Martha S. Peyton, Head of Global Real Estate Strategy & Research
September 6, 2012
The debut of department stores, supermarkets, and regional malls were all revolutionary in their day, and the revolution in retail continues today. In the roughly three years since the bottom of the last recession, for example, the retail sector has seen a dramatic uptick in ecommerce and the use of new smartphone and tablet devices, which are transforming the way consumers shop. As a result, ecommerce and new technology are affecting how retailers use space, how much space is needed and property values.
In 1999, when the U.S. Census Bureau began collecting data on retail sales transactions on the Internet, ecommerce accounted for $4.6 billion out of total retail sales of $724 billion, or 0.6% of the total. The most recent data for the first quarter of 2012 shows the proportion has grown to 4.9%. The more startling measures are the comparative annual growth rates of retail sales overall versus ecommerce sales separately; the former has grown just over 3% per year on average since 1999, while the latter has grown in excess of 20% per year on average over that period.
As a retail property investor, TIAA-CREF has monitored the growth in ecommerce carefully over this entire time frame. Since 1999, both pure-play web retailers and traditional retailers have grown their online sales more than 20% annually. But the more striking development is the increasing diversity in the types of products that are sold online—in particular, the increasing popularity of online sales of clothing and accessories along with electronics and appliances (see Exhibit 1). This surge represents a sea change in the conventional wisdom that grew up in the early years of ecommerce, which focused on the relative invulnerability of these product categories to the incursion of ecommerce. In particular, clothing and shoes were defined as difficult to sell online because of consumer preferences for seeing, touching and trying on. The recent enhancements in technology and consumer preferences that have allowed for growth in these categories point to further erosion ahead in the role of traditional retailing, and consequently to implications for retail property investors.
Impact of New Technology on Retail Space
With ecommerce clearly on the rise, a recent survey conducted by Deloitte asked retailers to rank the importance of the various uses of store space over the next five years. Eighty-five percent of the retailers responding to the survey indicated that providing customers with a compelling brand experience is becoming the primary role of stores. Seventy-nine percent of the survey respondents ranked the traditional role of store space as a place to shop. Seventy-one percent of the survey respondents said the role of stores was to offer interaction with sales associates and 50 percent of the survey respondents said that retail stores provided an environment for social interaction.
As retailers will need less physical space due to the increase in ecommerce, leases negotiated between landlords and retailers will have to be flexible in the allowed use of space. Furthermore, since sales transacted using mobile devices might or might not be associated with individual stores, traditional sales per square foot measurements are becoming less and less meaningful for valuing sales productivity, calculating percentage rents, and appraising the value of retail property. The link between sales and space is even more distorted when customers visit stores to check out items physically and then order from lower-priced retailers via the Internet. Online services such as Amazon Prime facilitate this kind of price discovery. Thus, retailers are essentially paying rent on stores that consumers are using as showrooms without generating sales revenue.
Counteracting “show-rooming” is a hot topic in the retail sector. Strategies to deal with it include extreme focus on customer service, customer experience and customer loyalty programs in order to drive store sales. These strategies are more useful for addressing higher-end shoppers making non-commodity purchases, such as luxury goods. Lower-income shoppers and those making commodity-like purchases are more price-sensitive, and discouraging show-rooming is more difficult. Relief here might only come from manufacturers if they can somehow be persuaded to assume some of the cost of show-rooming or calibrate their pricing to compensate the victims of show-rooming.
Dealing with Change
The retail property sector is just beginning to feel the pressures associated with show rooming, as the need for physical retail space is changing. Some retailers are using store space to handle inventory and shipping for online sales and returns. Others are opting for smaller stores (WalMart), some are closing less productive stores (Sears) and still others are disappearing altogether (Borders). On balance this has translated into very weak overall appetite for new construction of retail space in recent years. More recently, a flurry of new store formats are rolling out for 2012–2013 as the competitive landscape continues to boil, but it remains to be seen whether and how construction will respond.
Investors in retail property are well-advised to consider the relative vulnerability of their portfolios to these forces; it will depend on the characteristics of both tenants and physical space. Financially stronger and more technically savvy retailers are the best positioned to deal with the challenges of ecommerce now under way.
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