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Retail real estate is in the midst of a significant transitional phase due to the changes wrought by e-commerce. At Invesco Real Estate, we believe retail real estate investment trust (REIT) landlords should work to differentiate themselves from e-commerce by re-tenanting, undergoing redevelopment and creating mixed-use retail ecosystems. Through our team’s fundamental lens, we have observed a widening gap between higher-quality and lower-quality retail real estate. In this blog, we briefly explore one of the top retail real estate operators today, as the team believes that selectivity within the retail REIT sector is essential due to the deepening bifurcation between the haves and have-nots.
A transitional phase for retail real estate
News headlines have been quick to prophesy the secular decline of US retail real estate. Understandably, the rise of e-commerce over the last decade has greatly impacted iconic companies that have been unwilling or unable to evolve. Sears, once the country’s largest retailer, filed bankruptcy recently after years of floundering. Toys R Us, founded shortly after World War II, underwent a full liquidation in the United States. With all these events, it is easy to jump to the conclusion that retail is staring at future obsolescence.
The Invesco Real Estate team, which has managed real estate investments over the last three decades and experienced multiple real estate cycles, sees things in a more nuanced perspective. We believe that retail real estate is in the midst of a transitional phase that likely will create both winners and losers.
Invesco Real Estate believes that retail REIT landlords must differentiate themselves from e-commerce by optimizing the tenant rosters of their centers to create a more robust experiential environment for shoppers. This includes adding into their property mix more tenants that are less impacted or cannot be replaced by e-commerce. To adapt, many retail REITs have increased their floor space for uses such as food and beverage, health and fitness, and entertainment. In some cases, they’ve added grocers as well. Furthermore, adding adjoining hotels, offices and apartments into mixed-use retail ecosystems is a way for retail landlords to create a “shop-work-live-play” footprint that can drive more consistent shopping traffic.
The haves and have-nots of retail real estate
The Invesco Real Estate team has observed a widening performance gap between high- and low-quality retail real estate. After considering company-specific fundamentals, the physical and locational attributes of a retail REIT’s properties, and the evaluation of each company’s balance sheet strength, the divergence between the haves and have-nots of retail real estate becomes quite stark. We find that many of these higher-quality companies are still seeing rising rents and stable occupancy rates, and continue to maintain more flexible balance sheets. The lower-quality companies in aggregate are witnessing declining rents and increasing leverage levels — all signposts for potential troubles on the horizon. Much of this divergence can be summarized in the chart below of e-commerce threats to retail. Invesco observes that higher-quality companies have higher exposure on average to the tenants and centers less impacted by e-commerce.
Source: Invesco Real Estate, as of Dec. 31, 2018. For illustrative purposes only.
Adapting to survive: Simon Property Group1 as an example of retail real estate’s future
As the largest publicly traded retail REIT and the only real estate company in the S&P 100 Index, Simon owns top-tier retail properties in the United States, Japan and Europe. The company — which operates many Class A malls, many of which combine traditional retail alongside deep portfolios of food and beverage, entertainment, and sometimes hotels and apartments — is no stranger to a changing retail landscape. The company’s adaptability and flexibility to shift its tenant and business model have been vital for the firm to thrive long-term. As an example, six of Simon’s 10 largest tenants at the time of its initial public offering in 1993 are no longer in existence. Even with frequent tenant turnover and boom and bust retail cycles, Simon has steadily increased occupancy over the past 25 years with tenant sales productivity reaching record highs in 2017.
Although news headlines prophesy deeper pain for retail landlords, the Invesco Real Estate team believes that retail real estate is in the midst of a transition phase. On the positive side, there is little in the way of new supply, but market conditions remain soft due to vacancy challenges from retailers closing stores and/or declaring bankruptcy. To add value over the long term, we believe retail landlords need to evolve with the structural challenges from e-commerce, creating more value for visitors through experiential retail and mixed-use redevelopment.
The Invesco Real Estate team believes that for REIT investors, selectivity is essential due to the sector’s deepening bifurcation of haves and have-nots. In the team’s view, the highest-quality retail real estate names with the best fundamentals, best locational and physical attributes of their assets, and the best balance sheet strength are more likely to not only survive this sea change in the retail space, but thrive as well.
About Invesco Real Estate
Invesco Real Estate has over 490 employees in 21 different markets worldwide with assets under management exceeding $64 billion as of Sept. 30, 2018. Our focus areas include US real estate, global real estate, global real estate income, infrastructure and master limited partnerships.
1 As of Nov. 30, 2018, Simon Property Group represented 3.28% of Invesco Global Real Estate Fund, 2.27% of Invesco Global Real Estate Income Fund and 5.17% of Invesco Real Estate Fund. Holdings are not buy/sell recommendations.
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A basis point is one hundredth of a percentage point.
A real estate investment trust (REIT) is a company that owns (and typically operates) income-producing real estate or real estate-related assets.
The S&P 100® Index is an unmanaged index considered representative of large cap companies in the US stock market.
Investment in infrastructure-related companies may be subject to high interest costs in connection with capital construction programs, costs associated with environmental and other regulations, the effects of economic slowdown and surplus capacity, the effects of energy conservation policies, governmental regulation and other factors.
Investments in real estate related instruments may be affected by economic, legal, or environmental factors that affect property values, rents or occupancies of real estate. Real estate companies, including REITs or similar structures, tend to be small and mid-cap companies and their shares may be more volatile and less liquid.
Senior Client Portfolio Manager
David Wertheim is a Senior Client Portfolio Manager focused on real asset securities. In this capacity, he works with Invesco’s real assets investment management team, serving as its representative to clients and prospects.
Mr. Wertheim began his career in 2000 and joined Invesco in 2018. Prior to joining Invesco, he was a senior client portfolio manager for real assets, commodities and equities with Deutsche Asset Management.
Mr. Wertheim earned a BBA from George Washington University with a dual concentration in international business and marketing.
Paul Curbo, CFA®
Portfolio Manager, Invesco Real Estate
Paul Curbo is a Portfolio Manager and member of the Real Estate Securities Portfolio Management and Research team with Invesco Real Estate.
Mr. Curbo entered the industry in 1993 and joined Invesco in 1998. Prior to assuming his current position, Mr. Curbo served as a senior research analyst in the real estate research group. He led one of Invesco’s regional teams and directed the firm’s research and strategy efforts in the Western region of the US.
Before joining Invesco, Mr. Curbo was a senior research associate with Security Capital Group, where he was responsible for analyzing multifamily, industrial and office real estate markets. He produced research on economic, demographic and real estate market information for Security Capital’s affiliate companies. Mr. Curbo previously held a position with Texas Commerce Bank.
Mr. Curbo earned a BBA in finance from The University of Texas at Austin and has completed graduate coursework in economic theory and econometrics at The University of Texas at Dallas. He is a CFA charterholder.
Chris Faems, CFA®
Director, Real Estate Securities
Chris Faems is a Director with the Real Estate Securities Portfolio Management and Research team with Invesco Real Estate. His current duties include researching fundamental and quantitative information on real estate securities.
Prior to joining Invesco in 2006, Mr. Faems worked at Flagstone Securities as a senior research analyst focusing on equity research and investment recommendations of mortgage finance companies. Previously, he worked at Kennedy Capital Management as a research analyst covering small- and mid-cap financial services companies, and at Stifel, Nicolaus & Co. as an investment banker in the financial institutions group. He entered the industry in 1996.
Mr. Faems earned a BS degree in finance from Washington University in St. Louis. He is a CFA charterholder.