Overview
- There are 33 publicly traded Retail REIT constituents with a market cap totaling $175,165.
- 17 Shopping Centers $57,159
- 7 Regional Malls $70,136
- 9 Free Standing $47,870(NAREIT, 2019)
- Average dividend yield of retail REITs is 4.64%. (NAREIT, 2019)
- Retail REITs own 12.5% of retail real estate in the US. (Seeking Alpha, 2019)
- Retail is in the process of undergoing a tremendous shift, 5,000 stores have closed every year since 2001.
- According to a Deloitte survey, investors anticipate increasing allocations to retail real estate investments by 10% in 2019. (CNBC, 2019)
What are Retail REITs?
Retail REITs are classified based on the types of retail assets they are predominantly invested in. Below are the three subclassifications of retail REITs:
- Shopping Centers can be broken down into two sub-categories, general purpose and specialized purpose. General purpose shopping centers usually consist of a group of stores, restaurants, entertainment and service providers, sometimes anchored by a grocery store or similar anchor tenant, designed to serve the needs of the surrounding community. Shopping centers are usually open-air, with on-site parking. Specialized shopping centers typically have a more specific theme such as entertainment or lifestyle, but also seek to serve the needs of the surrounding community. (ICSC, 2019)
- Regional Malls are traditional malls defined by the International Council of Shopping Centers as “General merchandise or fashion-oriented offerings. Typically, enclosed with inward-facing stores connected by a common walkway. Parking surrounds the outside perimeter.” Super regional malls include the same but about twice the size of regional malls on average. There are 1,220 regional and super-regional malls in the US, totaling more than 1.1 Billion square feet in gross leasable area. (ICSC, 2019)
- Freestanding Retail are stand-alone retail buildings that are smaller in scale than shopping centers or regional malls, offer convenient curbside parking and usually contain 1-3 tenants. Walgreens, McDonald’s and Starbucks are common freestanding retail tenants.
Freestanding retail REITs have outperformed regional mall REITs and shopping center REITs in total returns consistently for the last five years. Total returns for freestanding retail REITs were 15.2% while the others experienced negative growth. Due to the declining nature of the stock price, dividend yields exceeded 10% for the less productive subsectors. The underlying assets are still performing well due to predominantly long-term leases, credit-rated tenants, favorable demographics and aggressive strategies to divest underperforming assets. (NAREIT, 2019)
REITs tend to invest in high-quality real estate assets, so despite some of the risks that have plagued retail real estate with the evolution of online shopping, retail REITs are shielded to some degree due to the sound real estate fundamentals of their portfolio. It is safe to say there will always be a need for high-quality local retail, as some things simply can’t be digitized.
Many retailers are also leveraging the lower cost of products sold in retail stores through more robust omnichannel strategies; including incentives for in-store pick up, and leveraging the impact of online sales when a retail store is opened in a new market. Restaurants and grocery stores are adding high tech solutions that allow online ordering, robotic food prep and digitized store shelves. Investment in existing spaces and in new space is a favorable indication that retail tenants are committed to strategies that include a long-term physical retail presence. While there certainly is an excess supply of retail space, opportunities to repurpose many locations as mixed-use or for more specialized goods and services, such as fitness, continue to evolve.
REIT quality retail assets trade at 4.5%-6% cap rates despite the challenges some of the tenants have faced in recent years. Fundamentals to retail real estate include location, surrounding population density, household income, market occupancy, average remaining lease term and tenant credit among other variables. Much like other sectors of real estate, however, retail tends to follow housing trends very closely. As millennials are choosing to live in multifamily communities in higher numbers than previous generations, the mixed-use retail model is becoming more popular. Which provides smaller retail spaces, and more convenient access for consumers. (ICSC, 2019)
Pros and Cons of Retail REITs
Pros
- Investors plan to increase investment allocations to retail commercial real estate by 10% in 2019. (Deloitte, 2019)
- Retailers are continuing to evolve omnichannel offerings in an effort to identify the ideal balance between online and retail locations.
- Many opportunities to repurpose obsolete retail space are developing.
- REITs tend to own the highest quality retail real estate.
Cons
- A massive shift to online retailing over the last decade has resulted in a great deal of excess supply and a need to repurpose some assets.
- Retail is significantly overbuilt, with almost twice as much retail sf per capita than other developed countries.
- 5,000 stores have closed every year since 2001. (Seeking Alpha, 2019)
- E-commerce currently accounts for 16% of retail sales, UBS projects this number will be 25% by 2026, which equates to another 75,000 store closures, largely clothing and electronics. (CNBC, 2019)
- Grocery delivery is emerging as a potential threat to retail REITs, as well.
Outlook for Retail REITs
According to a recent Deloitte survey, investors plan on increasing allocations to retail real estate by 10% in 2019. This is partially due to a broader trend towards investors increasing real estate portfolio allocations, but nevertheless should bode well for retail REIT share prices. Dividend yields are expected to continue to perform consistently. (Deloitte, 2019)
The retail sector will likely find an equilibrium once the fundamentals show signs of stabilizing, however in the short term there is still much volatility and speculation involved in what the next generation of retail looks like. For an asset class that had been virtually static in terms of evolution and change for the better part of the last 50+ years a period of revitalization was probably overdue. Despite the massive transition to e-commerce retail real estate has benefited from the on-going growth of coworking, local merchants, gyms and experiential retailers in small community centers and malls and is now experiencing benefits of omnichannel strategies. (CBRE, 2019) As many investors are well aware REITs have strict, well defined due diligence criteria that assets must meet before investing.
Retail is proving to be resilient as it continues to evolve. As retail continues to work through the struggles of modernization a polarization has occurred among assets. The premium retail assets are increasingly valuable, and the undesirable assets are becoming virtually obsolete. The REITs are quick to identify the less desirable assets and dispose of them prior to a significant loss in value and cash flow. Through this process, the REITs have had the opportunity to reinvest in more stabilized, premium assets. As retail continues to evolve diligent management of the assets is extremely important. Assembling ideal tenant mixes, identifying opportunities for repurposing assets and evaluating the potential success of tenants will be extremely important.