings later in the year.
 
Another reason why this feels different – and why so many retail professionals are paying very close attention – is that more stores are liquidating and going directly into Chapter 7 as opposed to declaring Chapter 11. Other brands (including The Limited, American Apparel, and Wet Seal) declared Chapter 11 before being forced to liquidate when they couldn’t secure financing. I can’t help but wonder if that’s happening at least in part because private equity firms are becoming increasingly leery about getting into retail. In an eyebrow-raising move that made headlines both inside and outside the industry, Warren Buffett recently sold all of his shares in Wal-Mart, dropping a cool $900 million in stock.
 
Despite the accelerated pace of closures and growing concern in some circles, the structural issues driving these big changes have not really changed. It’s not exactly breaking news that department stores are struggling, and have been for quite some time. The biggest issue on my mind remains a lack of any real point of differentiation–particularly at a time when online and discount operators have continued to carve out an increasingly large slice of the retail pie. 
 
Sears, which sold its Craftsman brand and is looking to sell its Kenmore brand, and which continues to see year-over-year comp store declines of around 10%, has been the poster child for these challenges. There are even some rumors floating that Sears won’t be around by the end of the year. I’m skeptical that that’s the case. Sears has so much valuable real estate it is in no immediate danger of going under and could go on like this for a very long time, even with a retail operation that is losing money and bleeding market share. The big question is, when will Chairman and CEO Ed Lampert decide that he doesn’t want to subsidize the retail stores anymore? For years now I’ve determined that with little to no value on the retail operating company side, Sears could leverage the substantial value in its real estate assets and become a real estate holding company – and a very strong one. In addition to closures, Sears is already consolidating some of the spaces in its existing stores, moving from two floors to a single-floor format in cities like Cleveland, Phoenix and Los Angeles. 
 
While big names have struggled to evolve, the continued growth of online retail remains the digital elephant in the room. It’s interesting to note that online sales were strong over the holidays, and while that strength isn’t necessarily a direct cause of closings, it certainly highlights the impact of a trend that has been building for some time now. Hence, my comment about a tipping point. I think it’s also important that online shopping is not just for young consumers anymore. Older shoppers are becoming increasingly comfortable with technology, and the phenomenon is expanding in a way that clearly transcends age. At the same time, younger folk are spending less time at malls and with traditional retailers – especially department stores. This store format just hasn’t been able to figure out how to combine retail shopping with the experiential element that younger shoppers prize.
 
The bottom line is that this is unlikely to be an anomaly or a blip on the radar screen. These closings are the result of a significant structural shift in the industry, and it’s something that has been building for some time now. We aren’t done seeing store closures, either. Expect to see more closing announcements from both the brands listed above and from around the industry. If I’m right, and this is the beginning of a true tipping point, the pace of change will continue to accelerate in the year ahead. For industry analysts and observers such as myself, the scale of what is clearly a seismic shift means that there isn’t much point to forecasting beyond 2017. The retail landscape will almost certainly look very different at this point next year. Buckle your seatbelts, because we are just getting started.
 
 

Good vibes, but serious concerns, emerge from New York ICSC show

The good vibes, as well as the negative rumblings, that percolate through big events are an annual check on the pulse of an industry. In the case of retail real estate, I am happy to report that the positives seemed to outweigh the negatives at ICSC’s Deal Making show in New York last week. 

Let’s start with the good stuff.
 
The conference seemed very well attended in comparison to years past, particularly on Monday. There was enough of a drop-off on Tuesday that I couldn’t help but wonder if some attendees treated it like a one-day event going in. This is an East Coast event and attendance is naturally weighted toward eastern companies, but this year’s edition had a noticeably national and international flavor. Perhaps it’s not surprising since international retailers are moving into the U.S. at a headier pace. I particularly noticed that Asian-based retailers in attendance (names like Muji stood out to me), but badges also carried the names of brands and businesses from South America and Europe.
 
Retailers seemed to be embracing the notion they needed to right-size their box prototypes based on what was most efficient for them in an increasingly omnichannel world. Everything from store design to merchandising strategy is evolving, and it was exciting to see brick-and-mortar retailers demonstrating flexibility toward embracing some of those ongoing changes.
 
That flexibility was also in evidence when it came to the topic of redeveloping and repurposing vacant or under-performing enclosed malls. Developers appeared to be finding more interesting and creative ways of subdividing vacant department stores with an eye toward inspiring greater customer interest and generating more sales than the previous use. Restaurant and entertainment brands tend to be the lead players here, but we’re beginning to see more supermarket brands and daily needs retail moving into those spaces.
 
The big idea here is attracting different visitors and driving daily business to the larger mall, an objective that helps explain the ongoing mixed-use renaissance. Mall developers, after shying away from it for many years, are embracing mixed-use. Perhaps more importantly, so is Wall Street. There is a general understanding that the real estate itself is a true value and can generate more profit in the near future.
 
Based on what I saw at ICSC New York, there is also plenty of urban and close-in redevelopment taking place–a trend that allows retail to be located closer to the customer and closer to transportation patterns and transit hubs.
 
While these are all heartening developments, there were a few trends and talking points in evidence that I was less enthusiastic about. A number of developers I spoke with said they are having trouble getting deals done. I’ve been aware of this issue for some time, but not to the extent that I heard in New York. Retailers are taking more time deciding on locations and negotiating mutually agreeable solutions. It’s possible that retailers who have tightened up their portfolios and invested more in online presences are being more deliberative about site selection and growth plans. As growth curves get tighter than they used to be, the operational mind-set is that every decision is impactful.
 
What I saw and heard at ICSC also raised some questions about the future of luxury retail. Many experienced people on the show floor expressed the belief that it was an overbuilt segment. We aren’t seeing many outlet-driven malls proposed for development -- and some that were in the pipeline have since been cancelled. The growing general consensus is that most metro markets can only really support one or two outlet-retail-based developments. The prevalent thinking was that luxury can be like teen apparel, where brands can go from very hot to very cold seemingly overnight. Coach is a prime example of this phenomenon.
 
While well attended, the mood at ICSC New York was not as buoyant as in past years. There seemed to be concern about how developers refinance their assets if interest rates go up–which some were predicting would happen. I also found it odd that there was not more talk about the results of the presidential election. Maybe it’s a reluctance to discuss politics, or uncertainty about what the markets will do given the poor performance of predictions both before and after the election. It may be that, no matter what side you are on, everyone is still a little bit in shock at the results. 
 
At the close of another December show in New York, that quiet questioning about what the future may hold might have been the biggest and most important takeaway of all.

Now Trending: Is it closing time?

I’ve been thinking quite a bit lately about an article I read earlier this summer, a piece by Krystina Gustafson that appeared on cnbc.com entitled, “For retailers, closing stores isn't as easy as it once was.”

The article points out that, despite the fact that “investors are demanding it” and “industry analysts are pushing for it,” and the wave of media attention over high-profile closures from iconic brands like Sears and Gap would seem to indicate otherwise, companies are moving extremely slowly when it comes to actually closing down underperforming stores. Gustafson cites ICSC numbers that indicate that there were only 1,422 announced store closures in the first quarter of 2016 – a figure that is down substantially from an average of 2,160 closures during the same period over the last six years. In addition, as the article highlights, shopping center occupancy rates were up 93.2% at the end of 2015 – the highest year-end figure in eight years. That number ticked up even higher during the first part of 2016, reaching 93.5%.
 
The article discusses some theories as to why this discrepancy exists, including a recovering economy muddying the waters and obscuring the comparatively poor performance by some assets, accompanied by the perspective espoused by some industry professionals that there is no particular urgency to close a profitable store.
 
I disagree. My thinking is more in line with Citi's Paul Lejuez, who is quoted in the article with a statement taken from a research note he sent to investors: "Too many companies are focused on each store's individual cash flow when making the determination of whether to keep it open or to close it." 
 
Lejuez argues that “the amount of working capital and inventory costs that go into a particular store should also be considered,” suggesting that they can be thought of as "ongoing capital required that could get put to other uses." He goes on to talk about how trimming poorer performers from a portfolio could free up inventory, reduce corporate costs, and, in the case of struggling retailers, yield a smaller portfolio that would potentially be easier to manage and control costs. 
 
Despite the numbers quoted in the article, I think this perspective is gaining traction in the industry. For so many years, investors seemed to be looking almost exclusively at store/unit growth. Expansion was the sign of success. Today I’m seeing a growing focus on profitability – which probably should have been the priority all along. I think industry decision-makers and investors alike are starting to recognize that closing poorer performing stores is an important part of a healthy strategy. For struggling retailers, it can even herald a return to profitability. While online sales considerations can certainly make these decisions a little bit more complex, the fundamentals are fairly straightforward.
 
For evidence of the fact that investors don’t view closing stores as a liability anymore, we don’t have to look any further than the recent announcement from Macy’s that the department store giant will be closing 100 stores in 2017. Macy’s shares were up over 17% in the wake of the announcement. Now, Macy’s has many more structural and competitive challenges on its plate, and it’s clear that the venerable retailer has more work to do going forward, but I think this is a positive step–and it’s encouraging to see investors and analysts respond accordingly.
 
More needs to be done in the reporting the whys and wherefores of these store closures, something that was off-target in most of the Macy’s coverage. In an article on CNN Money, for example, the closures were directly tied to online competition (“The Macy's move is the latest in a wave of store closures amid the rise and success of Amazon and other online shopping options”). The Macy’s closings were lumped in with other store closures announced in recent months by names like Sports Authority, Target, J.C. Penney, Kmart and Sears. 
 
There is considerable debate about the impact of online and mobile shopping, but when you think about the fact that digital sales represent only about 8% of total retail sales, the notion that Amazon and its digital brethren are what’s prompting the closure of 100 Macy’s stores just doesn’t stand up to scrutiny. Macy’s and other department stores have taken a far bigger hit from discount brick-and-mortar retailers, and the story of their decline over the last two decades is complex and cannot easily be boiled down to any one factor.
 
The decision to lump all of those brands together doesn’t make sense, as the closures were all prompted by very different circumstances. Sports Authority has essentially died of old age, while Kmart and Sears have genuinely struggled with declining market share, poor strategic decisions, and the results of a strategy that has prioritized real estate over retail viability. Target and Macy’s are very different. In those cases, the closures seem to be the result of brands trying to understand ongoing shifts in demographics, consumer preferences, shopping patterns, and a desire to trim the fat from their portfolios. 
 
Not all store closings are created equal. My hope is that if and when another major retailer announces a store closing, there is a more thoughtful discussion behind the real estate strategy and long-term success of the store.

Now Trending: Macy's May See Changes

Macy’s may be flailing, but the department store icon can’t be accused of taking its struggles lying down. As sales were falling 7.4% in the first quarter of 2016 (numbers that represented the fifth straight quarter of declining sales, and capped off a year in which Macy’s stock prices were nearly halved at 47%), Macy’s continues moving forward on plans to roll out its new off-price Backstage concept – both as a series of new stand-alone stores and as in-store locations integrated inside a number of existing Macy’s stores.
Perhaps most intriguing, however, is Macy’s recent announcement that it plans to debut an entirely new store design at its newly remodeled Easton Town Center location in Columbus. According to The Columbus Dispatch,the 200,000-sq.-ft. location will reopen with a comprehensive series of décor and design updates. When the prototype makes its formal debut on June 25, changes will be evident in everything “from the lights to the flooring to the fixtures.
That is an encouraging development, as many Macy’s locations are in dire need of a facelift. The aesthetic refresh is far from the only big news, however: Macy’s has announced that it will be unveiling a number of new concepts and services including dedicated store-within-a-store spaces for LensCrafters, Papyrus, and the Tux Shop (a Men’s Wearhouse brand), a Connect @Macy’s kiosk that will offer “one-on-one service to customers as soon as they walk into the store,” and a complimentary personal shopping service called My Stylist @Macy’s.
While similar personal shopping services have been available for some time at high-end brands like Nordstrom, Von Maur, Neiman Marcus, and Saks Fifth Avenue, Macy’s is the first department store brand in its price range to offer such a service. While Macy’s deserves credit for being willing to try something new, I’m unconvinced that the new services are the right fit for the Macy’s brand. Unlike at Nordstrom, for example, where the personnel operating the personal shopping service are compensated based on commission and sales volume, my understanding is that the Macy’s service providers will not be paid commission. Without that incentive, I wonder how successful the program will be. More importantly, this feels like a strange fit for a brand that has long based its value proposition on deals and lower prices. While personal shopping services might have some appeal to those who cannot afford or prefer not to pay premium prices, but still want premium services, it doesn’t seem like something that going to drive traffic to Macy’s stores. In other words, I see this as more like a welcome perk than a difference-making differentiator.
From Macy’s perspective, however, the calculus is probably fairly straightforward. Implementing these services is relatively inexpensive, and Macy’s can offer the service, promote it heavily, and potentially raise interest based on fairly minimal risk and investment. It also may have the result of making Macy’s look and feel more like a higher end brand, which makes me wonder about Macy’s overall strategy going forward. Prior to the price-and-promotions model Macy’s has pursued for some time now, Macy’s used to be very service oriented. Is this the beginning of a larger attempt to reclaim some of that original service-oriented reputation?
Macy’s is also clearly trying to diversify its offerings, as the LensCrafters, Papyrus, and the Tux Shop openings are clearly designed to continue a formula Macy’s began experimenting with when it added Blue Mercury as a store-within-a-store brand. From a brand standpoint, I think Papyrus is a good fit with its selection of stationery and greeting cards that offer the kind of impulse buy item that could do well in a department store setting. Incidentally, it’s not a bad move for Papyrus either, which is facing stiff competition from Paper Source. The Tux Shop also works. Tux rental has long been available in malls, and so bringing it into a department store seems like a natural move that confers a certain level of quality. However, I’m not convinced that LensCrafters make sense. The eye care retailer is already convenient and easy to get to, and Macy’s can’t be everything for everyone.
But, then again, maybe Macy’s doesn’t have to be; maybe they just need to look like it.
Maybe it’s more about optics and impressions, and about making Macy’s seem like a place where shoppers can go for everything they need. Maybe it’s all part of that shift back to service–and perhaps also a move toward increased quality, convenience and variety. If it works, it’s a way to add value in ways other than price and promotions, and it’s new, fresh, easy, and relatively inexpensive to implement. Most importantly, it’s something Macy’s can try: The brand is in such disarray that they have to try something.
There’s no doubt that from an economic and operational standpoint, the store-within-a-store concept is fundamentally a great use for the oversized boxes. It allows Macy’s to fill space in stores that are often too large, and to make that space more productive in the process. As for all the speculation about strategy, brand direction and fit, maybe I’m overthinking it: maybe the bottom line is simply the bottom line, and a brand that has taken some financial roundhouses in recent years is simply trying to find a way to punch its way off the ropes. Macy’s is clearly reeling, but this willingness to try new things shows that it’s clearly not time to throw in the towel.

Retail Rap: www.brick-and-mortar.com

As pure-play retailers take to the streets, what are the site considerations? At a time when more and more online retailers are successfully expanding to brick-and-mortar locations, it’s worth taking a moment to examine how those brands are approaching the site selection process. The specific and strategic considerations that online retailers review when assessing possible brick-and-mortar locations not only tells us a lot about what’s behind that thought process, but provides important hints about the priorities and perspectives shaping retailer behavior in an increasingly omnichannel world.

It shouldn’t surprise anyone that it all starts with the customer. The vast majority of online retailers moving into brick-and-mortar spaces appeal to a younger demographic (their success has been built in online and mobile, where shoppers tend to skew younger). With that in mind, decisions about where to begin taking a virtual business to physical storefronts boils down to two questions: where are those consumers living, and where are those customers shopping.

While the first question is fairly straightforward, the second is a little trickier. Fortunately, online retailers have a resource that many smaller brick-and-mortar retailers and startups don’t: a sophisticated understanding of who their customers are. This deep knowledge includes everything from where they live and what they buy, to surprisingly detailed consumer profiles. While supermarkets, drug stores, and other large retailers with robust customer loyalty programs collect similarly detailed customer origin data, online retailers can do so with relative ease—simply because of the realities of online shopping.

Those psychographic and demographic profiles make it possible for online retailers to glean enormous amounts of information from a simple ship-to address, and they also make site selection a more precise and targeted exercise. It’s all about the data– information that enables retailers to separate good locations from not-so-good options. And it’s clear that many online retailers have concluded that the right location for them is typically not “the mall.” Brands like Warby Parker, Athleta and Amazon Books have chosen their initial brick-and-mortar sites in locations calculated to appeal to younger shoppers.

Athleta has mostly chosen to take non-mall sites, either in lifestyle centers or street retail locations. Warby Parker is very focused on street retail, working to emphasize the brand’s destination status. Amazon Books’ first location was in University Village, an open-air lifestyle center in Seattle, and while its second is slated for a traditional mall location (Westfield UTC mall in San Diego), that store will be optimally positioned opposite an Apple store and next to a Tesla store.

While age and income play a role in site selection, perception is also a factor–specifically, the desire to be perceived as something different or special. And while demographic and psychographic data is useful, another important consideration for virtual retailers looking to plant their brick-and-mortar flag is the strength of their existing business in the market. Online retailers’ brick-and-mortar iterations consistently perform best in locations where they already have a strong online presence–and they are understandably leery of opening store locations in areas where they don’t have strong brand recognition. On one level this may seem a little counterintuitive, but strong brand recognition is the best way to establish brick-and-mortar traction, and initial forays into brick-and-mortar cannot afford to underperform.

Additionally, while some online retailers may have initially looked at brick-and-mortar as a novelty—or as a showcase for their online marketplace—they quickly recognized that boosting brand recognition from an established brick-and-mortar presence subsequently increases online sales. This creates a positive reinforcement loop, where multiple channels of distribution create a kind of 1+1=3 effect. Perhaps nobody knows that better than catalog retailers, which have a third channel to consider. One of the first retailers to leverage this strategy effectively was Talbot’s, which had a strong catalog business and made a point to open stores where catalog sales were highest. A more contemporary example is Sundance, currently rolling out the third leg of its multichannel operations by expanding into brick and mortar.

Ultimately, this speaks to a larger truth about today’s evolving retail marketplace: to be competitive, retailers must be effective multichannel operators. Creative relationships are forming between traditional and online retailers—cultivating new and different mechanisms for traditional retailers to establish their omnichannel credentials. I’ll explore those dynamics in my next column.

Now Trending: Changing the Channels

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One of the most important trends to track these days is that of online retailers making the jump to brick-and-mortar. The different strategies and tactics they have taken, and the new and different ways that retailers are adapting to the realities of an omnichannel world, can not only reveal some fascinating truths about retail today — but also provide some insights into where the retail industry might be heading in the future.

Today we have four different distribution channels in wide usage: online, catalog, brick-and-mortar, and wholesale. While a brick-and-mortar brand bolstering their online presence is a familiar story, it’s where we see online (and, to some extent, catalog) retailers evolving from virtual vendors to physical storefronts that things get really interesting.

Simply opening up a store is one strategy. In my last column I wrote about exactly that: how online retailers like Warby Parker, Athleta and Amazon Books are selecting physical store locations and establishing themselves as viable brick-and-mortar brands. I also referenced the “creative relationships being formed between traditional retailers and their online brethren–and new and different mechanisms for traditional retailers to establish their omnichannel bona fides.” That is where we start to get into the wholesale category (which also includes “store-within-a-store” concepts), and some of the “hybrid” solutions that online retailers are using to get their foot in the brick-and-mortar door.

While Australian skincare and cosmetics brand Aesop had brick-and-mortar locations Down Under, it decided to expand its first with an online-only U.S. presence, then opening dedicated freestanding stores, and finally by going into the cosmetic department at Nordstrom’s. Men’s pants brand Bonobos also chose the wholesale route – but with a twist. Bonobos is also available at Nordstrom’s, but the retailer has also opened a number of non-traditional brick-and-mortar locations it calls “guide shops” in cities across the U.S. The guide shops allow customers to try on pants with the help of trained guides, who help determine the right fit and then place the order online to have the selected purchases shipped to the customer’s home.

The Bonobos example is illustrative of the fact that when online retailers are looking to expand or enhance their brick-and-mortar distribution channels, there is no rulebook–they have to figure out the best way to showcase their product. Canadian apparel retailer Kit and Ace determined that the best way to do that was to take an entirely new approach: open up pop-up locations in luxury hotels in several cities around the world. From San Francisco to Melbourne, and from London to New York, Kit and Ace’s “The Carry-on,” pop-up concept (featuring “easy-pack carry-on essentials”) appears for a limited time at select high-end international hotel venues.

The push to bring online brands into brick-and-mortar isn’t just a one-way street, either: Macy’s actually bought online skincare and cosmetics company Blue Mercury to begin selling their products in-store. Developments like that show that department stores realize that they have to diversify their offerings, and that the “direction” of flow within these new distribution channels can go both ways – and sometimes meet in the middle. Macy’s likes having the exclusive on a line of products that won’t be sold at other stores in the mall, and it’s easy to see why online specialty retailers can benefit from piggybacking off of a mass merchant, reaching new markets and potentially dramatically broadening their appeal. A similar dynamic is at play with Sephora and J.C. Penney: Sephora can now go into J.C. Penney locations in smaller markets that the cosmetic retailer would never have been able to justify opening as a stand-alone store.

So what does all of this tell us? First, the willingness and enthusiasm of retailers pushing to try new ideas and expand into new frontiers is an acknowledgment that retailers understand something important: to be successful in today’s retail industry, they have to have an effective multi-prong distribution strategy.

Fundamentally, it’s about being creative with how you distribute your product. For so many years there were just two options, brick-and-mortar or catalog. And then the internet came along and online opened up. Now we’ve added wholesale, hybrids, hotels and more to the list. This is without a doubt the most dynamic and diverse age of distribution in history–and it continues to evolve as traditional boundaries break down and new innovations and opportunities emerge.

I’ll be the first one to admit that I didn’t see it coming. For years the perceived threat of online sales was something brick-and-mortar retailers would have to grapple with–or at least, so went the conventional wisdom. While it’s true that online and mobile sales continue to creep up, the story isn’t nearly as simplistic as we may have thought. The retail landscape today isn’t a binary black and white place: there are shades of gray. It’s not so much online versus brick-and-mortar as it is online with brick-and-mortar: collaboration, not competition, is the theme. Successful retailers have recognized that, embraced it, and flourished as a result.

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Now Trending: The Replacements

There has been a great deal of discussion and analysis in recent years regarding the ongoing struggles of many traditional department store giants. Brands like Sears, J.C. Penney and Macy’s are scratching and clawing to continue to stay afloat, together with a number of big-box retailers that are also struggling to remain competitive in an evolving retail marketplace. As more and more department stores and big-box locations go dark, owners and developers are faced with large gaps in shopping centers that need filling. The challenge is not just making up for lost square footage, it is in accommodating large formats and suboptimal layouts, and finding uses and tenants that add something new to the existing center. There have been a number of solutions to replace these fallen giants – strategies that have met with varying degrees of success – from redevelopment and restructuring, to backfilling with new and emerging retail concepts. Perhaps to consider the best fit for today’s marketplace is to reflect on what past solutions have emerged successfully and, in some cases, not so successfully.

Regardless of the specific strategy, it’s clear that owners and developers need to think strategically and creatively about how to fill those large, open spaces in their centers. But is that happening? Are new options being put in place because they work, or because they are simply available?

I think the biggest issue isn’t about tenancy or square footage–it’s actually one of perspective. You can’t prescribe the right solutions if you don’t fully appreciate the nature of the problem.

To do that, we first need to trace the struggling department store trend to its origins. The way many talk about these issues, you might think this has all just popped up out of nowhere in the last few years. But the idea of a mall losing its anchors isn’t new. The reality is that what is taking place in the industry today is the culmination of developments that have been percolating for at least twenty years. Prior to the acceleration of the department store and big-box struggles we have seen in recent years, the last time the decades-long trend experienced a spike was the late 1990s and early 2000s, when an economic slowdown cranked the Darwinian vise that was already applying pressure to a few extra notches.

Examples of adaptive reuse that emerged in the wake of that trend include medical and educational uses, some of which were successful – like the addition of a new offsite campus for the Vanderbilt medical center on the second floor of the 100 Oaks Mall in Nashville, Tennessee – and others that didn’t work out – such as the attempt at adding a community college facility to the University Mall in Tampa, Florida.

Today, the industry is focused on looking at alternative retail and entertainment concepts, along with multifamily and hotel. But the “right” solution is about understanding what works for each specific shopping center. Some of the conventional wisdom today was barely on the radar just a few short years ago. Unfortunately, that’s a continuation of a long-term pattern that has plagued the industry: the next big thing comes along, everyone jumps on board until the bubble pops – and then on to the next next thing! History has taught us that we have to be extremely careful about evaluating an asset from a local and regional demand perspective.

While many centers that are losing anchors are turning to new experiential entertainment components, many of those concepts are unproven and may face their own issues adapting to social changes. These concepts are increasingly popular when it comes to filling these large available spaces. But will they bring new visitors? Will they get them to stay longer? And is it a cross shopping opportunity?

Knocking down a vacant anchor and replacing it with new restaurants and a selection of specialty retail has also worked–to a point. But even that can easily become oversaturated. Food uses are not a panacea for a mall – they have to be one of a number of strategies when it comes to potential redevelopment opportunities.

We tend to go from one potential fix to another in a very global sense, at times losing sight of on-the-ground elements that can and should play a critical role in decision-making. That’s not to say that any of the solutions discussed above can’t work – many can and will work very well – but each case has to be studied very carefully. Context is so critical. Understanding each individual market: what are the voids in the market–and how can you fill them? And that assessment needs to encompass not only the retail marketplace, but also the voids that exist in other commercial and residential segments.

Today, the retail real estate industry is doing what it always does: looking for an answer and searching for a formula. The reality is that there isn’t one–at least not a one-size-fits-all variety. Customers don’t shop that way. They only respond to what they want and need. When it comes to solutions, creativity and analytical rigor is key. However, when a mall is repositioned long term, it has to fit its market — taking into account everything from demographics to future growth potential and finally to the changes likely to occur in the retail consumer, both short and long-term.

Retailers and retail real estate developers need to avoid making the same mistake that the department stores they are replacing made–the mistake that contributed to their downfall in the first place: inflexibility, and an inability or unwillingness to adapt. The last thing you want to do is to solve a problem caused by a failure to abandon an outdated formula by being too formulaic.