The success of the omni-channel sales approach increasingly embraced by national retailers depends on brick and mortar stores providing a retail market presence, product showrooms and fulfillment capabilities. Early this year it was reported on Amazon and other Internet retailers’about early forays into leasing retail space in the coming years.
All good news indeed for retail property investors. However, the market shift brought on by mobile technology poses challenges for CRE investors. What are the best property types to target, in what locations, and how should they handle the properties they already own?
The success of the omnichannel sales approach increasingly embraced by national retailers depends on brick and mortar stores providing a retail market presence, product showrooms and fulfillment capabilities. Just last month, it was reported on Amazon and other Internet retailers’ early forays into leasing retail space in the coming years.
All good news indeed for retail property investors.
However, the market shift brought on by mobile technology poses challenges for CRE investors. What are the best property types to target, in what locations, and how should they handle the properties they already own?
CoStar News examined a handful of investor strategies, including those from Deutsch Asset Wealth Management, Duke Realty, Menlo Equities, Monmouth Real Estate, UBS and USAA, to get a sense of the strategies among major investors.
Will Retail or Industrial Dominate Omnichannel Success?
The Census Bureau of the Department of Commerce reported this week that total e-commerce sales for 2014 were $304.9 billion, an increase of 15.4% from 2013.
That kind of growth has placed supply chain (i.e., industrial properties) firmly on the front line of retailers' growth strategies.
Individuals recently surveyed by the E&Y accounting firm seem to conclude that while brick-and-mortar is still the dominant sales channel for most retailers, the proportion is falling rapidly. In five years’ time, brick-and-mortar stores could account for just 81% of sales down from 93% this past year, E&Y projected.
And nearly 9 out of 10 consumer goods firms said they can no longer rely on traditional retail sales channels to drive growth.
So the key questions for investors sizing up the omnichannel strategy are: will brick-and-mortar stores still dominate as a sales channel in the omnichannel mix, or does industrial property stand to reap the most benefit from the trend?
Based on that question, here is how a variety of CRE investors are approaching opportunities presented by ecommerce growth.
Deutsch Asset Weighting Up in Industrial, Shrinking Retail
Saying growth in e-commerce will likely provide demand for modern logistics space in more inner-ring locations going forward, in part by capturing demand from the retail sector, Deutsch Asset & Wealth Management said it wanted to allocate about 9% more of its portfolio to industrial and would take away 2% or so from retail to do that.
Meanwhile, the firm said in its 2015 investment outlook, it expects retail will continue to be hampered by minimal income growth. Additionally, e-commerce is shifting some demand growth that would have previously gone to physical stores to the industrial sector. Furthermore, tenants are currently shifting toward smaller prototypical store plans, reducing demand for big-box properties.
Duke Realty Views E-Commerce as Another Industrial Driver
Denny Oklak, chairman and CEO of Duke Realty, believes the market is ripe for new industrial construction, and not just build-to-suit.
“If you look at the demand driver today among the retailers, e-commerce and the consumer products companies, it's for brand-new, big state-of-the-art buildings, 36- to 40-foot clear, million-square-foot buildings. The predominant number of those end up as build-to-suits," Oklak said during his firm's earnings conference call this month.
Menlo Equities Likes Data Centers
Data centers offer a different investment angle on the growth of e-commerce. Since its inception, Silicon Valley-based Menlo Equities LLC has developed and built over 3.2 million square feet of office, R&D and engineering commercial real estate properties.
The loan on one of its latest investments, a three-story internet exchange and colocation data center facility in Palo Alto, showed up in December in a CMBS offering. The property is one of just a handful of such centers to back a CMBS loan.
According to the appraiser on the $38.6 million loan, the top five data center markets in the United States are (1) New York / New Jersey, (2) Los Angeles, California, (3) Chicago, Illinois, (4) San Francisco/Oakland/San Jose (Silicon Valley) and (5) Washington, D.C./Arlington. The drivers of telecommunication and data center space are diverse, with e-commerce driving significant co-location demand in the markets. According to a data center research company, “the inevitable movement of transactions toward e-commerce will continue to drive data center demand in the area.”
Monmouth Sees Retailers Themselves Driving Industrial Demand
For Michael Landy, president and CEO of Monmouth Real Estate, omnichannel distribution requires more state of the art industrial buildings but implies less brick-and-mortar retail space.
"It wasn’t long ago when the big focus among shopping center and mall REITs was gaining scale, and scale would give you greater leverage with the major brands and world domination, etcetera," Landy said. "Today, they are spinning off portfolios. They are even spinning off entire REITs. And that’s what I am talking about, about the Internet Century. They see the headwind they are facing and that headwind is a tailwind for industrial. We are benefiting from it."
Landy said there is tremendous demand from retailers for distribution properties in their supply chain that are focusing on getting goods to the consumers as fast as possible and that’s driving demand towards FedEx locations.
"Historically, industrial is the quickest (space) to develop from inception to completion. It’s a 12-month to 18-month cycle of development. So, it’s very responsive to economic changes,” Landy said. “Much of the demand for industrial space is now retailers becoming e-tailers, and that wasn’t the case looking backwards.”
UBS Sees Retail Holding its Ground
International financial services firm UBS says e-commerce sales is both a threat and a complement to traditional in-store sales. There is no doubt that sales in this segment are growing faster than any other category. Still, e-commerce remains a small portion of total retail sales.
“Real estate professionals should carefully evaluate their retail tenants' omnichannel marketing and distribution strategies, especially for the segments of the market that are most vulnerable (e.g. books, clothing, electronics),” the company said in its 2015 outlook.”
UBS said E-commerce sales continue to grow, but traditional storefronts are holding their ground as the primary marketplace by improving service, matching online prices, and choosing to embrace e-commerce rather than fight it.
"To help fortify occupancy in the face of rising online sales, landlords should consider filling vacant space with service oriented tenants or goods retailers with strong omnichannel retail strategies," the firm said.
"Under a wide range of assumptions on growth rates and dollar-to-square-foot conversion ratios, e-commerce is unlikely to roll back demand for physical retail space,” noted Ryan McCullough, a senior real estate economist for CoStar Group. “E-commerce is weighing on physical absorption -- current demand growth is running at about one-third the average level from 2006-2008, with some of that shortfall attributable to the internet. But we have continued to see physical demand growth remain positive on the margin, and we expect that to continue indefinitely, pending economic conditions.”
USAA Sticking with Grocery Anchored Retail
To counteract the impact of ecommerce on its retail portfolio, military insurance provider USAA is planning to continue to focus on one type of retail sales where the internet has made little or no inroads, grocery stores.
Specifically, USAA said its investment profile is for properties anchored by a dominant grocer in primary and secondary markets, with a focus on locations where the grocer is achieving the highest level of sales per square foot.
“This asset type has proven to be e-commerce resistant relative to other retail segments, and has subsequently seen an increasing level of investor demand and price appreciation,” USAA’s global head of research, Will McIntosh noted.
USAA’s investment strategy targets key sectors of the “new” economy including energy, technology and health care. Its long-term outlook is optimistic for Houston and Dallas, San Francisco, Silicon Valley, Seattle, Austin, New York, Boston, Los Angeles, Denver, and select secondary markets.
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