Retail Real Estate

Retail Real Estate: Evolution of the Sector
Retail real estate has undergone a profound transformation over the past decade, first encountering the "retail apocalypse" due to the growth of e-commerce, and then the COVID-19 pandemic. Today, the sector demonstrates selective recovery: some formats remain under pressure, while others show resilient growth.

Typology of Retail Properties

1. Regional Malls
   Size: 400,000 - 2,000,000+ sq ft GLA
   Anchors: Department stores (Macy's, Nordstrom, JCPenney)
   Characteristics: Enclosed, multiple levels, food court
   Status: Most affected segment; Class A malls are recovering, Class B/C — under pressure
   Cap rates: 5.0-7.0% (Class A), 8.0-12%+ (Class B/C)

2. Power Centers
   Size: 250,000 - 600,000 sq ft
   Anchors: Big box retailers (Target, Walmart, Home Depot, Best Buy)
   Characteristics: Open-air, category-oriented
   Status: Moderate stress, depends on anchor quality
   Cap rates: 6.0-8.0%

3. Neighborhood / Community Centers
   Size: 30,000 - 150,000 sq ft (neighborhood), 150,000 - 350,000 sq ft (community)
   Anchors: Grocery stores (Kroger, Publix, Whole Foods)
   Characteristics: Convenience-oriented, necessity retail
   Status: Most resilient segment
   Cap rates: 5.5-7.5%

4. Strip Centers
   Size: 10,000 - 30,000 sq ft
   Characteristics: Small-bay retail, convenience services
   Tenants: Restaurants, salons, services
   Cap rates: 6.0-8.0%

5. Outlet Centers
   Size: 300,000 - 800,000 sq ft
   Tenants: Brand outlets (Nike, Coach, Levi's)
   Characteristics: Tourism-driven, destination shopping
   Cap rates: 6.0-8.0%

6. Single-Tenant Net Lease (STNL)
   Examples: Walgreens, CVS, McDonald's, Starbucks
   Characteristics: NNN lease, passive income
   Lease terms: 10-25 years
   Cap rates: 4.5-7.0% depending on tenant credit

Role of Anchor Tenants
Anchors are critically important for the success of the shopping center:

Functions of anchor tenants

• Traffic generation — attracting visitors to the center
• Credit stability — long-term commitments from large companies
• Co-tenancy clauses — lease conditions for inline tenants are tied to anchors
• CAM contribution — contribution to common area maintenance expenses

Problem of Department Store Anchors

• Bankruptcies: Sears, JCPenney (restructured), Neiman Marcus
• Presence reduction: Macy's, Nordstrom are closing underperforming stores
• Co-tenancy triggers: withdrawal of anchor may allow inline tenants to reduce rent or exit
• Dark anchor stores: vacant spaces reduce traffic

Anchor Replacement Strategies

• Grocery conversion — transformation into grocery-anchored center
• Entertainment — cinemas, bowling, entertainment venues
• Fitness — large fitness clubs (Life Time, Equinox)
• Medical — clinics, urgent care centers
• Mixed-use redevelopment — addition of residential, office space

Omnichannel Retail: The New Reality
The "online vs offline" confrontation has transformed into channel integration:

Omnichannel strategies of retailers

• BOPIS (Buy Online Pick-up In Store) — order online, pick up in store
• Curbside pickup — curbside delivery
• Ship from store — stores as fulfillment centers
• Returns processing — return of online orders in stores
• Showrooming — try in store, buy online
• Webrooming — research online, buy in store

Impact on Real Estate

• Reduction in the size of typical stores
• More back-of-house space for fulfillment
• Importance of loading docks and accessibility
• Technological infrastructure (WiFi, mobile payments)

Experiential Retail: Response to E-commerce
Retail is evolving from transactions to experiences:

Experiential categories

• Food & Beverage (F&B) — restaurants, food halls, concept bars
• Entertainment — cinemas, bowling, escape rooms, VR centers
• Fitness & Wellness — gyms, yoga studios, spa
• Education & Enrichment — cooking classes, art studios
• Services — beauty salons, medical services

F&B as Traffic Driver

Tenant Sales Analysis
Key metrics

• Sales per square foot (PSF) — sales per sq ft
• Occupancy cost ratio — rent as % of sales (target: 8-12%)
• Comparable store sales growth — like-for-like sales growth
• Gross margin — tenant gross margin

Benchmarks by Category (US)

Lease Economics: Base Rent vs Percentage Rent
Structure of rent payments

• Base rent (minimum rent) — fixed rent rate
• Percentage rent (overage rent) — additional charge as % of sales above breakpoint
• Breakpoint — sales level after which percentage rent is charged
• Natural breakpoint = Base Rent / Percentage Rate

Calculation example
Base rent: $50,000/year
Percentage rate: 5%
Natural breakpoint: $50,000 / 5% = $1,000,000
Actual sales: $1,500,000
Overage rent: ($1,500,000 - $1,000,000) × 5% = $25,000
Total rent: $75,000

Typical percentage rates

CAM (Common Area Maintenance) and Other Recoveries
Typical structure of recoveries

• CAM — expenses for common area maintenance
• Real estate taxes — property taxes
• Insurance — insurance
• Marketing fund — center marketing fund

CAM Caps
Large tenants often negotiate CAM caps:

• Absolute cap — maximum CAM amount
• Annual increase cap — limit on annual growth (e.g., 3-5%)
• Controllable expenses cap — cap only on "controllable" expenses

Grocery-Anchored Centers: Defensive Segment
Why grocery-anchored is considered defensive

• Necessity retail — food is a basic need
• E-commerce resistant — online grocery is growing, but penetration remains low
• Traffic generation — frequent visits (2-3 times a week)
• Cross-shopping — visitors also visit other stores
• Recurrence — stable and predictable foot traffic

Key Grocery Anchors (US)

Investment Strategies in Retail

Defensive/Core

• Grocery-anchored centers with strong anchors
• STNL with IG tenants
• Top-tier outlet centers
• Target cap rate: 5.5-7.0%

Value-Add

• Re-tenanting with improvement of tenant mix
• Redevelopment of underutilized parcels
• Anchor replacement
• Target IRR: 12-16%

Opportunistic

• Distressed mall acquisitions
• Mixed-use conversion
• Ground-up lifestyle center development
• Target IRR: 18%+

Recommendations for CIO

• Selectivity is key — focus on necessity retail and experiential
• Avoid distressed malls — conversion is complex and capital-intensive
• Grocery as anchor — prioritize grocery-anchored centers
• Tenant credit analysis — in-depth analysis of creditworthiness
• Lease structure protection — attention to co-tenancy and kick-out clauses
• Demographics — focus on affluent and growing demographics