Retail: No shopping maul
The end of bricks-and-mortar retail? Far from it, argue Steve Shigekawa and Brian Jones
Occasionally a company exerts such a profound effect on society that our language bends to accommodate it. We no longer look for information; we ‘Google’ it. Amazon is another such company. We no longer talk about the impact of e-commerce on the world, but about ‘Amazonification’.
Amazonification is the number-one industry trend for real estate investors. It touches parts of the sector that you might never imagine. Amazon Web Services, the firm’s cloud-computing provider, is one of the world’s largest users of data centres. Even offices and residential apartments feel its mass. It is the largest employer in Seattle, where it has its global headquarters, occupying almost one-fifth of the city’s office space. As it proposes a second HQ elsewhere in the US, major cities compete for those jobs and their office and residential markets respond as a consequence.
Of course, the biggest impact of Amazonification is being felt in the retail supply chain. That impact is more nuanced than many assume.
Global online sales doubled to more than $2trn (€1.6trn) in the five years to 2016. They are forecast to double again by 2020, and still only take a 15% market share, according to e-Marketer and Prologis Research.
Behind this growth are the twin forces of the emerging world coming online and the shopping habits of Millennials. A CBRE survey published in 2017, Millennials: Myths and Realities, found young people in the UK leading the pack, on course to do more than half of their non-food shopping online by 2019. But the rest of the world’s 20 and 30-somethings are not far behind.
We often hear that online shopping means ‘the end of bricks and mortar on the high street’. Nothing could be less true.
Consumers are increasingly demanding same-day and even same-hour delivery. That is taking us from a distribution model in which a single retail outlet with storage space receives a delivery once or twice a week to a model in which thousands of consumers receive deliveries several times a week or even several times a day.
The resulting ‘e-fulfilment’ is real-estate intensive. It uses a range of assets, from multi-storey warehouses, to infill service centre s, to local self-service locker and pick-up locations. Wider product choice, smaller orders and increased incidence of product returns mean that e-commerce also uses more of those assets than traditional retail. In 2016, Prologis calculated that each square foot of logistics real estate worldwide supports just $750 to $1,000 of online sales, as opposed to more than $2,200 of traditional bricks-and-mortar retail sales. It estimated that e-commerce generated 20% of all new leasing, up from 5% in 2011.
Logistics is the clear real-estate growth opportunity in e-commerce. But investors should not neglect the value opportunity. That value opportunity has arisen due to a somewhat indiscriminate de-rating of retail assets as investors have become more cognisant of the Amazonification trend. There are three reasons why we believe it will pay to be more discriminating in this sector.
First, the extent of Amazonification varies regionally. There are no territories in which online sales are predicted to lose market share, but some are starting from a lower base than others and some are forecast to transition more slowly. That can be due to local shopping culture or a simple lack of support infrastructure.
Elsewhere, e-commerce has much more room to grow without having the same brutal impact on retail malls that we expect across much of North America simply because these territories have substantially less retail space per capita to begin with. Some of the biggest online shoppers are found in the UK and Germany, but the latter market has just one-tenth of the retail space of the US. Even a country such as Australia, which has plenty of space for retail malls, has restricted growth with a relatively tight planning regime.
In these cases, we might expect e-commerce logistics property to command a premium, but also greater use of existing traditional retail assets within the e-commerce supply chain, and more focus on non-apparel outlets that are less at risk from the e-commerce trend. That is precisely what we see in Australian and Asian malls. Rather than anticipating that the brutal mall cutbacks of North America will spread elsewhere, we think the established trends in other territories will spread to North America – and these are the second and third reasons to be more discriminating in the retail sector.
Even in the over-supplied US, we believe that traditional stores and malls that enjoy prime locations are likely to benefit from Amazonification as they double as pick-up points for goods bought online. About a fifth of customers in the Americas and Asia Pacific prefer in-store delivery over home, office or other third-party pick-up points, according to CBRE research from Q4 2016. A higher proportion of goods bought online are returned, too, and customers often like taking their purchases back to a real person in a local store.
This helps explain why retailers that are slowing their physical store openings remain committed to the top locations, but also why many leading US online brands – such as Warby Parker, Bonobos, Amazon Books, Toms and JustFab/Fabletics – have been opening bricks-and mortar stores in these grade-A shopping malls.
Figure 3 shows realised annual revenue per available square foot (RevPAF), indexed to 100 in 2007. High productivity malls typically have tenants whose sales are in excess of $500/sqft, while low productivity malls have average tenant sales of below $500/sqft.
The best-located malls are also the ones most able to adapt their retail offering to the pressures of Amazonification. If you own the primary mall at the heart of a large, thriving community, you are more likely to be able to change the apparel stores most at risk from online shopping into grocery stores, restaurants, bars, gyms, wellness facilities, cinemas and the other entertainment offerings that are becoming the new source of demand for A-grade retail space. This is the third reason to discriminate properly in retail real estate.
We are reassured by the fact that there are other sophisticated investors who recognise that the shares of these A-grade mall landlord groups are trading at material discounts to their underlying net asset values, and that those assets are attractive. A number of activist investors have taken meaningful positions in US mall REITs, and we have also seen a bid to acquire a 100% stake in a large US mall REIT. Europe has also just seen two major mall mergers proposed, signalling an appetite within the industry to consolidate these assets.
This interest reflects the fact that, while the Amazonification of retail worldwide is creating a notable growth opportunity in logistics real estate, it is also sharply delineating the winners and losers in retail real estate itself, and giving the winners exciting new opportunities to redefine what they do.
The weaker locations in the retail pack will continue to get mauled by e-commerce, but the best locations in the sector, far from being devoured, can benefit from this strengthening trend.
Steve Shigekawa is senior portfolio manager and Brian Jones is portfolio manager at the REIT group, Neuberger Berman