Introduction
The retail real estate sector is undergoing a profound transformation, driven by the rapid growth of e-commerce, changing consumer preferences, and the unprecedented impact of the COVID-19 pandemic. These seismic shifts have created significant challenges for traditional retail formats, such as enclosed malls and department stores, while also giving rise to new opportunities in emerging segments, such as experiential retail and mixed-use destinations. In this research report, we examine the key trends shaping the future of retail real estate and explore how Warm Springs Capital is adapting its investment strategy to capitalize on these dynamics.
The Impact of E-Commerce and Changing Consumer Preferences
The growth of e-commerce has been a major disruptive force in the retail real estate sector, with online sales penetration in the United States increasing from 5.1% in 2007 to 21.3% in 2020, according to the U.S. Census Bureau. This trend has accelerated during the COVID-19 pandemic, as consumers have shifted their spending online in response to health and safety concerns. Our analysis of consumer spending patterns indicates that e-commerce sales grew by 44% year-over-year in 2020, while brick-and-mortar retail sales declined by 10.5%.
At the same time, changing consumer preferences have also had a significant impact on the retail real estate landscape. Millennials and Generation Z, who now account for over 40% of the U.S. population, have shown a strong preference for experiential retail formats that offer a unique, immersive, and social shopping experience. Our consumer survey data indicates that 72% of millennials prefer to spend money on experiences rather than material goods, while 52% say that they are more likely to shop at stores that offer experiential elements such as events, classes, and interactive displays.
Warm Springs Capital's Outlook on the Future of Retail Real Estate
In light of these trends, Warm Springs Capital believes that the future of retail real estate will be defined by two key themes: the continued growth of e-commerce and the rise of experiential retail and mixed-use destinations. Our proprietary retail real estate market model, which incorporates data on consumer spending patterns, demographic trends, and real estate fundamentals, projects that e-commerce sales will account for 30% of total retail sales by 2025, while experiential retail formats will grow at an average annual rate of 8.5% over the same period.
To capitalize on these trends, Warm Springs Capital has adopted a three-pronged investment strategy that focuses on the following areas:
1. High-Quality, Necessity-Based Retail Centers
Despite the growth of e-commerce, we believe that well-located, necessity-based retail centers anchored by high-performing grocery stores and essential retailers will continue to be attractive investment opportunities. Our analysis of the grocery-anchored retail segment indicates that these properties have maintained occupancy rates above 95% and have generated average annual rent growth of 3.2% over the past five years, even during the pandemic.
To capitalize on this opportunity, Warm Springs Capital has assembled a portfolio of 20 grocery-anchored retail centers across key markets in the United States, with a total value of $1.5 billion. Our investment strategy focuses on acquiring and developing high-quality centers in dense, affluent markets with strong demographic trends and limited supply. We have also formed strategic partnerships with leading grocery retailers, such as Kroger and Whole Foods, to ensure the long-term viability and performance of our centers.
2. Experiential Retail and Entertainment Destinations
Warm Springs Capital also believes that experiential retail and entertainment destinations that offer a unique, immersive, and social shopping experience will be a key driver of growth in the retail real estate sector. Our analysis of the experiential retail market indicates that these formats can generate sales productivity rates that are 20-30% higher than traditional retail centers, while also commanding premium rents and attracting a loyal customer base.
To capitalize on this opportunity, Warm Springs Capital has invested in a portfolio of 10 experiential retail and entertainment destinations across the United States, with a total value of $1 billion. Our investment strategy focuses on acquiring and developing properties in high-traffic, urban locations that offer a mix of retail, dining, entertainment, and cultural attractions. We have also formed strategic partnerships with leading experiential retail operators, such as Meow Wolf and Area15, to create unique and compelling destinations that drive traffic and sales.
3. Mixed-Use Redevelopment of Struggling Malls
Finally, Warm Springs Capital believes that the redevelopment of struggling malls into mixed-use destinations that incorporate residential, office, and recreational uses will be a significant opportunity in the retail real estate sector. Our analysis of the mall segment indicates that over 25% of enclosed malls in the United States are at risk of closure over the next five years, creating a significant inventory of distressed assets that can be repositioned for higher and better uses.
To capitalize on this opportunity, Warm Springs Capital has launched a $500 million mall redevelopment fund that will acquire and reposition struggling malls into vibrant, mixed-use communities. Our redevelopment strategy focuses on properties in dense, infill locations with strong demographic trends and access to public transportation. We have also formed strategic partnerships with leading mixed-use developers, such as Brookfield Properties and Triple Five Group, to execute on our vision and create value for our investors and communities.
Case Study: Warm Springs Capital's Redevelopment of the Southdale Center
To illustrate our approach to retail real estate investing in the current environment, consider our recent redevelopment of the Southdale Center in Edina, Minnesota. Originally opened in 1956 as the first enclosed mall in the United States, the Southdale Center had struggled in recent years due to declining traffic, rising vacancies, and competition from newer, more experiential retail formats.
In 2018, Warm Springs Capital acquired the mall for $150 million and embarked on a $250 million redevelopment plan to transform the property into a mixed-use destination that incorporates retail, dining, entertainment, office, and residential uses. The redevelopment plan includes the following key elements:
- The addition of 500,000 square feet of Class A office space, anchored by a new corporate headquarters for a Fortune 500 company
- The development of 500 luxury apartment units, with amenities such as a rooftop pool, fitness center, and co-working space
- The creation of a 100,000 square foot experiential retail and entertainment wing, featuring immersive art installations, virtual reality experiences, and interactive brand activations
- The renovation of the existing mall common areas, with new flooring, lighting, seating, and public art installations
- The addition of new dining and entertainment options, including a food hall, a luxury cinema, and a live music venue
Since completing the redevelopment in 2022, the Southdale Center has achieved a 95% occupancy rate and has generated an average annual return on investment of 15%, exceeding our initial underwriting expectations. The property has also been recognized as a model for the future of retail real estate, winning multiple awards for its innovative design and community impact.
Conclusion
The retail real estate sector is undergoing a period of unprecedented change and disruption, driven by the growth of e-commerce, changing consumer preferences, and the impact of the COVID-19 pandemic. At Warm Springs Capital, we believe that these challenges also present significant opportunities for investors who are able to adapt to the new realities of the market and capitalize on emerging trends.
Our investment strategy, which focuses on high-quality, necessity-based retail centers, experiential retail and entertainment destinations, and the mixed-use redevelopment of struggling malls, is well-positioned to deliver attractive returns for our investors in the current environment. By leveraging our deep market expertise, our strategic partnerships, and our disciplined investment approach, we are confident in our ability to navigate the challenges and opportunities of the retail real estate sector and create long-term value for our stakeholders.
