The Evolution of Retail Ownership

John Meador  /   May 30, 2019

The consumer retail sector continues to strategize around how to reposition physical stores to offset the growing demand of online shoppers. Many experts suggest that retailers have figured it out—companies understand the necessary steps to create a profitable retail experience. This strategy, however, could just be delaying the inevitable. Pop up shops and smaller stores may present a way to merely stay afloat until technology makes physical retail—other than dining and entertainment—entirely obsolete.

The industrial sector has been the widely-reported beneficiary of retail’s supposed demise.  Conventional industrial, consisting of loading docks and ample clear height, has become one of the hottest institutional investments of this real estate cycle.  Moreover, as yields have continued to compress for well-located industrial, operators have had success creating scale within the product type by way of small to mid-size transactions. These operators are being handsomely rewarded for their efforts through portfolio exits to buyers with a longer-term investment horizon and a lower cost of capital. Industrial’s popularity has created a new vernacular: “E-commerce,” “Clicks and Bricks,” “BOPIS,” “The Amazon Effect” and more. The historical separation of retail and industrial has created a conversation predicated on one of them winning and one losing. Since the interdependence of retail and industrial is more obvious than ever, why does industrial exist as a separate product type at all?

Across the country, the exploration of physical retail and/or mall conversions into industrial has become fairly commonplace; however, only a handful of owners have decided to spend the capital to execute this strategy. Some of the reported difficulties around converting retail shopping centers into industrial include:

  1. High-quality retail assets have historically garnered higher triple net rents and valuations than industrial product. A combination of improved leasing fundamentals and cap rate compression within urban areas and high quality suburban industrial, will soon make this point moot.
  2. Zoning typically prohibits industrial use within retail-oriented areas. While this is true today, an increase in big box retail conversions into quasi distribution centers will pressure many municipalities to rethink either the use definition or the underlying zoning entirely.
  3. Municipalities tend to gain more tax revenue from retail uses (additional layer in sales tax) than industrial. However, E-commerce sales projections ($1 trillion+ by 2025) will make this argument less relevant over the coming decade.

Will there be a tipping point where the real estate community merges conventional definitions of industrial and retail into one product type?  Will it only happen once downtown retail storefronts and/or full buildings finally evolve into true “last-mile” drone delivery warehouses?  Only time will tell, but the changing market suggests this merger is at least justifiable.  If current retail owners have the confidence and capital to weather the storm of an evolving market, they could profit considerably from owning the best “industrial” locations all along.



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