E-tailers and Storefronts Attempt a Peaceable Coexistence

Online and in-store retailers square off for consumer dollars. Will storefronts have to hit the bricks?

September 1, 1999

Early this year, Hamid Moghadam, president and CEO of a San Francisco–based retail and industrial REIT, took a hard look at his books and growth projections and walked away from the retail real estate business--picking up a cool $950 million in the process.

Except for a few retail odds and ends, Moghadam can now focus on his industrial assets. He intends to reinvest the proceeds from the retail sell-off in warehouse space, where goods, such as those sold via e-commerce, quickly move in and out.

With the retail economy barreling ahead like a power shopper at a liquidation sale, what possesses the owner and manager of $4 billion in neighborhood grocery- and drug-anchored shopping centers to dump a quarter of AMB's portfolio?

"A reasonably conservative assumption about how retail is going to perform because of the threat of the Internet," Moghadam says. "Conservatively, we figure we'll lose 10 percent to 15 percent of our sales to alternative formats over the next 10 years. That doesn't sound like a lot, but it's about 1 percent to 1.5 percent of our growth rate. This whole business grows 2 percent to 2.5 percent in a good year anyway, so we'd be losing up to 60 percent of our growth rate."

E-commerce’s precise impact on retail sales remains hazy. But few question that there'll be an impact—a large one. Business-to-consumer e-commerce sales are expected to spike from $7.1 billion in 1998 to $12 billion in 1999, according to Jupiter Communications' analyst Ken Cassar.

Even with its growth, e-commerce isn't putting a halt to store openings, experts note. Although projections of online retail have convinced some–like Moghadam--that the growth opportunities in bricks-and-mortar retail space will wane, others see new space opening up. There'll be a need for more warehouse than storefront space in anticipation of increasing online sales; for stores located more conveniently to shoppers’ homes; and for vast, dramatic spaces that’ll accommodate experiential shopping—the music, videos, cafés, kiosks, and entertainment that many retailers are using to make in-person shopping more fun than the point-and-click variety.

Economy favors online and offline retail, for now

What's adding to the uncertainty about the future of retail space is a red-hot U.S. economy that has retailers selling online and offline. "Retailers are operating in a very strong retail environment, and the wealth effect of the market is spurring them to continue to develop their bricks and mortar," says Shelia Stoltz, a vice president with REIT analyst Cohen and Steers, New York.

She believes that demographic trends and the power of the economy will keep retail, and existing storefronts, very strong. But the retail industry must be watchful. "The Internet is another distribution channel, and a potentially more dominant one," says Stoltz. "Unless the retailing pie gets bigger, e-commerce will hurt bricks and mortar."

Moghadam concurs. "The economy is hitting on all eight cylinders, and it shouldn't surprise anyone that retail is doing well." But his recent divestiture reflects his belief that physical storefront space--particularly regional power centers—won't maintain the momentum in the long term.

Hard goods lead the way

Some experts believe the retailers who sell books, music, videos, electronics, and software will be first and hardest hit at their brick-and-mortar stores. By 2002, Cassar predicts "conservatively,"35 percent of software industry sales, 13 percent of PC sales, 11 percent of book sales, and 9 percent of music sales will be online.

Already the book industry is experiencing challenges to its business model. Just as superstores edged out some independents, those booksellers—especially the remaining small independents—that didn't establish an online presence early are feeling Amazon.com's sting, says Seema Williams, a consumer e-commerce analyst with Forrester Research in Boston. "Borders joined the e-commerce fray late, and it wasn't particularly aggressive about it," she says. "It didn't offer something that was easier, better, or faster to use than either Amazon.com or BarnesandNoble.com."

BarnesandNoble.com is playing catch up to Amazon.com, too, Williams notes. The site generated $39.1 million in sales in the second quarter of 1999, small compared with the $314 million in sales generated by Amazon.com in the same quarter, according to the BP Report.

Even apparel sales, which lend themselves to tactile, in-person shopping, may see some marginal drift—7 percent or $23.3 billion—to the Internet by 2004, according to Williams. Pushing them there will be clothiers whose Web sites maintain records of people's sizes and preferences, show you how to put a stylish outfit together, and let you dress cyber mannequins with your body type.

Necessity retailing may not be immune either. Although Jupiter originally forecast that only 1 percent or about $3.5 billion of the $450 billion a year grocery industry would move online by 2002, it's retooling those numbers in its latest round of forecasting. Cassar would say only that the grocery numbers will "increase significantly."

Moghadam evidently agrees that grocery shopping is moving online. "A company in northern California, which is planning to expand nationally, has an unbelievably efficient model for home [grocery] delivery that will bypass the grocery store model. It has 300,000- to 400,000-square-foot warehouses in dense neighborhoods that serve the function of 20 grocery stores. You dial up the company's Web site and schedule your delivery in a half-hour window. [The delivery person] can take returns on the spot." In addition, he notes that 15,000 to 20,000 square feet of individual grocery store space today houses banking, film processing, and video departments, all of which "are subject to disintermediation by the Internet."

But Joe Edens, CEO of Columbia, S.C.–based Edens & Avant, a developer and owner of $1.3 billion in necessity retailing, such as grocery stores, isn't concerned about e-commerce crimping his bottom line. "We're not oblivious to the fact that it can have some impact. But we don't think [our portfolio] will be nearly as impacted as other forms of retailing." Edens believes that necessity retail, like e-commerce, is driven by convenience (lots of stores near shoppers' homes) and therefore will remain vital.

Whose numbers are to be believed?

OK, so economic researchers believe that e-commerce numbers will explode. Forrester Research estimates that a projected $18.2 billion in online sales (everything from electronics and housewares to pet supplies and tickets) for 1999 will sprout to $108 billion by 2003. Cassar breaks out online commerce according to business-to-consumer sales and predicts $25 billion in sales of hard goods will be online by 2002.

But International Council of Shopping Centers spokesperson Malachy Kavanaugh says there's a lot of "misinformation and misunderstanding" related to e-commerce statistics, which are small compared with the entire $2 trillion retail pie and often don't reflect true retail numbers. "Some of the stats include business-to-business, stock, and hotel transactions," he says, rather than only hard goods to consumers. And he believes that "the Internet isn't going to replace brick-and-mortar stores. It's going to be an adjunct the way catalog and home shopping channels are."

Barnes and Noble also believes that's true. Not only is its online division going strong--it reports a 250 percent increase in sales in the first six months of 1999, compared with the same period in 1998--but its cyberstore has "increased brand awareness for Barnes and Noble Inc., which in turn adds more interest in the retail stores," says spokesperson Lisa Lanspery. Barnes and Noble Inc. reports a less dramatic 13.7 percent increase in in-store sales between 1998 and 1999.

Now showing: stores!

To stay in the game, retailers are figuring out how to keep people in stores, Kavanaugh notes. Some incorporate Internet access into their stores on the theory that if they don't have your size or color, you can order the product from their Web site and have it delivered to the store or your home.

Others, like Chicago-based shopping center owner and developer General Growth Properties, have partnered with CoolSavings Inc., an Internet-based promotion service that creates customized pages for malls. Shoppers find coupons and special offers at CoolSavings.com that they can redeem at General Growth malls.

George Tanasijevich, General Growth's corporate vice president, says the company is also creating "a portal page that will encompass all our malls and give shoppers an opportunity to learn about promotions and products at our centers. It'll drive traffic to the malls."

Like Kavanaugh, Barbara Baker, vice president of investor relations for Taubman Centers Inc., Bloomfield Hills, Mich., believes retailers will lean toward creating entertainment for shoppers at brick-and-mortar stores, because ultimately in-store shopping provides a sensory and social experience that cyberstores can't.

But a positive outlook for brick-and-mortar doesn't mean Taubman isn't taking precautions. It recently added an online retail venture to its portfolio, purchasing a $7 million stake in Fashionmall.com, a site that sells various brands of clothing and accessories. "The Internet enhances the shopping experience, so we made this investment to understand how that happens," Baker says. For instance, "we see that customers gather information online and then come to the stores knowing what they want."

E-commerce creates market for brick-and-mortar

Besides turning up the fun quotient to keep in-store shoppers happy, retailers are bullish on buying or leasing storefront space. A Merrill Lynch study of 36 REITs found that retailers anticipate opening 3,020 stores in 1999, compared with 2,196 openings in 1998. "We were curious to see whether anyone was pulling back on lease commitments given the growth in e-commerce," says Craig Schmidt, Merrill Lynch's vice president of security, research, and economics. "But we found that across the board--The Gap, Dollar General, Circuit City, Dayton-Hudson--retailers are stepping it up."

Take drug retailers, such as Walgreen's and CVS. "They're building more stores than ever before," says Cynthia Shelton, CCIM, vice president of acquisitions for Commercial Net Lease Realty, Orlando, Fla., which buys and builds retail space. Sure, pharmaceuticals are going strong on the Internet, but many retirees, for instance, like to visit the pharmacy. "My parents know everyone at the drugstore; going there is part of their routine," Shelton observes. "And when I'm sick, I don't want to order prescriptions over the Internet—I want them right then."

And even as e-commerce eats into storefront space, it's generating new brick-and-mortar buyers and renters, Shelton notes. Gateway, the computer dealer, sold online exclusively but has opened small showrooms called Gateway Country, where customers test-drive computers and work with sales reps to configure a system. Then they order a PC there or online and have it shipped to their home or business.

Successful retailers, like Gateway, are finding that it's best to cover their bases in all three venues. Maine-based catalog and Internet seller L.L. Bean is breaking ground at Tyson's Corner Center, Tyson's Corner, Va., in summer 2000, says Chuck Cope, general manager of the mall. "I'm amazed. So many Internet and catalog-based companies—Lillian Vernon, Harry and David, and J Jill—want a key presence in brick-and-mortar stores to gain additional credibility with customers."

Edens, whose malls include grocery stores, Bed, Bath & Beyond, and Office Depot, confirms that opportunity abounds for retailers who are willing to rethink their site search model. In fact, hard goods retailers can dam the e-commerce tsunami by offering a more convenient option to shoppers than the toe-tapping wait for an Internet-purchased delivery.

Edens' solution: Retailers who traditionally locate stores in regional malls could open multiple small stores within three to 10 minutes from shoppers where they can buy or return merchandise. When customers don't have to drive 30–45 minutes, they may be more likely to visit a store. "Wal-Mart is doing something similar with its 'baby' Wal-Marts, which it's opening in multiple locations closer to customers in their neighborhoods," Edens says.

Industrial looks lucky

Some retail specialists who are concerned about the impact of e-commerce on their business may want to put more of their eggs in the industrial basket or in other ventures. AMB's Moghadam is playing the e-commerce and industrial sides of the fence by investing in "promising e-commerce businesses and becoming their partner on the real estate side to build or acquire facilities where they can conduct their business."

There are plenty of other examples, too, of the e-commerce spillover to industrial:

First Industrial Realty Trust, based in Chicago, will build an 800,000-square-foot warehouse and distribution facility for Amazon.com in Atlanta, with a 10-year lease. First Industrial owns and manages 77 million square feet of industrial space.

BarnesandNoble.com spokesperson Lanspery says the .com and brick-and-mortar divisions share warehouse space in New Jersey but that ".com will need to grow that space or add additional distribution centers to accommodate all the products waiting to be shipped."

Start-up Furniture.com, a Framingham, Mass.–based furniture seller just moved into a 30,000-square-foot office facility, according to its spokesperson.

The retail glass is half full

With new space opportunities and consumers' penchant for shopping through multiple channels—at the mall, by catalog, and online--according to Williams, practitioners will be frontline spectators as retail's online and offline business enterprises learn to compete and cooperate.

Even Moghadam, who doesn't see opportunity for his company in retail real estate, acknowledges that there'll always be opportunity for others. "I don't believe for a minute that people are going to sit around, do everything on their computers, and never leave their homes. We like to see product."

Christina Hoffmann
Content Manager

Christina Hoffmann is the content manager for consumer homeownership, buying, and selling site HouseLogic.com, which is produced by NAR.

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