The growing reliance on contact-free e-commerce is providing new opportunities and unique challenges to the commercial real estate sector, specifically those focused on retail and industrial space.
The holiday season is upon us and like most everything that has happened in 2020, it will bring unprecedented experiences due to the pandemic. Most people associate the holidays with buying presents for friends and family and getting together to share each other’s company. But with the coronavirus still raging, these time-worn practices may not be possible. Early indicators of holiday sales have been disappointing, to say the least, and, with most states rolling back reopening measures, the season is not shaping up to provide the much-needed survival boost many businesses had hoped for—with some exceptions. The growing reliance on contact-free e-commerce is providing new opportunities and unique challenges to the commercial real estate sector, specifically those focused on retail and industrial space.
Retail
Retail had been undergoing a technological transformation for years, but the pandemic sharply accelerated the shift from brick-and-mortar sales to e-commerce. Prior to the outbreak, retailers had progressively put more attention on the omnichannel customer experience due to the growing popularity of online sales. The great emphasis on e-commerce led to a stream of store closures. But the pandemic put that trend in overdrive; more 40 major retailers, including well-known names like J.Crew, GNC and Lord & Taylor, have declared bankruptcy in the past year. As a result, more than 11,000 stores have been slated for closure totaling 150 million square feet of retail space. And these figures are conservative; they are limited to public announcements prompted by material events and do not account for the pandemic’s impact on small businesses, which is driving totals even higher; as of Aug. 31, 2020, nearly 164,000 businesses were closed that had been marked open in early March, according to Yelp, representing close to 100,000 permanent closures.
It’s not all doom and gloom. While you may might think e-commerce’s rise would have resulted in significant downsizing of the retail space, the national retail vacancy rate is still just two percentage points below its 2010 peak. The reason? Retailers are shifting away from selling merchandise in stores and offering experiences such as escape rooms, gyms, movie theaters and highly curated showrooms for online merchandise instead. But experiential retailers, too, are facing pandemic-induced headwinds. Extended stay-at-home protocols pushed more people to set up their own home gyms with treadmills and Peloton bikes. How many of these users, having had a long taste of commute-free workouts, will choose to retain their gym memberships when the economy recovers? Movie theaters may also have a rocky recovery. Movie studios are ramping up their direct-to-consumer efforts, giving Netflix and Amazon Prime subscribers the ability to stream new releases. WarnerMedia’s film division recently announced that it would release all of its 2021 movies on HBO Max the same day they hit theaters. The smell of popcorn may not be enough to lure skittish customers back to seats in public movie houses.
To be sure, those retailers that have grown their online presence, coupling it with smaller, appropriately configured store fronts and improved in-store experiences, have done well. Target, for instance, has expanded its e-commerce business while continuing to sign leases and build out slimmed-down footprints ranging from 20,000 to 60,000 square feet in and around urban areas, compared to their larger 130,000-square-foot suburban stores. Another space that has performed well are necessity retailers, which include pharmacies, grocery chains and discount stores like Dollar Tree. These businesses have continued to expand their footprints to meet demand in lower-income and lower-density areas. These are examples of how the retail sector is continuing to evolve to better serve the interests of the twenty-first-century consumer.
Industrial
As the shift to e-commerce increases, the traditional retailer’s loss has become industrial real estate’s gain, as Amazon, Target and other major e-tailers have brought logistics has been a front and center in the supply chain. As these giants and others now promise delivery in two days or less, they need last-mile distribution facilities close to communities to meet consumers’ elevated expectations.
This trend is clearly on the radar of private equity groups, which have been purchasing millions of square feet of warehouse space. On a forward-looking basis, according to JLL, a leading commercial real estate services company, the industrial real estate market could require another one billion in square footage by 2025 and the firm anticipates the e-commerce market to grow from $602 billion in 2019 annual sales to an estimated $1.5 trillion through 2025.
The takeaway
While traditional brick-and-mortar retail stores will likely continue to see more store closures, they do not signal the death knell for commercial real estate. On the contrary, commercial real estate will likely see a revitalization and repurposing of retail space, as store fronts shift to warehouse space and existing retailers look to retool their current footprints to help cope with changing consumer demands. All of this is positive news for construction and real estate companies heading into 2021.
