An organisation’s approach to occupying real estate impacts not only on the occupier, but on consumers, employees and landlords. An integrated real estate strategy can present real benefits to an occupier, while posing both opportunities and risks to investors. By Ilse French and Philip Dennison
To translate the impact of local and global trends into an integrated real estate strategy that is practical, functional and implementable, you need to understand how each trend is impacting on the specific organisation’s industry sector and predict how to align with their real estate requirements. This article focuses on the impacts of the changing state of the retail industry on real estate; however, the principles apply to any evolving industry where market participants hold a high volume of property assets.
Industries as varied as health, banking and finance, warehousing and distribution, telecommunications, and higher education can all derive benefits from developing an integrated real estate strategy aligned with, and derived from, their evolving business strategy.
RETAIL TRENDS IMPACTING ON REAL ESTATE STRATEGY
The business environment for retailers has never been more complex. Consumers are developing their own approach to researching and purchasing, both online and in-store. More and more people are purchasing online instead of in-store. The total value of business-to-consumer (B2C) online retail e-commerce in 2014 was
R0,3 billion and this is expected to rise to R9,5 billion in 2018.
However, this is not the complete story. According to PwC’s annual consumer survey Total Retail: Retailers and the Age of Disruption the physical store still remains the retail touch point for most consumers. As many as 81% of South African online shoppers (70% globally) still prefer to do their regular shopping in-store. Reasons for shopping in physical stores relate to experiencing the merchandise, confirming goods are a good fit, and obtaining immediate ownership. Even for goods where consumers predominantly buy online, consumers may research online but actually buy in-store – 58% for consumer electronics and 29% for books in South Africa (25% and 13% globally). Yet despite their continued use of physical stores, today’s consumers want their shopping needs met in a way that minimises uncertainty and inflexibility and maximises efficiency, convenience and pleasure.
As a result of these actual and anticipated changes in consumer behaviour and the resulting challenges to retailers’ economic models, PwC predicts that by 2020 many of the current models for successful retailing will have undergone significant change. Retailers will have to develop new strategies and tactics to engage the consumer in a profitable manner. Historically, the retail store model required a store to sell enough product at a sufficiently high margin per physical building to offset real estate and operating costs and deliver a successful return on investment (ROI). With new pricing mechanisms and changes in buyer behaviour, intense pressure will build on this margin structure. As a result, there will be a need for retailers to find new ways to keep stores profitable. If sales from physical store locations decline, a reduction in real estate operating costs will be key to achieving this.
THE PHYSICAL STORE – AN EVOLVING FORMAT
From a real estate perspective, PwC anticipates that retailers’ strategies are likely to develop to find new real estate environments from which to engage with the consumer. Over the coming decade, the pressures of competition and the range of digital shopping solutions may force retailers to reconsider the value of their store formats. Many of today’s major retailers will be transitioning from traditional, larger stores into non-traditional, typically smaller store formats. Those formats are likely to be numerous and varied to match the shifts in what, when, and where consumers want to shop, and will be supported by the deployment of technology to enhance and support consumers’ shopping experience. This may include short-term formats such as pop-up stores and mobile retail trucks. Pop-up stores are currently booming in South Africa, with shopping malls making use of empty units or unused space to house small retailers, short-term consumer experiences, and temporary food stalls.
Retailers will also demand greater flexibility through shorter lease terms, break clauses and options to alter their store area, despite the higher costs involved. Also, the need to create destination shopping environments will impact on occupiers’ demands of investors. Occupiers will not accept a lacklustre shopper experience in the wider shopping mall, due to the need to complement their own drive to control consumers’ in-store experience and spending behaviour. We have also seen that changing store formats are forcing property-level strategy changes, with e-commerce enhancing the integration between industrial and retail real estate.
Some of the changes in retail occupier portfolios could include:
• Decreased footprint per store
• High demand for store presence in new or growing consumer markets
• Increase in demand for warehousing/distribution centres
• Relocation to transport hubs or centres with good infrastructure
• Prioritisation of shopping locations that provide additional attractions beyond shopping, and
• Flexibility in leases to allow for rapid response to changes in consumer behaviour
These are just a few of the possible developments in occupier requirements. However, the key issue for occupiers will be how to implement these types of strategic decisions without adversely impacting on business operations and within the constraints of their existing portfolio. This is where an integrated real estate strategy adds real value.
DEVELOPING AN INTEGRATED REAL ESTATE STRATEGY
Juggling current and future consumer trends requires regular reviews of and amendments to a retailer’s business strategy. However, in the retail and many other sectors we have found that this is often not translated into property practice. In some cases, business and real estate strategies do not align or, worse still, are at odds with one another. In other cases, occupiers’ existing real estate strategy fails to keep pace with the changing nature of the business, leaving them with high operating costs and vacant premises.
The approach set out in figure 1 provides a real estate strategy that is practical, functional and implementable, responds to business and consumer demands, and optimises operating costs during transition.
THE BENEFITS FOR AN OCCUPIER
The benefits of adopting an integrated real estate strategy include improving and increasing market access and the organisation’s operational advantage by responding to consumer demand. Workplace and retail function flexibility, increased employee productivity and an improved consumer experience can be combined with sustainable occupancy cost management, future proofing and de-risking the organisation’s real estate portfolio, and allowing a rapid response to any change in the business environment.
AN INVESTOR’S PERSPECTIVE
And what does this mean for property investors, owners of shopping malls and the like? Investors need to be aware of changes in their tenants’ real estate strategies and make their own leasing and development plans accordingly, taking into account demographic differences in retail habits. Shopping malls engage with and predict future trends to offer market-leading retail space to their tenants, while also considering new opportunities for investment areas such as warehousing and distribution and supporting infrastructure.
Investors should also be alert to new opportunities. For example, one potential result of an integrated real estate strategy is the possible spin-off of real estate assets into separate vehicles or into sale-and-leaseback or strip-income transactions. Retailers such as Toys R Us and Walmart, and corporates such as UBS, American Tower, and Iron Mountain, have all sought to use their real estate holdings to gain access to cash for shareholders or investment in repositioning business. In South Africa, a recent example was the announcement by gaming group Tsogo Sun that it plans to spin off its hotel, office and retail property assets into a separate vehicle. This new entity would then be listed on the JSE. This type of targeted release of property will provide investment opportunities for direct acquisitions or indirect investment.
Considering the potential challenges that will emerge from new and evolving operating environments, occupiers should give careful consideration to the benefits of implementing integrated business and real estate strategies that provide a competitive advantage to their organisation.
Author: Ilse French CA(SA), PwC Africa Real Estate Leader and Philip Dennison, PwC Senior Manager