US zombie malls offer scary insights for Australian investors

I recently had the opportunity to visit the United States for almost a month to get a feel for how the various commercial property sectors are faring in the US, and in turn gleaning acquisition strategy insights.

One sector I was especially interested in was retail (and specifically product retail), particularly as Forbes recently reported that over the past 40 years, malls in the US have been on a slow, steady decline.

Back in the 1980s, the US boasted 2,500 malls nationally of significant size. Today, that figure is around 700.

One in three surviving malls have occupancy rates below 70 per cent, leading to the term ‘zombie malls’ – retail centres that are still trading while not really being ‘alive’.  

Some experts predict that only about 150 US malls will make it through the next decade.

Are these forecasts overly dramatic? My visit to the US suggests the dire forecasts are certainly feasible.

Firstly, it’s worth mentioning that the US in general is over-retailed.

As a guide, the retail space per capita in the United States is almost double Australia’s. Although the trends in the US will therefore be less impactful in Australia, they nonetheless hold important lessons worth heeding.

Sun not shining on Florida mall

I inspected a lot of retail centres. Some successful, others less so.

The first zombie mall I encountered was in South Florida.

The mall had lost two main anchor tenants, only a handful of outlets were trading in the food court, and foot traffic at peak hour (lunchtime Saturday) was almost non-existent, except for the Apple Store. 

So, what was driving this decline?  

The South Florida mall had made some critical errors.

The centre had no non-discretionary retail outlets, such as supermarkets, that draw people in.

There were no leisure facilities such as restaurants, bars or cafes that give people an additional reason to visit the mall.

And there appeared to be little attempt to arrest the decline.

Three lessons from US zombie malls

The whole experience highlighted what I believe are three critical considerations for investors in the retail space.

1. The need to provide an experience

The evolution of online retail means that in-person visits to the shopping mall are no longer the only way to get goods. As a result, shopping malls focusing solely on product retail are at risk of becoming irrelevant.

However, if a mall can deliver a great experience – either through convenience or though entertainment (or both), it becomes a more interesting place to visit, and ultimately spend.

2. A willingness to evolve

Long-term success in any industry calls for a willingness to evolve and change with the times.

The reality is, the traditional rental model of larger shopping malls, where up to 18 per cent of smaller tenants’ turnover goes towards paying rent, is no longer viable for retailers – particularly so as online retail evolves as an alternative option. In these larger centres, rents must come down to make the retailers viable.

3. Local will beat large

The view of our team is that larger-scale shopping malls will struggle to compete with online retailing.

That’s not to say all shopping centres will become irrelevant – and it’s certainly not to say that other forms of retail don’t make for a great investment.

Neighbourhood shopping centres, local service centres and large format retail will continue to have a significant advantage, and in our view will continue to offer solid returns to investors for several reasons:

• Lower operating costs – centres with outdoor parking and no internal malls are very cost efficient to run, with total rent as a proportion of turnover as low as 3-5 per cent in a Coles and Woolworths environment.
• Economic viability – In spread out cities like most cities in Australia, home delivery from large warehouses is less economically viable for supermarkets and large format retail centres, meaning the centres themselves act as the last mile distribution – whether this be through indoor shopping, or a hybrid click-and-collect model, or even local delivery from that local store.
• Convenience and the desire to “touch and feel” products – many of the products incorporated in large-format retail, such as furniture and home goods, are products that consumers want to see and feel before purchasing. Also, for groceries, people largely want to choose their fresh food themselves.

Retail alive but selection is key

The growth of online retail is inevitable. In the US, up to 20 per cent of retail spending is online and it’s forecast to grow to over 30 per cent. Australia is still at around 10 per cent, though this is also forecast to rise.  

This doesn’t mean that retail space is no longer a desirable investment.

The key lies in knowing which retail properties are likely to survive – and thrive – in the years ahead. It is an area where professional insights pay dividends.