How Will Retail Fare in 2010?

As 2010 gets underway it is inevitable the same questions which many had in ’08 and ’09 will be asked again. Concerns about the health of our economy, specifically retail, have not been resolved. Outright recovery is not forecasted and many are now predicting an extended economic quagmire. Since it appears likely the climate will be similar to last years, the companies that do well in 2010 will likely be the same that succeeded in the previous two years.

As reported by Shopping Center Business, the top three expanding U.S. Retailers in 2009 were: McDonald’s with 1000 stores, Walgreens with 554 and Dollar General with 500. These three companies perfectly illustrate that “value” is the biggest seller in today’s market. This trend has continued into 2010. In February Walgreens agreed to buy Duane Reade (257 drug stores) and the operator of T.J. Maxx and Marshalls announced “plans to nearly double its overall store count from just above 2,700 units to 4,200 locations”, with 130 new stores planned for this year. Dollar General not only plans to open 600 new stores this year, but will feature investor friendly lease terms as it moves away from its traditional modified double-net lease to a more favorable triple net lease. This will definitely be a crowd pleaser for net lease investors, who seek no landlord responsibilities and wish only to receive a monthly check.

While the 0.3% and 0.5% increases in retail sales respectively for December and January encourage the possibility that sales will significantly increase this year, it seems likely they will generally remain flat. With an average unemployment rate of 9.8% forecasted for 2010, many families will continue to place a preference on savings and value. This plays to the advantage of companies such as McDonald’s, Dollar General and Walgreens, ensuring their expansions will continue. Furthermore, a recovery may not necessitate a return to 2005 spending practices. Many consumers were badly burned through the over-leveraging which allowed for the high level of purchases seen in the “boom years”; this could encourage a long term preference for value.

In the past two years the most successful net lease tenants have been value tenants such as McDonalds, Dollar General and Walgreens. Their focus on affordable products has not only ensured survival, but allowed for great amounts of store expansion. With no indicator to say otherwise, it is likely this trend will hold for the duration of 2010.

Sweetgreen: A Fresh Dining Experience

Unbeknownst to many, an interesting new dining concept is springing forth in the Washington DC area. Sweetgreen is a modernly styled salad/yogurt restaurant, which caters to the ever-growing demand for healthier foods and is quickly spreading in popularity. It is headquartered in Washington DC and just opened its newest location in Logans Circle (DC) on the ground floor of the luxury Metropole residential condominium, across from the 15th and P Street Whole Foods. Currently it has four retail locations but its immediate success has encouraged plans for further store expansion.

The idea behind Sweetgreen is simple: a sustainable salad and yogurt bar with a chic atmosphere and unique dining experience. In the Washington DC area, this approach has established Sweetgreen as a leader in fast-casual dining by combining the convenience of fast food with healthy, high-quality menu options. Due to its favorable position, the owners think the new Logan location will be their best store yet.

The last twelve months have seen a surge in popularity of retail condominiums located in dense urban markets. Properties located in these areas, especially in the Washington DC urban core, are experiencing increased demand as they have prospered even in the face of the recession. Sweetgreen stands at the forefront of this trend, taking advantage of the current opportunities in the urban market to expand its presence. As highlighted by RE Business, many individual investors are drawn to urban retail because the size and price points often allows them entry to prime urban markets previously beyond their reach.

Retail condominiums are also a popular choice among many 1031 investors who are seeking suitable replacement property. The retail condo units are typically NNN meaning the tenant is responsible for all expenses associated with the property. The properties are actually easier for both the landlord and tenant to manage because the services required to maintain the property are already contracted by the condominium at large. The tenant simply pays the retail unit’s portion of the condo, management and maintenance fees.

Another potential benefit to investors lies in the assessed value of the property and the weight given to improvements and land. Since the improvements are a greater part of the overall value in a condominium it is possible to depreciate a significant portion of those improvements on a 15 year schedule through a detailed cost segregation study. That means a stronger return and more cash in your pocket at the end of the year. All of these factors make retail condominiums and some of their prime tenants such as Sweetgreen very attractive investments.

Net Leases Grow on Chains

It’s no secret that most net lease properties belong to nationally established retail chains. Among the more popular are McDonalds, Walgreens and 7-Eleven. Recently two more restaurant chains, Chipotle and Chick-fil-A, have shown they are poised for expansion. This should signify possible buying opportunities for net lease investors.

In the year ending on December 31, 2009, Chipotle experienced very positive results:

• Its revenue increased 14.0% to $1.518 billion


• Comparable restaurant sales rose 2.2%


• Net income increased 62% to $126.8 million


• Diluted earnings per share rose 67% to $3.95

For 2010, Chipotle expects its sales to remain steady and plans on opening 120-130 new stores. This expansion creates new investing opportunities with a highly successful tenant.

Chick-fil-A also had a successful year in 2009:

• Overall sales increased 8.6% to $3.217 billion.


• Same-store sales increase of 2.52%.


• Opened 83 new restaurants.

In 2010, Chick-fil-A plans on opening 78 new locations, also creating more investment opportunities.

Though many lament the current market, the steady expansion of many successful quick service restaurants has provided fuel for the net lease market. Chains like McDonalds, whose global same store sales rose 2.6% for January and Buffalo Wild Wings, who has experienced rapid growth, represent enticing opportunities for investment. Tenant growth and that of their applicable brands ensures products are widely dispersed and potentially adds the to staying power of those tenants. Those who have demonstrated steady, durable demand and will only attract more attention as they expand.

Urban Might

Wal-Mart and Target plan on developing smaller stores in order to penetrate the urban market. By decreasing square footage, entrance will be easier, allowing companies to take advantage of low prices in high traffic areas. This continues the recent trend of urban expansion, demonstrating the strong attractiveness of that market.

Typically, urban areas are associated with higher “real estate and fixed costs”, rendering big box stores somewhat ill-suited and clumsy. For retailers like Wal-Mart and Target, it was easier to move to locations more suitable for their gargantuan constructions. However, the wave of foreclosures which has washed over commercial real estate has forced prices down and tenants out, leaving many attractive properties in its wake. In order to take advantage of these opportunities, the traditional big box model has to be scaled down, with a focus on smaller, streamlined stores which will be able to enter the urban market.

This urban move would seem somewhat risky; can a model based on large stores and inventories really be shrunk? But the high traffic provided by these areas along with an increase in demand for value products, should ensure success. Furthermore, these developments lend credence to the notion that urban investments are at present some of the best and most secure. The net lease market has observed continued success in regard to its urban properties and expects the trend to continue.

Franchisee or Franchisor?

Currently there are around 1 million franchise outlets in the United States and over 40,000 international ones operated by U.S. based franchisors. Ownership and operation of these outlets can differ greatly depending upon their parent corporation. For instance Burger King franchises around 90% of their restaurants, McDonalds 80%, Wendy’s 79%, and Arby’s 69%. Conversely, large investor groups, such as Bain Capital, can also decide whether to license out the business model and make money off royalties or operate the franchises themselves, earning revenue directly. This decision is highly dependent upon the market in question and impacts future management of the property.

Typically, franchisors have three main sources of income, (1) retail sales at Company-operated restaurants; (2) franchise revenues, consisting of royalties; and (3) property income from restaurants that the parent company leases or subleases to franchisees. If a company were to engage in the first, it would necessarily negate the latter two and vice versa. In order for the first option to make sense, the specific franchise would need to operate with larger margins. For example, Bain Capital, which owns a 93% controlling economic interest in Dominos Pizza, chooses to sell the franchise rights of most of their stores (including U.S. based ones) but operates outlets based in Japan. This is because pizza delivery is considered a luxury item there, with people willing to pay up to $43.00 dollars for a single delivered pizza. Thus in Japan, it is more economical to operate rather than sell the franchise rights. Conversely, in the U.S., where pizza delivery is assuredly not a luxury item, it makes more sense to sell the franchises as margins are lower.

Should a parent company choose to own and operate a store, it can receive benefits related to its applicable real estate. A location operated by a parent company with investment grade credit, will instantly increase in value. This is because the locations returns are no longer guaranteed by an individual franchisee who has no credit rating but by a company which does. Furthermore, that company can still pull money out of the property through a sale-leaseback. This allows the company to take advantage of the properties increase in value and pull capital out for other uses. These factors are highly evident in net lease properties, where credit ratings are of high importance and sale leasebacks have always been very popular. A property which is corporate owned and guaranteed will typically fetch a much higher price than an individual franchisee due to the flight to quality in the current market.

The decision between owning/operating and franchising a property greatly impacts how it is valued. It also impacts the level of commitment and funds a franchisor dedicates to it. The applicable margins of the specific locale and the opportunity for greater profitability will then be the decisive factor.

An Urban Trend or an Urban Legend?

A new trend could be emerging across our nation’s urban areas. With commercial real estate prices down and many locations vacant, the opportunity has arrived for well positioned investors to grab prime space in urban markets. Though many postulate commercial real estate has not yet bottomed out (Moody’s recently forecast another year of declining prices), there may simply be offers that can’t be refused in today’s cities.

This possible trend is highlighted in a recent story by Retailing Today, concerning J.C. Penny’s move into Manhattan. For most of its history, J.C. Penny purposely avoided Manhattan because of the number of competitors and their store space needs. However, recent times have seriously cut down the level of competition, while also providing new vacant space to occupy. The result was a two-level, 153,000 square foot store, which opened on July 31st. In its first month, the new store surpassed sales expectations by “double digits”. The location, which sits above a subway station and commuter rail line terminus, relays 250,000 people past the stores gates each day.

Another development has been the rising popularity of retail condominiums. As highlighted by RE Business, many individual investors favor this real estate type because it often allows them to own space in prime locations they couldn’t previously afford. They are also a popular choice among many 1031 investors who are seeking suitable replacement property. Furthermore, the economic downturn has caused a glut of vacant properties to fill the market; meaning retailers who are looking to buy or lease have great negotiating leverage. Retail condominiums are not only located in prime space but can often be bought by investors seeking to acquire real estate for their own use. These advantages make retail condominiums very popular today.

Net Lease properties are experiencing similar effects concerning urban locations. Properties located in these areas are experiencing increased demand as they have remained successful despite the recession. This coincides with the changing tastes of many investors from high risk/reward properties to ones with more stability. Taking into account the slump in property values, not only investors but retailers alike are jumping for the chance to own real estate in high density urban areas they previously would not have thought possible.

D.C. Has Global Appeal

According to a new study from the Association of Foreign Investors in Real Estate, Washington D.C. is the top U.S. city for investment. A major reason cited is the “government activism we have now”, which is spurring job growth and attracting residents. The survey also revealed other positive indicators, such as two-thirds of respondents planning on boosting their investment in U.S. real estate this year as compared to last and half expecting U.S. commercial real estate to recover by or before the fourth quarter 2010.

For the D.C. net lease sector, this survey can be seen as a portent of good things ahead. Should the some of predictions of the survey pan out and both investment in the D.C. area rise and commercial real estate see a recovery by the end of the year, it would certainly be a better turnout than many would have predicted. While it has been widely reported that D.C. is doing better than nearly all other U.S. metropolitan areas, it is refreshing to see this fact backed up by those with foreign perspectives.

Net lease properties have already been on many peoples watch lists due to their bond like structure and relative security & stability. When the economy picks up and money starts to flow again, there is a reasonable school of thought saying it will first flow into secure investments rather than the riskier types seen in years past. Net leases fit this bill perfectly.

What the Association of Foreign Investors in Real Estate Survey is essentially saying is that commercial real estate recovery has a reasonable chance to be around the corner and one of the main centers of growth will be Washington D.C. Though this is by no means certain (note the survey itself is split 50-50 on recovery in 2010), if it does prove to be true, it will be quite the year for our nations capitol. However, whether widespread commercial real estate recovery does or does not arrive in 2010, net leases in the D.C. area should see a positive year regardless of the encircling climate, due to their inherent demand and the city’s growth.