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Should we rethink the future of retail real estate?

The health crisis linked to Covid-19 has led countless commercial activities to close while triggering a strong surge in e-commerce. The short-term consequences may be clear, but at the same time fairly irrelevant since purchases in physical stores have quickly ticked up again. What might be more interesting are the medium- to long-term effects: Is a systemic crisis in physical commerce a real possibility? Could this lead to a (more or less drastic) drop in the value of retail real estate?

If we look at the long-lasting effects of the crisis, topping the list is the sudden, massive acceleration in the migration to online shopping, even for Italian consumers, who until recently were among the most reluctant to make that move. In fact, in late December 2019, habitual online shoppers numbered 700,000 in this country and the share of total retail purchases was 7%, compared to a European average of 15%, and 16% in the US. But by May 2020 more than two million people were making purchases online.The repercussions of the pandemic for consumers involved many weeks of social distancing, and the ensuing perception of crowded spaces as an individual risk factor, along with a growing popularity of e-commerce. But it’s not yet clear whether all this will strike a new balance in the relationship between procurement (obtaining necessary goods), and shopping & leisure in the experience that consumers are looking for, eliminating the key competitive advantage of physical commerce. When shopping malls started opening again, initial indications on the number of visitors would lead us to think that the opposite is true. In any case, the effects will be different for retail procurement-based retail as compared to retail as a shopping experience.The function of retail real estate is continually evolving, destined to change in tandem with the changes in the way of life and the preferences expressed by the people who frequent these venues of commerce. Yet retail spaces have always served a social function, by offering experience more than procurement. In other words, retail spaces fulfill a higher order of needs by providing gratifying experiences that are shared and repeatable. So purpose-built retail - dedicated to a true, complete shopping experience - serves as a social gathering place, with the clearest example being the shopping mall.As of today retail has undergone drastic transformation, with e-commerce initially considered an alternative to physical commerce. In fact, we went from talking about ‘multichannels’ (alternative distribution channels), to ‘omnichannels’ (integrated distribution channels), ultimately coming to the conclusion that at this point the proper expression is ‘no channel.’ In other words, it’s not about different channels, but only different purchasing methods on a single platform, where to avoid becoming irrelevant retailers must offer every option, and where customers can chose whichever one they prefer, or combine more than one.

The pandemic and the resulting economic crisis are simply accelerating the changes that were already underway in retail, but to such an extent that the ripple effects of these changes have the potential to upend a wide range of different commercial activities and in turn, impact the attractiveness of investments in retail real estate.Procurement retail is certainly in the best position to leverage online sales, since its strengths lie in vast assortments and convenient prices; the same is true of pure on-line players. In this arena, however, when physical retailers also know how to effectively propose their offering online, they’re not relegated to playing a secondary role - quite the contrary. Unlike pure on-line players, they already have a key infrastructure: the logistical ‘last mile’. In other words, they have a network of stores that can easily serve as pickup or departure points for home delivery of online purchases, beyond representing exceptional physical touchpoints between the customer and the product during purchasing decisions.

So it is no coincidence that in the first quarter of 2020, Walmart and Target saw online sales skyrocket by 74% and 143% respectively, far above Amazon’s certainly positive 29%. (Comparable data refer to the North American market.) This goes to show that when physical retailers continued using their model, while effectively proposing the online option too, they outperformed even Amazon. This may also depend on the direct, concrete relationship that Walmart and Target have with their customers, compared to what e-retailers can build on the web alone. To sum up, Walmart and Target are merchants, whereas Amazon is primarily a logistical platform.What’s more, in recent years all mass market players in the grocery sector, beyond shrinking the size of all their biggest stores, are introducing new formats with urban locations. Other players, such as Mediaworld, are experimenting with ‘click and mortar’ hybrid models, which are smaller in size and stocked with limited physical merchandise. Here the infinite store enables customers to access the complete product range, using high quality kiosks with help of store personnel, to get more information on available options or decide to make other purchases. They can also choose the purchase and delivery methods they prefer. This is a way to create a shopping experience that goes beyond the limits of a physical offering, but without turning into something drily transactional like online purchases. By observing the efficiency and reactivity of this type of retail lead, we can draw this conclusion: there is no real reason to fear a systemic crisis and a loss in value in retail real estate in the aftermath of the pandemic. This despite the fact that uncertainty about the near future is still high and totally dependent on external factors.

So purpose-built retail (in particular shopping malls) won’t become less important for customers, nor less attractive for investors. The condition is that these spaces must be conceived, designed and realized (or transformed) to propose an offering that is not limited to purchases, but instead extends to other activities with high experiential content that cannot be replicated online. No longer simply ‘shop’, but ‘eat, shop, and play’ – with architecture and layouts that align with the innate purpose of serving as a social gathering place.

The shopping mall will continue to play a central role in the world of consumption and leisure, completing the evolution underway and becoming a virtual (as well as physical) platform, totally integrated into the network of social relationships of its denizens. What’s more, malls are highly flexible structures, basically containers that can be adapted with relative ease to new needs for using space, keeping in step with the evolution in demand. But to do this, malls have to be designed with more communal areas that are not intended exclusively for making purchases. Malls need more spaces that are earmarked for eating, entertainment, and personal services, and fewer places for commerce.

But even though the recipe might seem simple, applying it is definitely not. From a real estate investment point of view, this means that the same sized structure will bring in less rental income, as more space is given over to leisure activities which are typically less lucrative. Looking at the experience of markets where this evolution is more advanced, we seem to see that a fair portion of the lower profits is recovered by capturing higher market shares thanks to the attraction of leisure. This in turn enables commercial activities to sell more and pay higher rents.

Naturally, not all existing malls will be able to adapt to the new evolutionary model. They will need to develop while paying very close attention to new format paradigms, so as to create products that are flexible enough to respond to future changes. So a careful economic evaluation is essential to verify long-term sustainability, more so than short-term profitability. But what we can say is that the purpose-built retail model embodied by the shopping mall has survived under various forms and names for more than two thousand years, from the time of Trajan’s Markets in Rome. So this model will not, from one day to the next, become obsolete.