On nearly a daily basis, we read headlines of retailers filing for bankruptcy protection and shutting their doors. The Darwinian nature of the retail business persists, as it always has, but there are a few subsectors that are doing well. For example, experiential retail is doing well; Class A malls are doing better than ever. On the opposite end of the spectrum, non-discretionary and low-price point retailers are also doing well (Dollar Store operators, Ross, TJ Maxx, etc.). This article, however, is focused on less discussed sub-sector of retail that is strong – convenience retail. Before we get into this investment strategy, lets briefly touch on the current retail environment.
First off, who are the retailers struggling in today’s environment?
Department stores: Macy’s, Sears, JC Penny’s
Big-box retailers: The Sports Authority, Hhgregg, Gander Mountain, K-Mart
Apparel: Wet Seal, American Eagle, Payless Shoes, The Limited
Casual Dining: Applebee’s, Chili’s
By contrast, these are a few retailers who are thriving in today’s environment:
Discount retailers: TJX, Ross, Burlington, Nordstrom Rack, Hobby Lobby
Low Price Point/Non-discretionary: Dollar General, Dollar Tree
Auto Parts: O’Reilly Automotive, Advance Auto Parts
Fast Casual & Trendy Restaurants: Panera Bread, Zoë’s Kitchen, Shake Shack
Retail has become polarized in recent years. This is large part due to the rise of the ‘millennials’ – like yours truly. The entire US consumer base tends to spend their money at either the high end or the low end. What I mean by that is, consumers either pay for high-priced food and entertainment experiences, or low-priced non-discretionary products and services. Consumers tend to avoid the middle – department stores and casual dining. Millennials in particular, are less focused on acquiring possessions, that one would find in department stores, than former generations – which is one reason for the booming sharing economy. On top of that, millennials don’t have space to store unnecessary items in their 700 square foot apartments. Instead, millennials prefer to spend their disposable income on experiences – traveling and eating out at expensive restaurants. In 2016, for the first time ever, Americans spent more money in restaurants and bars than at grocery stores.
Consumers are willing to pay a few dollars more to get a much better-quality product than in years past. Casual dining restaurants are struggling, whereas, fast casual is doing well. Concepts like Chipotle, Five Guys, Zoes Kitchen, Blaze Pizza etc. are doing well. Consumers like that they can either get their food quickly and be on their way, or conversely, they can sit down and enjoy a nice meal without having to leave a tip.
At the end of the day, the change in consumer behavior is the primary catalyst for the bankruptcies. The weakest operators in a given category are generally the first to fall. Real estate developers and investors have found ‘convenience retail’ to be a profitable niche, given the change in consumer preferences. Now that we have an understanding of the change consumer preferences and behavior, we can turn to why there is strong demand for convenience strip centers – and why I expect strong demand to continue into the future.
Convenience retail, also known as convenience centers or neighborhood centers, are small retail strip centers with a handful of tenants that provide a non-discretionary products or services. The success of these centers is in large part predicated upon these three things:
1. Great visibility and high traffic counts
2. Great accessibility and ample parking
3. Merchandise in line with consumer behavior
Successful convenience retail centers vary in size from 7,000 square feet to 30,000 square feet, from two tenants to many. They don’t get much larger than 30,000 SF because the goal of these centers is to reduced risk by not having an anchor or junior anchor box.
The success of these centers depends on leasing space to strong tenants who are compatible and support one another. Many of these centers include the following tenants:
Medtail: Aspen Dental, American Dental Partners, Pacific Dental Services, urgent care, weight loss, vision, Physical Therapy, MRI facilities, Massage Envy, Urgent Care, dialysis centers
Fast Casual Restaurants: Chipotle, Firehouse Subs, Five Guys, Dunkin Donuts, Jersey Mikes, Zoë’s Kitchen, Smash burger, Smoothie King, Which Which
Fitness: Orange Theory, Kick Boxing studios, yoga studios
Service: Nail Salon, Sport Clips, Great Clips
Telecommunications: AT&T, Verizon, Sprint
Non-discretionary Products: Mattress Firm
All of these users fit one or several of the characteristics described above. Successful centers, create a healthy tenant mix of internet-resistant retailers, fast casual food service operators, service-oriented tenants, and medical uses. Additionally, they provide the products and services that cannot be sold on Amazon – and are thus resistant to e-commerce.
Recently, I’ve seen a number of developers look for pad sites in strong locations. Their goal is to tie up the site and build a 7,000 – 10,000 SF multi-tenant convenience center. These developers have identified Aspen Dental (and Mattress firm in many cases), who will take about 3,500 SF and pay a very healthy rent number. Aspen Dental will pay this healthy rent figure if they can secure a prime location (good visibility, good access, compatible surrounding users) and a large tenant improvement allowance. The developer will then seek to fill the remaining space with one or two compatible users, such as a fast-casual restaurant. Once built and fully leased, these developers can turn around in sell it to generate a healthy profit.
To add value to this sector, companies can improve visibility and signage. They can do so by trimming trees and installing monument signage. They can also improve the façade, seal and re-stripe the parking lot, repaint the center, improve the lighting, and ultimately attract better tenants and negotiate better lease terms. Additionally, if a center is full of non-compatible tenants, overtime, investors can improve the tenant mix to promote more cross-pollination.
The retail industry is evolving. The Darwinian nature of retail and it subsequent impact on retail real estate can be cause for concern or an opportunity for entrepreneurs to add value and make successful investments. The way you perceive and react to this evolution is entirely up to you.