On today’s show we’re talking about what happens when businesses shrink. The latest earnings season for retail brought some more bad news. But let’s be clear, retail isn’t dead. It just has too much friction. 

There is the perception that the lowest prices can be found on-line.

I as an average consumer believe that there are some things that I simply can’t buy online. I haven’t got my mind around buying shoes online. I find that only a small percentage of shoes fit my feet. I need to try them on. Shipping shoes that don’t fit back to the online shoe retailer is more work than going to the shoe store. But if there is a specific pair of shoes that I already own, and I’m looking to buy the exact replacement, then I definitely would consider buying that shoe online. Or if there is an article of clothing like a white dress shirt, here too I would buy that online. If I can save an hour of my time by ordering online, the savings are significant because my time is worth a lot, to me anyway.

So what does this have to do with real estate?

If bricks and mortar stores are facing declining sales, all retail commercial real estate will suffer, not just the ones that are landlords to Sears or JC Penney.

This past week, the shares of Gap, Abercrombie and Fitch, and J. Jill were absolutely hammered. The shares at Gap fell 9% on Friday. Shares at PVH which owns Calvin Klein and Tommy Hilfiger fell 10%. Abercrombie and Fitch was off 26% last Wednesday alone, and J.Jill fell 53% in a single day last week. What do all these retailers have in common? They rely primarily on shopping malls for the majority of their sales.  

Last year it looked like retailers were poised to rebound. It turns out that in 2018, many retailers numbers improved due to better inventory management. That change was short lived. So far sales in North America have been slow as cooler than seasonal weather has kept shoppers at home. 

Here’s the problem. Businesses either grow or they shrink. If they can’t move their inventory, they resort to selling at a discount to move the inventory. You can’t wait another 15 years until that color comes back in style. The product has a shelf life and it’s about 16 weeks in the case of fashion clothing.  

Once a store closes in a mall, I’m not seeing legions of new businesses looking to open up in the mall at $65 per square foot just waiting for a vacancy to open up. Sometimes, you will see a store reduce their footprint in the mall as a larger proportion of their sales shift to online. 

When there is excess inventory in the retail market, prices drop. When there is excess inventory in real estate, prices also drop. You don’t need that much vacancy to cause a precipitous drop in rents. Rents will drop to the point where any rent is better than no rent. We’ve seen mall after mall close down. So what will cause people to get up from their sofa, get in their car and drive to a business?