The Transformation of Retail – An Interview with Inland’s CEO Mitchell Sabshon
May 13, 2021 | James Sprow | Blue Vault
Mitchell Sabshon is CEO and President of Inland Real Estate Investment Corporation, one of the nation’s leading sponsors of real estate investment trusts (REITs), securitized real estate like-kind exchange programs, and other private real estate securities products. Blue Vault recently spoke with Mr. Sabshon about the changes going on in retail real estate and, in particular, the types of investments the Company has made in grocery-anchored shopping centers.
Inland has assets owned by several different portfolios, including their 1031 programs as well as their retail REIT program, Inland Real Estate Income Trust, Inc.
The following presents the main topics from our interview with Mr. Sabshon.
Prior Retail Trends in Place Accelerated by the Pandemic
“Prior to the pandemic, bricks and mortar retail had been undergoing a transformation, with the growth in online shopping. Consumer preferences have changed as well with respect to what consumers want to do when they get in their car and head out to shopping centers. The pandemic has accelerated these trends. It will be very interesting to see what retail looks like when COVID-19 is truly in the rearview mirror.”
“When malls were built in the 60s and 70s, Americans loved to go to malls. That has changed. There has been less demand for what enclosed malls have to offer.”
“The pandemic accelerated trends that were already occurring. People who did little or no online shopping started to order online so they didn’t have to go out. We saw the restaurant sector drop off. But we’ve seen a lot of creativity by retail businesses. We’ve seen home delivery grow tremendously with newer services like DoorDash, and FedEx and UPS volumes have, of course, increased significantly. We’ve also seen some changes in service businesses with online scheduling. That creativity and flexibility has helped blunt some of the effects of COVID-19, reducing the potential severity that we might have seen. We’ll continue to see curbside pickup and delivery to homes. Those changes are here to stay and they will impact retailers, for the most part in positive ways.”
“Looking beyond the pandemic as we start to emerge, retail locations with both hard and soft goods will be far more flexible in how they deliver merchandise to customers. And the trend of bricks and mortar retailers complementing their traditional sales with internet shopping will certainly grow.”
The Art of Selecting a Tenant Mix
“Retailers are looking at ways to increase the “dwell time” of shoppers. How can we get the consumer to the shopping center and keep them there longer? Owners of shopping centers can help in this effort by providing a mix of merchandisers, services and restaurants that motivate customers to spend more time at a shopping center.”
One of Inland’s commercial real estate portfolios is currently 81% grocery-anchored or grocery shadow-anchored. Grocery stores have traditionally attracted shoppers on average almost two times a week. If you can combine tenants in a shopping center that increase the dwell time, going for more than just to pick up their groceries, that’s the essence of active management – a cornerstone of Inland’s expertise in retail real estate. What other tenants can you add to the center that complement the grocery tenant’s business? What kind of goods and services will the customer of the grocery store also want to take advantage of at the center? If you have a Whole Foods, what kind of restaurant do you want there? Is it different from the restaurant that might be near a Pick ‘n Save? It often is. Selecting the right tenants is an art, not a science, and it can very well make the difference in operating a successful shopping center.”
The Synergies of Complementary Tenants
The complementary mix of tenants affects rents. “A tenant might be tempted to relocate to a competing shopping center nearby. The tenant might turn to you and say, ‘Hey, the other center’s owner is making me an offer of a lower rent in its center. Why should I stay at your property?’ “For most tenants, it’s about sales. What is it about my property that is better for the tenant than the competitor nearby? What can we do to keep that tenant? Physically maintaining the center is the easy part.”
“There are two kinds of shoppers. One kind will shop at a particular tenant no matter where it are located. That shopper doesn’t care if that tenant moves two miles away. There is another shopper that will go to the tenant near the anchor store because of the convenience of location. That tenant is picking up business they wouldn’t otherwise have gotten because they’re located near the anchor tenant that’s drawing customers. As a landlord, we don’t just want to have good tenants, but tenants that will complement each other. That’s why tenants will pay higher rents, they want those incrementally higher sales.”
The Inland Focus on Stabilized Retail Properties
“Traditionally, Inland has focused on buying stabilized assets in the retail space that are not in dramatic need of major improvements. We will buy assets with some amount of vacancies but not assets with substantial vacancies or meaningful amounts of deferred maintenance. Our strategy is to provide relatively higher current income. The opportunistic or value add strategies require considerable investment and won’t have cash flows for investors right away because of the capital investments required. Many of the firms that focus on value add and capital appreciation, when they have created the value through their redevelopment or repositioning strategies, they’ll flip the asset and take a big capital gain, but their investors may not receive significant cash flows until that asset is flipped, which typically will take two or more years.”
Dealing with the Problems of Big Box Retailers
“Big box properties have been the property type hardest hit by internet sales. We’ve seen a lot of retail bankruptcies in the big box sector; K-Mart and Sports Authority and DSW, for example. Finding an alternative use for the big box property is a challenge. Filling those large spaces can be difficult because there aren’t as many big box tenants as there used to be, equating to less demand for spaces of that size. There are a number of strategies that Inland is doing right now. One is a conversion strategy. You can take a big box space and convert it into a self-storage facility or other non-traditional retail use. That works very well. Now you can have a well-located infill self-storage facility right in the midst of a high-traffic retail corridor. And that type of capital investment isn’t huge.”
“Inland has done projects where we’ve taken a termination fee from a junior anchor, torn the building down completely, and built a strip of smaller footprint stores. And, because the rents per square foot for smaller spaces are generally higher than for big box spaces, we’ve increased rental revenues by executing on that strategy. Inland also had a property that had more parking than needed, and built from the ground up a stand-alone store on that site, such as an Ulta Beauty or some other well-regarded tenant, increasing revenues where none existed before.”
“We may have a big box tenant that is struggling and has 10 years left on a 20-year lease. That tenant could go dark and continue paying rent for years, which does not help the sales of the other stores in the center. Or Inland could take a termination fee, which might be lower than the present value of the future rents, but, using all or a portion of that termination fee, could then do a redevelopment of that big box into a number of smaller footprint spaces.”
Mixed Use as a Possibility?
Is the trend to do mixed use in shopping centers in your portfolios, adding apartments and offices, for example, to an existing center? “No, not at the moment. We are looking at ways to increase value through redevelopment. It is very dependent on location. At Inland we have a very large investment in multifamily properties, currently almost $4.5 billion across all of our portfolios. We tend to focus on properties that have more than 200 units, and really shy away from anything smaller than that. A shopping center as opposed to a mall is not likely to have square footage that could accommodate the construction of as many as 100 units. Also, it is very capital intensive to build an apartment building from the ground up and the payback time can be long, maybe two or three years. That type of investment doesn’t really fit with most of our investors’ expectations.”
Inland’s properties tend to have drive-up pharmacies. They also have a number of gas stations that some of their anchor tenants operate to enhance sales. “In many cases the grocer or other anchor, such as Walmart, may operate the gas station, another reason to draw people to their center.”
Underwriting Retail Shopping Center Acquisitions
In Inland’s underwriting we always look at demographics. “We look at existing demographics and future trends. Households within a certain radius, employment numbers, household income numbers. We also look closely at construction permitting to see if someone is building a shopping center down the road and determine if that is going to impact our center. It could negatively impact the value of the asset. We consider at what the profile of the tenancy might look like.”
“For example, we are looking at a site in Florida where we just learned there are 160 new homes being built nearby that will likely create more store sales in the future. This particular center had a grocer and a major distributor of liquors.” With those anchors, the new homes being constructed represent a potential major driver of increased value of that property.
What types of retailers have done well in this COVID-19 environment? “Grocers, of course, but the large liquor distributors have also done quite well. If you operate a grocery store or liquor store and your sales didn’t increase dramatically in 2020, then you really need to find a better located center.”
What Will Happen After the Pandemic?
“During the pandemic, consumers were cooking a lot more at home than they were doing before. There are two lines of thinking that are diametrically opposed. One view is that once the floodgates are open and people are free to go out, we will see a huge increase in the restaurant business and a reduction in grocery sales.” Mr. Sabshon believes the increase in grocery sales per square foot will fall in the first six to twelve months following the pandemic, when people are dining out as often as they can.
“Another line of thinking is that, because of the experience of far more family meals during the pandemic, when we get back to a more stabilized lifestyle, maybe families will realize that dining at home is a positive for family members. And maybe we’ll see more family meals that could result in grocery sales being not as great as during the pandemic but higher than they were pre-pandemic. The resilience of the grocery business despite the trend toward online shopping has been absolutely evident.”
“The staying power of bricks and mortar grocery suggests that people really like to go to the market. While some people will be happy with the grocer’s “pickers” for curbside pickup and home delivery, the vast majority of people want to select their own meat, fish and produce. Almost every other sector of retail has lost sales to the internet, but not the grocery sector to any significant extent. There are also a lot of spontaneous purchases where shoppers don’t want to wait for online delivery.”
Active Management to Maintain Occupancy and Rental Revenues
“It’s a little difficult to raise rents right now because tenants don’t know what their revenue profiles are going to be. Generally, rents have been flat. I think we’ll see the opportunity to raise rents after the next 12 to 24 months.”
Besides raising rents and keeping centers occupied, are there other strategies for active management to increase NOI in retail shopping centers?
“It’s a never-ending challenge. It’s always active management. Real estate ownership is not just collecting the rent checks. You have a myriad of challenges you have to meet. We’ve seen this intensify with the pandemic. We’ve seen retailers go out of business. Of course as a result of the pandemic, we’ve seen more bankruptcies. There may be opportunities to convert those big boxes into other kinds of space. And that’s something a good landlord has to be doing all of the time—focusing on tenanting, tenant mix, redevelopment, property appearance, creating additional revenue, and controlling overhead.”
“We may go to a big box tenant and ask, ‘how are you doing?’ We know you’re paying your rent because you’re a strong national brand. They may say, ‘Well, not as well as we would like.’ So we need to talk turkey. With one property in Utah, we negotiated a termination fee with the big box tenant and built a strip center. And, at another center we didn’t need as much parking, so we built an Ulta Beauty from the ground up. On the whole, active management is what you are supposed to do all the time in order to enhance the value of your property.”
Rental Deferrals and Occupancy Experience
“We have reached certain modification arrangements or deferral arrangements with a small but meaningful number of tenants. The prototype agreement is to reduce rents over a limited amount of time, then go back to the previous rent for a while, then after a certain time period the tenant begins paying the original rental rate as well as amortizing the deferred rent over some period of time.”
“If you had asked me back in March or April of 2020, I would have thought the impact would have been more severe. We took a very prudent defensive strategy to do our best to be in a financial position to be able to weather the pandemic. The truth is we’re not done. Our tenants have really stepped up and performed. They want to be in business. I don’t care if they are a national retailer or a “Mom and Pop,” they want to be in business and they want to perform in accordance with their agreements.”
“Our occupancy was at a little north of 94% before the pandemic, and then to have it drop just 1% or so from pre-pandemic to now is amazingly good considering what our country has gone through.”
Thank you, Mr. Sabshon
