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Top 10 Retail Leases of the Month: November

Mid-November to mid-December is almost always the Hanukkah/Christmas present retailers always crave, and so far this season hasn’t disappointed as far as their retail is concerned.

It was a good month for grocery stores and places for holiday shopping. The biggest lease was a 29,400-square-foot one for Morton Williams 1 West End Avenue. But it turns out it wasn’t the only grocery store that was active; Dumbo Market took 6,000 square feet at 66 Front Street in Dumbo, Brooklyn. And Westside Market took the old 8,000-square-foot Garden of Eden space at 170 West 23rd Street.

However, the big season stunner was the 19,000 square footer FAO Schwarz signed at 30 Rockefeller Plaza.

And in keeping with the places that are suited for holiday shopping, Levi’s took 17,000 square feet at 1535 Broadway and the athleisure brand Alo Yoga took 14,000 square feet at 96 Spring Street; the skatewear brand Vans took 8,753 square feet at 530 Fifth Avenue; The Shoe Box renewed their 3,600 square foot lease at 1277 Third Avenue; and J.C. Penney’s 2,800-square foot pop-up, Jacques Penne, opened at 446 Broadway.

But that doesn’t mean that there was nothing in the realm of food, beverage, experience or some kind of crossover. Kellogg’s signed on for a 5,000-square-foot permanent restaurant at 31 East 17th Street in Union Square.

See you next month!

Source: commercial

Regional Malls Look to Reposition as Retail CMBS Space Sweats

The e-commerce contagion has pulled brick-and-mortar retailers, regional malls and shopping centers under the weather, resulting in tenant bankruptcies and mass store closures that have, in turn, put pressure on maturing retail commercial mortgage-backed securities loans predominantly those issued in 2006 and 2007, prior to the financial crisis—and created refinancing hurdles for borrowers.

“The concern is everywhere, and in some cases, it’s a surprising reality,” said Manus Clancy, a senior managing director at Trepp. “Because of the outlook for retail in general, a lot of borrowers are struggling to refinance. The problems are across the sector.”

From November 2016 to October 2017, roughly $29.3 billion in securitized mortgages backed by retail properties were paid off or liquidated, 12 percent of which was disposed with losses, according to data from Trepp. The disposed loans were written off at an average loss severity of just under 55 percent, up from around 47 percent in 2016, while overall CMBS loss severity for all loans disposed within the same time frame fell to just under 43 percent. This year, there have been 244 retail loans—totaling $3.4 billion—that have been resolved with losses at around $1.8 billion, according to data from Trepp and Morningstar Credit Ratings.

“If I had to guess, [retail loss severities] are in excess of 50 percent,” said Andrew Hundertmark, a managing director at CWCapital Asset Management. “In my opinion, a mall was never worth what it was when the loan was made. There were assumptions made to rent growth and tenant strength that didn’t turn out to be true, and 10 years ago then these loans were made, no one saw Macy’s as a troubled retailer. J.C. Penney showed some cracks but wasn’t a concern. People underwrote loans thinking everything was going to stay as it was.”

The rest is history. Retail giants such as J.C. Penney, Sears and Macy’s have closed hundreds of stores as they try to shift investment focus to e-commerce, technology and the use of delivery services. On Nov. 2, Sears announced that it plans to close more than 60 locations by late January 2018, marking 243 total closures since January 2017. The retailer will be left with around 680 stores operating in the U.S., down from 3,500 locations in 2010.

What impact have these closures had on maturing retail CMBS? These loans have been made vulnerable, in part, because they’re propped up by leases from major anchor retailers. When anchor boxes come under increased stress or shutter, it creates a vicious cycle for the mall owner or landlord that can negatively affect overall consumer traffic to small- and midsized in-line retailers such as Radio Shack or Bon-Ton Stores—both of which have recently closed stores—who fill out the mall and benefit from a strong anchor presence.

“The best we can do [as servicers] is try to stabilize tenancy and get them in longer-term leases,” Hundertmark said. “We want leasing arrangements with tenants who can take advantage of co-tenancy if anchors close. Just because you have a mall that’s troubled, it doesn’t mean there aren’t retailers ready to come in. They’re all about traffic counts, and they don’t care so much if Sears is open for business or not.”

Chattanooga, Tenn.-based REIT, CBL Properties’ Mall of Acadiana in Lafayette, La., may be a transitionable survivor. Its debt was originated by Bank of America in 2007, and the loan comprises 63 percent of the roughly $196 million BACM 2007-2 CMBS transaction. The enclosed mall at 5725 Johnston Street was previously anchored by the usual suspects: Sears, J.C. Penney, Dillard’s and Macy’s. According to Trepp watchlist commentary, Sears will shutter its location at the mall by the end of the year, and “there are significant co-tenancy implications tied to the two anchors closing, which may have a significant negative impact on cash flow and potentially collateral occupancy.” The mall is buoyed by its collection of noncollateral tenants such as a Carmike movie theater, which occupies 247,072 square feet—or roughly 81 percent —of usable space, an Old Navy, a Barnes & Noble, an Olive Garden and a Taco Bell. As of November, Trepp commentary indicated that the borrower is “self-managing and leasing the mall and continuing to make monthly payments” despite the mall’s status as nonperforming beyond maturity.

Some major high-end national mall landlords, such as Washington Prime Group or GGP, look to reposition retail space to include entertainment and lifestyle services and national restaurants. Washington Prime has even moved to use online competitor Amazon’s fulfillment lockers to help draw consumers.

“Often, the property will be sold at auction for a discounted price, and now, at lower basis, the new owner can invest and turn them around. It’s a mixed bag,” said Edward Dittmer, a senior vice president of CMBS at Morningstar Credit Ratings.

Smaller entities may not be so lucky or may not have the capital necessary to make a change, being that repositioning an anchor into an entertainment venue or fitness center can be a daunting task. It can sometimes be an even harder challenge as malls in metro areas and gateway cities are just simply outdated and face competition from newer facilities complete with more modern amenities.

westside pavilion interior 2008 Regional Malls Look to Reposition as Retail CMBS Space Sweats
Interior view of West L.A.’s Westside Pavilion mall. Photo: Wikipedia Commons

Los Angeles’ Westside Pavilion is one recent victim of an oversaturated market. The future health of the three-story, 766,608-square-foot mall at 10800 West Pico Blvd. in the suburbs came into question in August after its debt service coverage ratio fell below 1.10x as it faced hurdles with lease terminations—major tenants have begun moving just a few miles away to the Westfield Century City mall.

“West L.A. has too many malls chasing the same customer and it was due for consolidation,” said Macerich Chief Executive Officer Art Coppola—Westside Pavilion’s owner—in the company’s third-quarter earnings call. In October, Macerich, announced its search for a buyer. The $142 million, post-crisis era loan was transferred to special servicer Rialto Capital Advisors for the first time in September due to imminent monetary default. The note comprises just under 13 percent of the remaining collateral in the roughly $700 million WFCM 2012-LC5, Wells Fargo-sponsored CMBS transaction.

“[Many borrowers] view retail as undervalued and come in at a good basis with a plan and some money and an opportunity to make some good return,” Hundertmark said. “In general, people are out there trying to sell the troubled stuff. Regional malls attract a much different buyer set. Strip malls or shopping centers tend to bring in more local buyers, those who know the market and may have owned the property next door and can bring some synergies there with repositioning. The buying universe really differs, and there are a couple names in almost all sales.”

CMBS retail issuance has climbed while delinquencies have fallen 16 basis points to 6.47 since August, Trepp data shows. Changes in the way retail space is being modeled and used have most certainly spurred new investment into the sector and enabled many operators to thrive despite widespread concerns over the performance of the physical retail environment.

“A lot of the new delinquencies we’ve seen have been maturity defaults in 2017 as a result of the 2007 issuance,” Dittmer said. “Some of those loans have not been liquidated yet and are going to take some time to work through. It may take a year or two to see what will be the ultimate resolution.”

Retail delinquencies recovered more quickly than other major property types after the most recent financial crisis, according to Trepp analysts. Special servicers acted more swiftly to foreclose on distressed retail collateral to cut losses, in contrast to the “extend and pretend” approach more commonly employed with other property types, analysts said.

“We’ve talked to a lot of landlords, and most of them are scratching their heads because every location is different,” Hundertmark said. “If we can get a gym in here and a couple of nice, national restaurants, the community is strong enough, so we can keep this moving. But, retail has moved away from us, so what can we do? We can partner with or sell to a multifamily developer to put up a new development. The old retail paradigm has been shattered. There is no one size fits all.”

GGP, a Chicago-based publicly traded owner and operator of high-end malls, has sought to survive retail market headwinds by renovating former department store boxes into restaurants, supermarkets and movie theaters. Meanwhile, GGP is considering a takeover bid by Brookfield Property Partners.

“[Landlords] have got more flexibility and more options than a servicer, and [they’re] definitely getting more creative and more aggressive, taking steps they’d never dreamed of 10 years ago,” Hundertmark said. “The model was you build the mall, and the anchors stores build around you.” That’s no longer the norm as landlords can no longer rely on anchors and must take matters into their own hands.

Some analysts argue that yield can be mined easily in the right market with the right strategy. “The bright side is pruning season is ending,” Clancy said. “Sears and Macy’s have been pruning and closing stores, but what’s left in their portfolio they’re confident in. Simon Property Group and GGP and others who provide experience can still make the business model work. The headlines have outpaced reality. People can still make a good buck with the right strategy, market and tenants. What’s disastrous is older malls, sagging demographics and newer competition.”

National mall landlords who can reposition these assets may be the future of regional malls as they’ve been able to exhibit the clout and capital needed to entice bondholders and take on such projects. And, these companies, like GGP, have seen its stock price climb in recent months.

There’s an interesting variety of players at auction for distressed regional malls, ranging from major national mall landlords to development firms looking to use the typically stellar locations where malls have been built to construct lifestyle centers full of national retail brands and restaurants, along with a residential building to help drive foot traffic and spark cash flow.

“First things we look for from a borrower is do they have the desire and the capital to reposition this mall, and three, do they have a plan?” Hundertmark said. “If they don’t know what they’re doing with the capital, they’re wasting everyone’s time. More and more we’re seeing them come in with a plan and turn it into a discount strip center or what have you.”

With approximately 25 percent of the CMBS arena being retail and roughly $3.1 billion in retail CMBS set to mature in the next 12 months, many borrowers may be done wiping their noses and ready to lick their chops.

Source: commercial

Brookfield’s Takeover Bid Is the Latest Chapter in Mall Giant GGP’s Turbulent History

When Brookfield Property Partners lodged a $14.8 billion takeover bid for GGP last month, it raised the possibility of one of the biggest real estate mergers and acquisitions seen in recent years—one that would create a massive company with nearly $100 billion in assets globally and annual net operating income of roughly $5 billion, Brookfield said in announcing the bid.

It also marked the latest chapter in the tumultuous history of the Chicago-based real estate investment trust formerly known as General Growth Properties. The past decade, in particular, saw GGP emerge from the wreckage of one of the biggest real estate bankruptcies in history in 2009—when it was unable to refinance more than $27 billion of debt in the wake of the financial crisis—to re-establish itself as one of the nation’s major players in the Class A mall space, with assets ranging from prestigious shopping centers in Honolulu and Southern California to high-street storefronts on Fifth Avenue.

GGP’s renaissance has come under the guidance of Sandeep Mathrani, who left his role as head of Vornado Realty Trust’s retail division to become the REIT’s chief executive officer in 2010, when the company was just getting back on its feet after the bankruptcy. With the help of investment from the likes of Brookfield and hedge fund investor Bill Ackman’s Pershing Square Capital Management, GGP shed dozens of properties, rid itself of burdensome holdings by spinning off Rouse Properties and the Howard Hughes Corporation into standalone companies and exiled to the past the legacy of the Bucksbaum family—which founded General Growth Properties in the 1950s but also oversaw its descent into financial ruin. Today, GGP has regained its status as one of the largest publicly traded owners and operators of retail properties in the U.S., with a portfolio of more than 120 properties spanning roughly 123 million square feet.

Yet, the Brookfield takeover proposal comes at a significant juncture for both the company and the market in which it specializes. The challenges facing the brick-and-mortar retail sector today have been well documented, with the Amazon-fueled rise of e-commerce having contributed to store closures at a rate unseen since the Great Recession.

Though GGP’s profile as an owner of high-quality, Class A malls has insulated it somewhat from headwinds that have most heavily impacted Class B and Class C malls and shopping centers throughout the country, the company has not been altogether immune from the great retail apocalypse of 2017. The struggles of department stores like Sears, Macy’s and J.C. Penney, which historically were counted on as mall anchor tenants capable of driving customer traffic, have prompted GGP to spend more than $2 billion to redevelop roughly 9 million square feet of space across its portfolio—mostly “anchor boxes” formerly occupied by such department stores that it has sought to reposition into restaurants, cinemas and other uses more relevant to the current retail market climate.

headshot mathrani e1512493521894 Brookfields Takeover Bid Is the Latest Chapter in Mall Giant GGPs Turbulent History
Sandeep Mathrani. Photo: GGP

Like fellow Class A mall REITs Simon Property Group, Macerich and Taubman Centers, GGP has seen its stock price undertake a slow and steady slide over the last 12 months as investors have increasingly subscribed to the doom-and-gloom narrative surrounding the retail sector. Market conditions have meant that GGP (also like its peers) has found itself consistently trading at a discount to its actual net asset value (NAV); by Nov. 6, the day before news broke of the Brookfield takeover talks, GGP’s share price had fallen to $19.01, down from its 52-week high of $26.63 and well below the company’s consensus NAV of more than $28 per share (analysts who spoke to Commercial Observer for this story pegged GGP’s NAV at anywhere from $26 per share to $35 per share).

Brookfield’s initial bid for GGP, meanwhile, came in at $23 per share, or $14.8 billion in total, and took the form of a 50-50 cash-equity offer comprising $7.4 billion in cash and another $7.4 billion in Brookfield Property Partners (BPY) stock. BPY, a subsidiary of Toronto-based investment giant Brookfield Asset Management, has held a sizable stake in GGP since helping bring the company out of bankruptcy in 2010, and the deal would see it acquire the 66 percent of GGP that it does not already own. (In the third quarter of this year, Brookfield exercised stock warrants to increase its ownership interest in the REIT from 29 percent to 34 percent by purchasing 68 million GGP shares for $462 million.)

“Brookfield’s access to large-scale capital and deep operating expertise across multiple sectors, combined with GGP’s high-quality retail asset base, will allow us to maximize the value of these irreplaceable assets,” Brookfield Property Partners CEO Brian Kingston said in a statement announcing the bid.

Brookfield noted that its takeover offer constituted a 21 percent premium on GGP’s “unaffected closing share price” of $19.01 on Nov. 6, as news of the proposal immediately pushed GGP stock to north of $22 per share the next day and above $24 per share on Nov. 13, when Brookfield officially announced its offer. In the wake of the bid, GGP said it had formed a “special committee” of independent directors—excluding Mathrani and directors affiliated with Brookfield, such as Kingston, BPY Chairman Ric Clark and Brookfield Asset Management CEO Bruce Flatt—to review and consider Brookfield’s proposal and “pursue the course of action that it believes is in the best interests of the company.”

Representatives for both GGP and Brookfield declined to comment for this story.

With the offer coming in well below most analysts’ valuation of GGP, many are split on whether the deal provides good value for GGP shareholders at a challenging time for the retail sector at large, or if it undervalues one of the top publicly traded commercial landlords in the country and could prove a mere starting point in negotiations between the two sides.

“I’m sure everyone would like to get a deal done; the question is, What is the price Brookfield is willing to pay?” said Alexander Goldfarb, a managing director and senior REIT analyst at Sandler O’Neill + Partners, who noted that the initial Brookfield bid “undervalues” GGP below Brookfield’s own internal net asset valuation of the company of around $30 per share.

Goldfarb and other analysts also called into question whether GGP investors would be willing to accept BPY stock as part of any deal. In a note released last month, BTIG equity research analysts James Sullivan and Ami Probandt described BPY’s stock, which has been trading between $21 to $24 per share for most of this year, as “relatively illiquid with very low average trading volume.”

“Our assumption is they’ll have to improve their offer; no one ever throws in their best offer first,” Goldfarb said. “I think Brookfield sees the real story, which is the company being undervalued by the Street.”

Anita Ogbara, a director and credit analyst at Standard & Poor’s, described the Brookfield bid as “opportunistic” at a time when there is “a lot of pressure on valuations” in the mall REIT sector. “We don’t know what the ultimate outcome is going to be, but there’s a clear sign that [Brookfield is] trying to take advantage of the discount versus the true value of [GGP’s] assets.”

While Brookfield’s first crack at a GGP takeover may have been “an underwhelming offer” for many stakeholders, Haendel St. Juste, a managing director and senior equity research analyst at Mizuho Securities USA, said that challenging conditions in the retail space could end up having outsized sway over whether a deal gets done or not. He noted that, speaking to participants at the National Association of Real Estate Investment Trusts’ annual REITworld convention last month, there is a sense that an offer of around $25 per share “would maybe carry the day.”

“People are disappointed [in the $23-per-share offer], but then again I think there’s been a resignation among folks—that maybe it’s not great on its face, but given the current dynamic, maybe it’s as good as you could hope for or expect,” St. Juste said.

gettyimages 171080470 Brookfields Takeover Bid Is the Latest Chapter in Mall Giant GGPs Turbulent History
Brookfield Place in Battery Park City, Manhattan. Photo: Getty Images

Should a deal go through and Brookfield acquire GGP, it is unclear what will become of the company’s leadership and whether the likes of Mathrani will remain in some position or capacity. What appears more certain, according to analysts as well as sources with knowledge of Brookfield’s operations, is that the combined company would look to leverage Brookfield’s exposure in nonretail sectors, such as office and residential, to potentially reposition underperforming properties in the GGP portfolio.

“We are excited about the opportunity to leverage our expertise to grow, transform or reposition GGP’s shopping centers, creating long-term value in a way that would not otherwise be possible,” Kingston said in his statement announcing the bid.

While GGP has already made steps toward pursuing such repositionings—having recently announced a partnership with residential REIT AvalonBay Communities to build apartments at one of GGP’s malls in Seattle—Brookfield would likely seek to further that approach, as it did with select Rouse Properties assets in New Jersey and Vermont in the wake of its $2.8 billion acquisition of the mall landlord last year.

Mizuho’s St. Juste said the integration of a more diverse array of uses at malls and shopping centers is warranted in an environment where “there’s too much retail in the United States” and landlords are seeking new ways to drive traffic.

Sources also said that while Brookfield would almost certainly look to hold long-term onto GGP’s premier retail assets—such as the Ala Moana Center in Honolulu, Glendale Galleria in Glendale, Calif., and Tysons Galleria in Washington, D.C., suburbs—it would probably seek to offload other lower-quality properties either through outright sales or joint-venture partnerships.

It would also remain to be seen what happens to GGP’s high-street retail portfolio, a market in which former Vornado executive Mathrani upped the REIT’s exposure via the acquisition of pricey storefronts along luxury retail strips like Manhattan’s upper Fifth Avenue corridor.

Sandler O’Neill’s Goldfarb noted that GGP’s foray into the luxury street retail space was one of the few areas where Mathrani “got pushback” from investors and observers, given that the REIT entered that market “right at the peak” of New York City property values—via deals like its nearly $1.8 billion acquisition of the Crown Building at 730 Fifth Avenue, which GGP acquired alongside retail magnate Jeff Sutton of Wharton Properties.

“[Mathrani] had done [street retail] at Vornado and he saw an opportunity at GGP,” Goldfarb said. “It was just that the prices he was paying were top of the market.” While GGP has found success with its street retail assets—most notably signing luxury fashion brand Bulgari to a pricey lease to maintain its presence at the Crown Building—depressed Manhattan street retail rents could contribute to a change in approach.

Whatever direction is in store for a new Brookfield-helmed GGP, it is almost certain that a successful takeover would shake up the market as far as publicly traded retail landlords are concerned—and very well signal a time of heightened consolidation as the industry takes on virtually unprecedented headwinds.

“It’s created an M&A tailwind and brought some investors back in the space,” St. Juste said, citing how the likes of Simon, Macerich and Taubman have also seen their share prices run up in the wake of the Brookfield bid. “Next year is going to be tough from an operational perspective; without this M&A buzz, the stocks would be down. They’re not trading on fundamentals right now.”

Source: commercial

$93M CMBS Loan on West Virginia Mall Sent to Special Servicing

The $93 million loan backed by the Charleston Town Center Mall in Charleston, W. Va., has been sent to special servicing, according to an alert yesterday from Fitch Ratings.

The 10-year term loan, which carries a fixed rate of 5.6 percent, had a securitized balance of $100 million, was originated by Morgan Stanley in September 2007 and was transferred to special servicer C-III Asset Management LLC on Tuesday due to imminent maturity default. It comprises nearly a quarter of the $392 million BSCMS 2007-T28 commercial mortgage-backed securities transaction—originally sponsored by the now defunct Bear Stearns.

The loan is secured by the 931,333-square-foot Charleston Town Center Mall—constructed in 1983 and located at 3000 Charleston Town Center Drive in downtown Charleston, W. Va. It features over 130 specialty shops across three levels of the building, according to information from the mall’s website.

In April, Sears—previously one of the mall’s largest non-collateral anchor tenants, occupying 179,199 square feet of space—closed its doors. Subsequently, the loan was marked as a “loan of concern” by Kroll Bond Rating Agency over heightened concerns about the fates of the location’s two remaining non-collateral anchor tenants, Macy’s and J.C. Penney, each occupying 118,864 and 121,517 square feet, respectively, according to information provided by Trepp.

The loan was then put on the servicer watchlist in June, and in July—as the loan neared it’s September 8, 2017 maturation date—the borrower claimed it was “making changes to the partnership, which they expect to complete concurrently with the loan maturity date” and anticipated it would have the wherewithal to be able to pay off the loan on time, watchlist commentary provided by Trepp shows.

Jeff Linton, a spokesman for Forest City Realty Trust, the property’s sponsor, said in an email statement: “As previously announced, Charleston Town Center is in the midst of restructuring their partnership.  Concurrent with those changes, ownership is evaluating the most efficient way to handle financing for the project.” Linton went on to say that the mall will continue to operate as usual. 

This marks the loan’s first trip to special servicing.

Source: commercial

$80M CMBS Loan on Maine Mall Sent to Special Servicing

An $80 million loan backed by Bangor Mall in Bangor, Maine has been sent to special servicing, according to an alert from Fitch Ratings.

The 10-year term loan was transferred to special servicer LNR Partners, Inc. on Tuesday due to imminent maturity default. It comprises just over 14 percent of the remaining collateral in the Morgan Stanley -sponsored MSC 2007-IQ16 commercial mortgage-backed securities transaction.

The loan is secured by Bangor Mall— located at 663 Stillwater Avenue in Bangor—a sprawling 658,827-square-foot retail center that was built in 1979 and is situated on 60-acres of land.

In January, the mall’s largest anchor tenant, Macy’s, which occupied 118,825 square feet, or nearly 22 percent of the property’s retail space, announced it was closing its doors. By June, the store had shuttered, according to watchlist commentary provided by Trepp.

Subsequently, Kroll Bond Rating Agency downgraded the mall’s performance outlook amid concerns that its other anchor tenants—Sears, which leases 105,817 square feet on a lease that will expire in October 2018, and J.C. Penney, which occupies 95,082 square feet on a lease set to expire in February 2019—were also struggling, according to information provided by Trepp.

Earlier this month, as the loan neared its October 1, 2017 maturation date, the borrower intended to reach out to potential lenders for refinance, but to no avail, according to Trepp. The loan, which was originated in 2007 with a rate of 6.1 percent, has been on the servicer watchlist since February 2016.

Although it was originated nearly a decade ago, the loan still remains at its origination balance of $80 million, according to Trepp. This marks the loans first trip to special servicing.

Bangor Mall, LLC, the entity that owns and operates the mall, did not immediately return a request for comment.

Source: commercial

What Retailers Can Learn from the Music Industry’s Meltdown

By any metric you like, retail is having a Falcons-in-the-Super-Bowl kind of year.

In April, Bloomberg reported that “year-to-date store closings [nationwide] are already outpacing 2008,” based on information provided by Credit Suisse, with “2,880 announced so far this year.” Last year at this time, the number was just 1,153.

Since Jan. 1, companies that have announced bankruptcies include Payless, HHGregg, BCBG Max Azria, Eastern Outfitters, Wet Seal and The Limited. Bebe announced it would close all 168 of its retail outlets, and other retailers closing quite a few include American Apparel, Macy’s, Sears and J.C. Penney. Using data from CoStar Group, Bloomberg wrote that at the current rate, “more than 10 percent of U.S. retail space, or nearly 1 billion square feet, may need to be closed, converted to other uses or renegotiated for lower rent in coming years.”

“I’ve been doing this for a long time. I was just driving up and down Madison Avenue and Third Avenue in the last few weeks, and I’ve never seen so many vacancies in my life,” said Bruce Shepard, a partner at SCG Retail. “It’s a scary world, because you just don’t know what’s going to happen.”

Part of the reason for the retail sector’s decline nationally is that malls have been vastly overbuilt. Another culprit is that retail chains took on too much debt. But consensus places most of the blame squarely on e-commerce—specifically, Amazon.

However, there is one business that had a 15-year head start on dealing with retail’s current e-problems: the music industry.

The 1990s were an exciting time for music companies and record stores, as the popularity of the then recently introduced compact disc had a generation of music fanatics willing to repurchase their entire music catalog for the higher-quality sound.

Then the roof caved in.

Younger fans learned about file-sharing services like Napster and LimeWire in the late 1990s and early aughts, and iTunes was introduced in 2001. Suddenly, music buying at retail fell off a cliff. In 2006, The New York Times, citing the Recording Industry Association of America (RIAA), reported that “the compact disc market fell about 25 percent between 1999 and 2005.” More remarkably, the Times noted that, according to market research firm Almighty Institute of Music Retail, one-quarter of the country’s 3,600 independent record stores had closed just since 2003. ABC News has reported that between 2000 and 2010, record store sales declined more than 76 percent.

The decline was disastrous for the industry, which enjoyed boom times in the 1990s. According to a 2010 CNN article, citing data from Forrester Research, revenue from U.S. music sales and licensing in 1999 reached $14.6 billion. By 2009, that figure had plunged to $6.3 billion. As profits from recorded sales fell, artists focused more on touring and merchandise to make up the difference, and record companies responded accordingly, signing artists to contracts that, for the first time, involved themselves in those areas—including taking a share of those profits—in addition to investing in their recording careers.

But it was the big Sam Goody’s and the smaller mom-and-pop record shops of the world that bore the brunt of the carnage.

While stores and sales disappeared, the remaining customers grew suddenly older. Young people, more adept at navigating the new online terrain, abandoned record stores en masse. The Times noted that in 1996, 15- to 19-year-olds bought 17 percent of recorded music; by 2005, that was down to 12 percent.

The present looks equally dire for the music industry and not just for the brick-and-mortar part of the business. Last July, Spin reported that based on sales data released by Billboard and Nielsen Music, 2016 was shaping up to be “the worst year for overall album sales since Nielsen started keeping track in 1991.”

Retail broker Jeffrey Roseman, an executive vice president at Newmark Grubb Knight Frank, worked on U.K.-based record store chain HMV’s U.S. expansion in the 1990s. He said that at the time, no one saw the disaster coming.

“Online was the furthest thing from my mind,” Roseman said. “I spent so much time with [the HMV people], I probably would have had an inkling if they were stressing out about it.”

In the first few years into the millennium, everyone in the music business was mired in the catastrophe. As sales plummeted and stores closed, the industry began a series of scattered, desperate, often misguided attempts to stop the bleeding.

The most ill-advised was when the RIAA, the music industry’s trade group, filed lawsuits against fans who shared music on peer-to-peer file-sharing networks. According to the Electronic Frontier Foundation, an organization dedicated to defending civil liberties in the digital world, by 2008, the industry had “filed, settled or threatened legal actions against at least 30,000 individuals…[including] children, grandparents, unemployed single mothers, college professors, a random selection from the millions of Americans who have used P2P networks.” If there was a dumber, less-effective strategy for winning back record buyers and ensuring their loyalty, no one found it. Needless to say, it did not come close to solving the industry’s piracy or e-commerce problems.

Labels scrambled to compete via technology they seemed to barely understand.

“There were a lot of experiments with formats to try to come up with different things,” said Chris Brown, the CFO for the Maine-based, 12-store Bull Moose record store chain.

“We had a summit meeting with BMG,” he recalled of the music conglomerate. “The company’s president held up what looked like a memory stick. He said, ‘People like MP3s, so we’re going to sell them MP3s on this memory stick here.’ It was maybe a one-inch square. They saw that as replacing the cassette. I never heard about it again after that meeting.”

Brendan Toller is the director of the 2008 documentary, I Need That Record: The Death (Or Possible Survival) of the Independent Record Store.

“The way they decided to react to these file sharing networks was crazy,” he said, invoking the RIAA lawsuits, as well as how they “even put viruses on Neil Diamond and Sarah McLaughlin CDs.” Toller is referring to antipiracy software Sony BMG placed on some of its CDs that weakened computers’ defenses against viruses or hackers.

Ed Christman is a veteran reporter for music industry bible Billboard who previously wrote for Shopping Centers Today. Christman recalled a confusing effort by the major record labels to become direct sellers, which never got off the ground.

“Each major [label] was going to have its own digital distribution thing, and when the consumer went into the retailer and wanted to buy an album, the buy was going to be directly from Sony or whoever,” Christman explained. “[The labels and retailers] were fighting over who was going to get the credit card number and who was going to make the sale, plus how the digital pipeline was going to work. It was ridiculous. Everyone was trying to get a bigger piece of the pie while also trying to navigate the legal contracts, and how to introduce a new format.”

In the end, the record companies had no grasp on how to deal with the threat, and the industry continued to contract.

While the industry never fully recovered, reinventing itself instead to accommodate Spotify, Pandora, iTunes and the like, a sliver of good news has emerged in recent years. The vinyl format—initially killed, ironically, by the introduction of the industry-reviving compact disc—began its own resurgence among the younger set.

Record Store Day—an annual promotion launched in 2008 for vinyl releases by independent artists—has been an essential component of that revival. Based on an idea by Bull Moose’s Brown, it began with around 200 stores participating, offering specialty releases produced specifically for the event, around the country, and now has closer to 1,600.

Moreover, there’s been a recent flutter in the number of independent record stores opening. After the number of stores nationwide cratered at around 2,000, recent numbers have that up to around 2,400. But unlike stores of old, many of the new entrants are leaner, meaner and more specialized in its merchandise selection and diverse in the type of offerings, which just might provide some guidance for retailers fielding threats throughout the digital-first purchasing environment.

Another vital factor in the resurgence is that many of these stores have minimal space and have broadened their function with bars or cafés, art galleries, performance spaces and sales of other pop-culture-related merchandise.    

If there are any optimistic lessons for nonmusic retailers in the plight of the music industry, they’ll be found here: the success of smaller, more nimble businesses that have taken new approaches to customer relations, distinguishing themselves from the large, impersonal chain stores of old.

Christman noted that Trans World Entertainment, one of the few remaining large music retail chains, has switched the terms and size of many of its retail locations.

“Trans World was building 15,000- to 20,000-square-foot stores and had five- to 10-year leases,” he said. “Now they have stores on short-term leases—for, like, two to three years—and their store sizes are probably less than 5,000 square feet. Retailers need to right-size their stores to the business models of today.”

Retailers also need to avoid the mistake the music industry made in waiting too long to make fundamental changes. The attempts to deal with the problem—like selling MP3s on memory sticks—were minor stopgap measures that allowed the industry to avoid making the larger, significant changes it had to make, which, time revealed, was shifting to smarter digital delivery formats, à la iTunes or Spotify.

“Stores have to start [changes like] this while they still have customers,” Brown said. “As soon as you see a potential threat, you need to jump on it right away. Don’t wait for it to shake itself out.”

Brick-and-mortar retailers also need to create excitement for products beyond just leaving it to be found in a store. Record Store Day is a perfect example of an industry uniting to create renewed excitement around a product.

Stores also need to be open to diversification, finding as many unique ways to turn their stores into destinations as possible.

“You have to have stores that people have a reason to go into, and the reason has to be more variety,” Shepard said. “There has to be something really positive to draw them in. Just to say, ‘I put it on sale,’ doesn’t mean anything because you can go online and get anything you want.”

Roseman believes the most successful retailers moving forward will be the ones who can combine highly functional, satisfying, easy-to-use experiences in both the brick-and-mortar and digital realms. As an example, he cites eyeglass company Warby Parker, which offers the option of ordering through its website, complete with pictures of all its eyeglass frames, or going into a store.

“[The current environment] has forced retailers to really optimize their brand and step up their game,” he said. “Stores built now need to be experiential to some degree.”

However retailers go about it, Brown, whose chain not only endured but thrived in the wake of the record industry meltdown, said that in order to survive you have to have a survival mindset. Many retailers today face an existential threat. They need to forge ahead as such.

“Basically, what you have to do is say, ‘I’m not going to let them beat me.’ That was our attitude in the 90s,” Brown said. “[Our attitude was], I don’t care if [online is] cheaper than us. We’re going to figure this out.”

Source: commercial

After Chewing Up Retail, Amazon Spits Out Its Own Plans For Brick-and-Mortar

Twenty years ago this month, Jeff Bezos took Amazon—the online book retailer he started up in his garage in Bellevue, Wash., in 1994—public with an $54 million initial offering on the NASDAQ stock exchange.

The IPO valued Amazon at $438 million. While Bezos would subsequently have to steer the company through investor concerns about its profitability (Amazon wouldn’t turn a quarterly profit until 2001) as well as the dot-com bubble’s eventual collapse, Amazon would persevere.

Today, you can forget about that $438 million valuation; Amazon’s market capitalization is approaching $460 billion, with its growth having accelerated in recent years thanks to its dominance in the increasingly influential e-commerce sphere it helped revolutionize. The company has long since outgrown the label of online bookseller, with loyal customers turning to Amazon for everything from electronics and appliances to clothing and furniture.

Along the way, Amazon—which accounted for a remarkable 43 percent of all online sales in the U.S. in 2016, according to a recent report by e-commerce data firm Slice Intelligence—has helped bring about an existential crisis of sorts in the traditional, brick-and-mortar retail sector.

As consumers have drifted toward the convenience of online shopping, retail chains dealing in products from shoes, like Payless, to electronics, like RadioShack, have drifted into bankruptcy. Department stores like Macy’s and J.C. Penney and big-box retailers like Sears and Kmart (both owned by Sears Holdings) have been forced to shutter hundreds of stores across the country, and even higher-end brands like Polo Ralph Lauren—which announced in April that it would close its flagship Fifth Avenue location, despite still being on the hook for $70,000 per day in rent—have vacated prime brick-and-mortar real estate.

By early April, nearly 2,900 physical retail store closings had been announced across the U.S. in 2017, according to Credit Suisse, with closings on pace to exceed 8,600 over the course of the entire year—a number well above the 6,200 locations that were shuttered in 2008, during the height of the Great Recession.

It is a trend that has forced retailers to adapt or die. Last month, it was reported that Wal-Mart was in talks to acquire online men’s apparel retailer Bonobos for around $300 million. That would follow similar recent ventures into the e-commerce space by Wal-Mart, which last year acquired Jet.com for $3.3 billion and picked up outdoor apparel website Moosejaw for $51 million in February.

The irony, then, is that just as Amazon’s business model has forced about a recalibration of the entire retail industry, so has Bezos’ company sought to venture into the brick-and-mortar space itself via an ambitious, multi-pronged approach to physical retail locations.

Since opening its first bookstore in Seattle in 2015, Amazon has opened an additional five stores in markets including Portland, San Diego, Chicago and the suburbs of Boston—venturing into a market that it helped annihilate, putting bookstores like Borders out of business in the process. The company has announced plans for another six stores across the country, including two in New York: one at Related CompaniesShops at Columbus Circle in Midtown and another at Vornado Realty Trust’s 7 West 34th Street, across from the Empire State Building.

Amazon Books
Amazon Books, the online e-commerce giant’s first brick-and-mortar book store, opened in Seattle in 2015. Photo: Stephen Brashear/Getty Images

In addition, it emerged last year that Amazon plans to significantly expand its pop-up retail presence at malls and other shopping locations across the country, with as many as 100 kiosks and small-footprint spaces expected to be open by the end of this year (Amazon had only around 16 such popups open as of last summer). The stores allow the company to directly peddle its electronic products, like the Kindle e-reader and the voice-interactive Echo “smart speaker,” to consumers.

Meanwhile, in Seattle, Amazon continues to pilot its Amazon Go convenience store concept, a grab-and-go store using sensor technology allowing customers to buy snacks, beverages and other goods without having to go through checkout lines. And 10 years after launching AmazonFresh, its grocery delivery service now active in around 20 markets in the U.S. and Europe, Amazon has sought to further grow the platform via AmazonFresh Pickup, which is being piloted at two locations in Seattle and seeks to cut delivery costs in the already low-margin grocery business by enabling customers to pick up their orders on-demand.

Most of these physical retail initiatives have launched or been announced over the course of the last year, and they signal a tangible shift toward brick-and-mortar operations that promise to further grow Amazon’s influence in the current retail climate. However, they still represent a mere fraction of the company’s overall business, and questions remain over their effectiveness as a business strategy.

“I think there’s a wait-and-see approach; on the surface, it does seem counterintuitive to how they’ve built up their business, which is bypassing stores and getting a wide selection of products delivered to [the customer’s] door,” R.J. Hottovy, a Morningstar analyst covering the retail, restaurant and ecommerce sectors, said of Amazon’s brick-and-mortar initiatives.

Hottovy added, however, that many facets of the company’s physical retail operations are “complementary” to Amazon’s business model. The bookstores, for instance, are perceived as a way to drive Amazon Prime memberships, Hottovy said, since Prime members get reduced prices on the books and products available. Like the pop-up stores, the bookstores also create another platform for Amazon to spotlight and sell its electronics products directly to consumers.

Amazon has also sought to bring the hallmarks of its online experience—convenience and personalization—to its brick-and-mortar offerings, further separating itself from traditional retailers whose business model it has torn up.

“I’ve been asked for 20 years, ‘Will you guys ever open physical stores?’ ” Bezos told Fast Company last year. “And I’ve answered pretty much the same way the whole time, which is that we will if we have a differentiated idea…It can’t be a ‘me too’ offering, because the physical world is so well-served already.” (Amazon declined to comment for this article.)

Barbara Kahn, the director of the Jay H. Baker Retailing Center at the Wharton School of the University of Pennsylvania, told Commercial Observer that she had recently visited both Amazon’s bookstore in Seattle and its Amazon Go pilot location and was struck by the extent to which the company seeks to deploy technology to provide a personalized, “frictionless” consumer experience.

“From a retail point of view, the merchandizing isn’t what’s driving it,” Kahn said. She noted how prices are not listed on the books sold at Amazon’s bookstores; rather, customers are able to scan the books (which face cover outward on the shelves, rather than spine out as in most traditional bookstores) with an Amazon app on their phones to receive information on the product.

“You not only get information about the book but also the price they’re going to charge you,” she said. “And they get all sorts of information that they can use.” Kahn speculated that Amazon would be able to use this data—the specific titles, authors and genres that customers browse through—to “calibrate what price they’re going to charge you” for specific items.

Hottovy echoed that Amazon’s wealth of customer information and ability to predict consumer preferences is part of the “end game” of every aspect of its retail operations—and one that will continue to give it an advantage on the traditional brick-and-mortar retail sector for years to come. “That [data] is going to be something nobody else has access to,” he said. “That’s clearly part of the design of the bookstores.”

Amazon Go
The Amazon Go convenience store in Seattle. Photo: Wikimedia Commons

Amazon Go, meanwhile, remains in the pilot stage at its solitary location in Seattle, despite plans to open the store to the public this year and expand via locations in other markets. That delay has been a consequence of technical issues related to the store’s sensor technology—which is supposed to automatically detect the items customers pick up off the shelves, allowing them to leave the store without having to go through a checkout process. (In March, The Wall Street Journal reported that the technology was experiencing difficulties when more than 20 people were in the store.)

Of course, Amazon is far from the only online retailer to have expanded into the physical world in recent years with the likes of Bonobos and eyeglasses designer Warby Parker, to name only a few, among the companies that have parlayed their e-commerce success into brick-and-mortar locations. Many of those brands have already seen the strategy pay off—and in perhaps unexpected ways.

“When I’ve talked to other clicks-to-bricks retailers, almost all of them have told me the same thing—that when they open a store in an area, their actual e-commerce [sales] in the same area shoots up 15 to 20 percent,” Garrick Brown, Cushman & Wakefield’s director of retail research for the Americas, told CO. “The physical store becomes the embassy of their brand.”

Physical locations also assist online retailers with an easier, more cost-effective way of dealing with merchandise returns and shipping those returns in bulk—a method that Amazon, with its business-wide emphasis on customer service at the expense of margin, is anticipated to deploy at its own locations in the coming years.

Brown noted that Amazon is entering the brick-and-mortar space at an opportune time from a real estate perspective, with the company able to capitalize on the rising vacancies and declining taking rents that its success has helped bring upon the market.

“They would get great real estate deals right now, especially with all the [store] closures,” he said. “Now suddenly, we have contraction from a lot of apparel [retailers] and markets where restaurants are struggling to make it. Vacancy is ticking up, and on a cyclical basis if you’re going to make a move, now is the time to make deals.”

Thus far, Amazon has shown a desire to open locations in high-traffic locations in close proximity to transit hubs and a relatively affluent customer base. James Famularo, a principal and senior director of retail leasing at Eastern Consolidated, noted that Amazon’s two announced New York bookstores to date, at Columbus Circle and West 34th Street, take advantage of heavy tourist and commuter traffic, respectively.

Famularo said that he and his team at Eastern have shown several retail locations around New York to Amazon on behalf of their own clients, and he echoed the widely acknowledged sentiment of the company as “tight-lipped” operators who are reluctant to give away any indication of their next move.

“You’ve got to give it to them: They’re aggressive,” he said, noting that retail landlords are largely more than receptive to whatever concepts Amazon may throw their way. “Nowadays, with the uneasiness of Ralph Lauren turning in the keys [at 711 Fifth Avenue], I think people are testing out different markets. And landlords won’t say no to the money.”’

AmazonFresh has had a slightly rockier road to market share. Amazon has had to grapple with logistical and economic challenges associated with grocery delivery—notably the “last mile,” as the transportation of goods from a local hub to the actual consumer is known in supply chain jargon—as well as customer reluctance associated with the psychology of buying food without seeing it first.

Jeff Bezos
Jeff Bezos.

Cushman & Wakefield’s Brown noted that, while Amazon’s ambitious expansion of its fulfillment centers in recent years means that there’s now an Amazon warehouse “on the outskirt of every major metro area in America,” that infrastructure doesn’t necessarily offer itself to AmazonFresh.

“These [warehouses] are 40, 50 miles outside of city limits; you can’t deliver groceries from there,” he said. “You’re looking at your [food] distribution hub being within a one- to two-mile radius, at most.” (Brown did cite the view that Bezos’ 2013 acquisition of the The Washington Post was at least partially motivated by the major daily newspaper’s expansive distribution network. “When they rolled out AmazonFresh in the Baltimore market [in 2015], they used The Washington Post distribution chain that was already in place [to deliver],” he said. “He did not just buy a newspaper; he bought trucks.”)

AmazonFresh Pickup, which was announced in March, is one way the company is seeking to work around that challenge.

“What [Amazon wants] to do to be efficient is to have the consumer take control of that last mile,” Kahn said. “If you can make it convenient for the customer to pick up the groceries, then they’re handling the last mile.”

There is also the possibility that, rather than looking at hard-to-find industrial properties in urban centers that it could use as food distribution hubs, Amazon instead looks at smaller retail locations—similar to Amazon Go—as a means of addressing the obstacles associated with the AmazonFresh delivery model.

“When I look at that [Amazon Go] convenience store they opened in Seattle, I ask myself, ‘Does Jeff Bezos want to sell slurpees?’ ” Brown said. “Instead of looking for an 80,000-square-foot warehouse that does not exist in the urban core, what’s readily available? There’s plenty of small retail space.

“This could be the way that they really ramp up the growth of AmazonFresh,” he added. “I’m not surprised if we’re seeing hundreds of these Amazon food and convenience stores popping up. Of course, they’ll have the benefit of being brick-and-mortar [stores], but the real goal would be to boost their delivery of AmazonFresh.”

Whatever direction Amazon ends up going in with its real estate, virtually no one expects that Bezos’ appetite for expansion is sated. In March, The New York Times reported that Amazon is exploring the idea of “showcase” stores specializing in furniture, appliances and other home merchandise that customers are usually reluctant to buy online without seeing in person first.

The Times also reported that Amazon has been working on a venture, known internally as “Project Everest,” that would see it open brick-and-mortar grocery stores in India—a massive, underserved market. And just this month, it was reported that Amazon is getting increasingly serious about long-gestating plans to get into the pharmacy market and compete with the likes of CVS, Rite Aid and Walgreens.

“It’s at the point where it’s clear, based on the number of closings in the retail space just this year, that Amazon is in a good position,” Hottovy said of Amazon’s physical retail operations. “Now is the time to take it to the next step. If done right, it’s a way to make it an extension of the online platform.”

After a wildly successful first two decades as a public company, no one is certain what the next two decades will bring for Amazon. But should it become the world’s first trillion dollar company—as some have suggested is Bezos’ goal—it would be in no small part due to the fact that it pivoted at a critical moment and conquered both the internet and brick-and-mortar retail simultaneously.

Source: commercial