Over the last two months, as a direct result of COVID-19, the commercial retail industry has experienced a drastic shift in trends. Landlords and investors are experiencing anxiety and uncertainty given the path the pandemic has taken around the globe. Apartment owners are struggling to get tenants to pay rent, retail landlords are facing high vacancy rates, and offices are experiencing mandated closures. The world could not have expected nor predicted such a detrimental event, and as we attempt to navigate through these times of uncertainty, analysists are publicizing their predictions about the future of the retail sector. Although there is no crystal ball to determine the exact path we are encountering, one certainty is that there will be a shift in the future of retail.
To get started, let’s review what current events are impacting retail investments.
1 – Social distancing.
The most obvious disruption in the retail sector is a result of social distancing. Many companies over the last few months have been forced to close their doors in compliance with government ordinances, including restaurants, movie theaters, bowling allies, and clothing stores, to name a few.
2 – Tenants filing chapter 11.
The CARES Act was passed in response to COVID-19, and part of the Act was expected to help the businesses struggling due to the pandemic. It provided resources to help companies maintain their payroll and provided grant opportunities to those that qualified. However, for many, it was not enough. It is reported that Chapter 11 business bankruptcy rates were up 26% in the first half of this year, and up 43% in May 2020 compared to June 2019. Unfortunately, it is expected for these numbers to continue to climb as businesses struggle to recoup the costs that they have lost.
3 – Difficulty in supply chains and distribution networks.
One impact perhaps not as visible to the everyday American is the impact COVID-19 has had on supply chains and distribution networks. For example, in March 2020, U.S. grocery sales rose 29% over the year prior and sales at restaurants declined 27%, resulting in a ripple effect in distribution. Clothing retailers, on the other hand, have had dramatic disruptions to their inventory due to overseas manufacturing essentially coming to a stop.
Unfortunately, this is just a glimpse at the consequences of COVID-19. There are many other challenges the industry faces, and many more to come if the pandemic continues to spread. With the future in mind and uncertainty accompanying it, investors are adjusting their strategies to cope with the changes.
Now, let’s take a look at the how these events are impacting the retail sector.
Buying patterns shifted.
When restrictions are placed on individuals, their habits change. So, when COVID-19 forced communities to stay distant, people’s activities changed. Until a vaccine is found, these changes are anticipated to remain. For example, there is a higher demand for cookware and office supplies, and a decline in many clothing sales. Of course, you can guess the reason, work and cooking have moved to the home while social engagements have become a non-option. The result: A change in consumer demands for goods and services.
Consumers have turned to e-commerce.
As a result of social distancing and closures, people turned to online ordering to fulfill their needs. This included shopping for groceries, fitness machines, personal hygiene products, and clothing, to name a few. In response, retailers were forced to restructure their business model to adapt to these new demands, and the updated model is anticipated to be the new future of consumer shopping. The result: More closures for retailers and a decrease in the requirement for a brick-and-mortar footprint.
All of the changes currently occurring are having a direct impact on investors, and many are recognizing the need to adjust their investment strategies. Here are a few key elements to understand when reassessing your portfolio.
Guarantors are weakened.
A strong tenant equates to a more secure investment. However, as companies file bankruptcy, these guarantors are weakened resulting in a decline in value for property owners. For example, if you have a Chuck E Cheese’s or 24-Hour Fitness in your retail center, you will undoubtedly experience a loss in equity.
As a result of closing stores and social distancing, tenants are also experiencing a decline in sales, which means paying their originally identified rent amount may be difficult. Typically, the average tenant would want to have their rent to sales ratio in the single digits, anywhere from 5% to 10%. Anything higher creates risk for the tenants and poses threats that they may be unable to keep up with asking rents. Therefore, landlords may need to adjust their tenants’ rents to ensure they keep occupancy up.
Location is key.
As consumer trends change and with such insecurity in the future of retail, location is more important than ever. Understanding the development opportunity, assessing the vehicles per day and foot traffic, and knowing the demographics of an area are essential to understanding the future potential of your real estate.
As a final note to the investor: when you developed your investment strategy, you may have had tenants in mind that you wanted to target, or sectors you felt strongly about. However, the trends have changed and it is time to assess if your investment strategy is up-to-date with the change in consumer demands. Furthermore, if you are new to investing, understanding these concepts is imperative to developing your future portfolio. In today’s market, ignorance is not bliss but instead a recipe for financial loss. Instead of being left behind, take the time to assess your portfolio and re-evaluate where the future potential is in the retail sector.
To read more articles on how Covid-19 has impacted commercial Real Estate- Read this.