Retail Apocalypse Or Renaissance? U.S. May Have Record Store Closings AND Openings In 2017.
Record store closings could be met with record store openings in 2017 as a retail renaissance reinvents and reshapes the space forever. Many legacy retailers are losing their relevance even in a swelling growth environment breaking retail sales records.
Retail sales disappointed last Friday (May 12), but only because reported growth was below analysts' expectations. Not because there was no growth. The Commerce Department reported that retail sales rose 0.4% in April and upwardly revised March sales. Excluding automobiles, gasoline, building materials and food services, retail sales gained 0.2% after advancing 0.7% last month. More importantly, sales rose 4.5% this April compared to April ‘16—continuing a solid trend of growth well above overall GDP since the Great Recession. Indeed, the outperforming U.S. consumer has led the world out of recession as a strong, consistent tailwind pushing the recovery forward.
Strengths came from familiar leading categories, such as construction materials and online sales. Furniture sales were strong, and Home Depot turned in another strong quarter as people kept investing in their homes. Auto sales were relatively weak, however, and have shown signs of slipping into a hangover following a push to new all-time high auto sales just a couple of years ago. Worse off, many department stores are on the ropes—led by continued evaporation in apparel sales. While online sales were up 11.9% year-over-year and restaurant & bar spending up 3.9%, department store spending was down 3.7%. Reports of weak sales were ubiquitous from department stores in the first quarter from weak hands and strong players alike. Macy’s, Kohl’s, JCPenney and Nordstrom each reported disappointing sales numbers.
Nordstrom—considered to be among the strongest department store brands—reported a canary like quarter. Its online sales were up 20%—a double-digit "success"—but its comparable same store sales were down 3.6%. Wall St. analysts were deflated and Nordstrom’s stock sold off on the report. It has continued selling off because the big part of Nordstrom’s business (brick and mortar) is shrinking faster than the small part (e-commerce) is growing, so the 20% success is a minor victory in a battle going badly. And the squeeze is accelerating, putting many retailers in a stranglehold—even best-of-breed retailers—causing them to close.
Nordstrom is emblematic of the broader trend that’s reached critical mass to the point where the clicks are crushing the bricks. The physical retail footprint is developing stress fractures as the old normal buckles under the virtual weight of e-commerce. Consumers are spending more money than ever. And there is no new trend towards savings, but today's shoppers are more thrifty and discerning than ever before. Consumers are not spreading money around to numerous retailers as in the past. As a result, large swaths of retail are not getting new marginal dollars in this hyper-competitive growth environment.
So, even though last week’s retail sales report showed growth in nine of thirteen categories, individual retailers are losing in a realignment of historic proportions. In quarterly reports, individual retailers continue to describe the same very soft, promotional environment they have for many years now. Many are struggling to drive traffic into their stores. Department stores in particular are getting killed because they just are not giving rational, resource-maximizing consumers enough reasons to come into their stores—unlike warehouse clubs (e.g., CostCo), which are still packing shoppers in.
Past the Point of No Return?
E-commerce is reaching critical mass now, but it took a while. The seed was planted in the 1990’s. It built up more seriously after the dotcom bubble popped. By 2013, it made a very loud and noticeable bang that rattled the retail sector and package delivery companies. So, retailers have had a lot of time to dig in and make defensive adjustments.
But now in 2017, it's becoming apparent that the defensive strategies retailers are deploying are not working. And this raises existential relevancy questions for many retailers. Some are abandoning their physical footprints and totally migrating online, such as Bebe.
Many once mighty retailers have lost the legacy of competitive advantage that made them great. Some seem unable to adapt. One-time department store superstar Sears, for example, recently acknowledged “substantial doubt” about its future as a going concern in mandatory disclosures. Shortly thereafter, suppliers began to squeeze Sears, according to its CEO, bringing future doubts about Sears into clear and present focus. This week, Sears followed up on its CEO’s threats to sue vendors who Sears says squelched on agreements. Meanwhile, J.C. Penney is still trying to recover from a reinvention gone horribly wrong in 2012. Another 140 J.C. Penney stores will close by the end of July. And though it managed to turn in a 6 cent profit this past quarter, its stock sold off to record lows on weak revenue and same store sales comparisons. Some analysts called the quarter a disaster. Penney's CEO admitted he has “no great optimism” that the retailer can make apparel sales profitable again.
And though Amazon makes up 50%+ of online sales, it’s not just a story about Amazon. Price discovery is a greater force than ever before. The pressure created by online, real time, world wide pricing is ever present. It’s a structural deflationary force that’s suffocated a number of segments. Before apparel and clothing, prices for electronics turned down and kept falling.
Big Store Openings
Macy's, another best-in-class brand, has been leaning into the retail realignment by making investments, closing stores and realigning its geography for some time. The number of Macy's brand stores dropped from 733 stores in 2014 to 673 stores at the end of last year. But the number of its Bloomingdale's brand stores grew by 5 over the same period, to 55 by the end of 2016. Bluemercury, a brand the company acquired in 2015, increased the number of its stores from 77 to 101. All in, Macy’s store count actually increased by six in the three years following the retail sea-change called by Starbucks’ Howard Schultz, growing from 823 in 2014 to 829 at the end of 2016—although earlier this year it announced it would close ~100 stores.
But while we're busy focusing on the retail apocalypse the number of stores openings this year will also hit very high levels. The first quarter opened more stores than any first quarter in recent memory:
According to research prepared by Alex Munoz of The Shopping Center Group, the first quarter of this year opened more stores than any quarter except the fourth quarter of 2006—the last holiday season at the height of the bubble before the Great Recession began.
Value-driven retailers have been rapidly expanding their store footprints. Dollar Tree plans to open 650 stores this year and T.J. Max more than 100. Experience related categories beauty and “athleisure” are helping to drive openings, led by innovative up-and-comers like Ulta.
Walton Empire Strikes Back
But not every legacy retailer should be left for dead. Wal-Mart has been aggressively reinventing itself and investing heavily in its own major structural reset. Despite its large size, it was quick to shed some of the bad habits built up in the largess of the old normal (and underperforming stores) and go back to basic strengths that made Wal-Mart great, such as its logistics network. Wal-Mart boasts having a store within 5 miles of 70% of the U.S. population. And though the company started culling underperforming stores even before Howard Schultz called his sea-change, Wal-Mart today has more stores than ever.
Many of the stores Wal-Mart closed were far-flung exurban areas and third-ring suburbs that were stranded by the recession. These areas were built up with new infrastructure and big box, but the mass migration of people slowed or stopped altogether. Most of Wal-Mart's new store openings have followed the people to more densely populated areas. And its Neighborhood Market store format is intended to infill into these urban markets more easily, with a much more compact, sometimes stacked architecture with less square feet, less inventory and pedestrian orientation.
Wal-Mart is evolving into the growth of this new cycle and starting to thrive again even in this otherwise very difficult environment. Its geographic realignment, store reinvestment and introduction of smaller footprint stores into new markets (there are now 700+ Neighborhood Markets)—not to mention Wal-Mart's ever-aggressive pricing—have helped Wal-Mart continue to lure more and more shoppers into stores.
On March 18, Wal-Mart announced that its comparable U.S. sales grew for the 11th quarter in a row—up an enviable 1.4%. And its comparable in store foot traffic grew by an even more enviable 3%. Best of all, Wal-Mart's e-commerce sales rose a massive 63%, on top of 29% growth last quarter. Despite making a number of acquisitions—and perhaps making more, e.g. Bonobos—the majority of these sales were made organically through Walmart.com according to company reports. Wal-Mart’s recent roll out of free two-day shipping for online orders over $35 has been a success. So much so that it prompted e-commerce juggernaut Amazon to flinch and slash its free-shipping threshold for shoppers who don't have a Prime membership (down to just $25).
Wal-Mart's success comes after huge investments, acquisitions and continued effort to embrace this evolutionary moment. Finally it seems its titanic redeployment is paying off. Simultaneously leveraging legacy strengths and core competencies while embracing innovation and change is a rare feat. But Wal-Mart has the scale to compete in the new retail normal and the drive to compete and win written in the company’s DNA. In its state-of-the-art fulfillment center in Bethlehem, Pennsylvania—a massive, partially automated 1.2 million square foot facility with every product Wal-Mart fulfills stacked on shelves 40 feet high as far as the eye can see—there are quotes on the wall from its passionate founder Sam Walton, such as “To succeed, stay in front of change.”
That’s no small task in this period of rapid transition in retail. We’re starting to see the results of the ensuing turbulence shake out many weaker hands. But it’s not an overall apocalypse. It’s a record-breaking growth environment. The total pie has never been larger, and in many ways it never tasted so good for consumers and owners of prime commercial real estate assets.
Record Retail Environment
Quite simply, there is record demand from consumers. Tenants are clamoring for quality space. Real estate investors are piling into quality asset classes, and there just isn’t enough to go around. There may be too much retail space in the U.S. overall, but there isn’t enough of the right size and shape of retail stores in the right place.
Going forward we’ll have to rightsize, refit and reconfigure the retail universe. It’s been done before. This time convenience, quality and experience are three megatrends all converging at once. And despite the doom and gloom, the consumer is booming and retail is thriving. So when extinction events occur, the bones of commercial greyfields make excellent reuse opportunities to be adapted to new demand—especially in markets where land resources are tight or constrained.
Because convenience comes so easily online, millennials—and likely every generation hereafter—expect other things from the built-environment. Namely, service and experience. Expect more entertainment to be redesigned in more retail developments—especially malls—which calls back to one of the original design ideas behind the invention of the mall. But all experiential retail will grow into nearly every format from here. The in-store experience is evolving as fast as anything else, with innovations across the spectrum from virtual and augmented reality technologies to high end in-store service like personal shoppers or vegetable/produce butchers.
Millennials will also pay for quality—quality of life, of experience, of goods and foods/beverages. Many millennials of the foodie variety tickle each of these fancies by cooking quality meals at home (often with quality cookware, naturally). They joined Boomers retrenching during the recession at the grocery store, which drove steady growth in the expansion of store space grocery segment—and anchored mixed use developments.
But many more millennials go out for food, and the return of restaurants—hit very hard in Great Recession—has been very impressive. Last year, U.S. consumers spent more money in bars and restaurants than grocery stores for the very first time. And while the strength of the U.S. consumer led the global recovery, the ability of bars and restaurants to attract consumption has led the retail sector. Sales at Food Services and Drinking Places grew twice as fast overall retail spending.
Millennials are attracted to quality of place both near and far. Turns out that Boomers are too, and so even though everyone hates flying, air travel is booming. Last year set a record with 823 million passengers flying on U.S. air lines. Not surprisingly, retail stores in tourist traps are doing just fine.
The key is foot traffic. Whether by value, convenience, quality, service or experience, retailers must be able to compete and win modern shoppers somehow. Or become extinct and make way for new or more adaptive species who can make higher and better use of the space. Restaurant, bar and entertainment uses can be more profitable venues anyway. And landlords are happy to trade underperforming tenants for growth opportunities.
It’s good for the economy, too, particularly because these segments employ lots of people. Entertainment, experience and service companies tend to require plenty of hands. They tend to create jobs across the spectrum, from entry level jobs to highly skilled workers. And whether it is venue usher, event organizer, electrician or sound engineer, these jobs seem well protected from displacement by any technologies currently in the pipeline. So, not only are their business models internet-proof but the jobs they create are automation-proof. Not surprisingly, jobs in leisure are growing robustly.
If these new modes can generate higher sales per square foot, then everyone's a winner on the other side: The consumer/shopper, the (new) business/tenant, the landlord/owner and the tax collector. And that appears to be precisely the situation playing out. The strong are getting stronger and already landlords of core, class A properties are raising rents. There will be pain along the way, but the industry will emerge much stronger than ever on the other side.
How long will it take and how much commercial greyfield property will require substantial adaptive reuse or be stranded are questions it's still too early to know the answers to. The record shop and video store armageddons are now long forgotten. The real estate industry took the hit, absorbed the space and moved on (and the music business is selling more records and video industry selling more content than ever before, by the way). But with online sales still only making up <10% of total sales and Wal-Mart just catching on (with 63% online sales growth this quarter) to give Amazon real competition, it's merely the end of the beginning.
There's plenty of realignment left to go and refitting and rightsizing to be done along the way. Oversized greyfields in poor locations will require major refits. Auto malls may be the next segment to start sliding down the slippery slope of innovation—and already litigation has broken out to protect local auto dealers (and the enormous tax receipts they generate municipalities). Many of these mega auto malls and other large greyfields will require a spark of reimagination to repurpose their very large size. And many communities will need support to battle against these tidal forces without too much collateral economic damage.
The wheels of renaissance are spinning incredibly fast. Friction is inevitable, but a little grease on the wheel will smooth the ride.
In the next and final installment in this series we’ll look at the reuse of larger greyfield properties and explore the future of adaptive reuse in this commercial real estate renaissance.
If your greyfield requires adaptive reuse contact BL about reinventing your site.