I recently worked as part of a team which was tasked with creating an alternative to old-fashioned REIT indices and their automatically high exposure to the highest cost cities, and to backward-looking asset classes (such as malls and chain stores). We found that cap-weighted indices tended to have their highest exposure to retail and lowest core exposure to industrial (which is mostly made up of the distribution system for e-commerce and similar industries). Big bet on bricks, small bet on clicks.
But that raises an interesting question: why allocate to bricks and mortar retail at all? The trends are against it.
And the headlines are harrowing.
But not ALL the headlines are harrowing. This Forbes.com piece points out that retail sales are growing, and that though some chains are failing, others are growing.
We concluded that there were reasons to stay in the sector (as an underweight, instead of as a zero-weighting). First, e-commerce might be taking a 'first beat them, then join them' approach. That is to say, Amazon is using the expertise it used to wipe many bookstores off the map to then turn around and open brick-and-mortar bookstores of its own. Amazon’s $14.6bn acquisition of Whole Foods is another example of this trend. We see similar trends in China, which has a more developed e-commerce market than the United States. Alibaba and JD.com have acquired more than $10bn of physical retail assets in the last two years.
Second, when stores shut down, that's a loss to the store, but not necessarily to the property manager. Former retail space can get re-tasked as offices or even churches. The property still has value, even if not as a department store.
Third, not all retail is a big box store in the suburbs. Sure, Best Buy was doomed, because it was all about price. But some retail is an experience. High-end shopping, customer service, and theme stores for example. Home video has hurt theaters, but not eliminated them. Why? Because certain films just need to be seen on the big screen in the presence of fellow fans. Just so, there are retail buying experiences like that, too. This is particularly the case for certain cities, which are tourist and visitor destinations. The following map shows the pattern of underweighting (red), neutral weighting (yellow), and overweighting (green) in the retail real estate sector according to a human productivity measure relative to cap weighting. Big cities with large pools of affluent residents and visitors will have a certain advantage in preserving and (dare we hope?) adding value. Fifth Avenue and Rodeo Drive and other places around the country will have enduring appeal.