A Light at the End of the Apocalypse

David Scharf, Partner and Chair, Morrison Cohen LLP

The Real Story Behind the Retail Hysteria

According to The Atlantic, 2017 was the year of “The Great Retail Apocalypse.” Citing nine retail bankruptcies and hundreds of shops shuttering, The Atlantic’s souring prophecy spawned countless other “end of retail as we know it” headlines. Today, the term “retail apocalypse” is commonplace in the industry. But is it warranted?

Not quite, as it turns out. There’s certainly a light at the end of the tunnel, anyway—for those retailers who know where to look.

“In early 2018, the highly publicized bankruptcies of Nine West, Claire’s, and Toys ‘R’ Us created a very dire atmosphere,” said Y. David Scharf, partner and chair at Morrison Cohen LLP.

An expert on retail and the current brick-and-mortar climate, Scharf claims that “bad news begets bad news,” thus creating our current doom and gloom environment. However, once bad news has hit rock bottom and has run its course, there is room for a necessary bounce back to occur. It’s this bounce back that Scharf and others are keeping an eye out for, proving the industry’s many naysayers wrong.

Of course, that’s not to say that things are peachy right now, either. 2018 saw a record number of filings in the first quarter in the retail space, as well as very high default rates. Not to mention that the demise of long-time market leaders like Toys ‘R’ Us and New York’s iconic Lord & Taylor flagship are disheartening at best.

“Cost basis and debt load is really what’s driving store closures,” said Scharf. “So when companies are over-levered, many times they are over-levered by virtue of their expansion plans and the cost of the space that they have. This causes them to sell in very large amounts, which cause tight margins, and, ultimately, closed doors. And when doors close, there is no rent.”

Scharf’s hypothesis outlines a domino effect that leaves the property in question with a big question mark. If the landlord who owns the space is extremely well capitalized they can respond to the new market, but CMBS loans cannot be negotiated—only extended.

The bottom line is that a retailer needs to be able to afford a space. Since foot traffic is down in most retail spaces due to e-commerce, landlords can afford to take less from the retailer.

“I believe that there must be a repricing in the capital stack in order to make retail space. That’s the single most important thing, even more so than experiential retail,” Scharf added. “There’s still a healthy population that is old school and that still appreciates walking into the store, so regular retailers without e-commerce components can still survive—if their rental payments aren’t out of wack.

“How many signs do you see when you walk down the street saying that a company is going out of business because they can’t afford the rent? Those are real-life stories.”

However, many retailers are adopting e-commerce tactics to thrive in our new, digital world. The most obvious candidate is Walmart, a store that has cultivated a strong e-commerce and brick-and-mortar presence. This doubles the possibility of the sought-after impulse purchase, as customers can see items while waiting in line in the store, as well as in the “recommended” section of their shopping cart. Walmart’s model capitalizes on consumer behavior and psychology, according to Scharf, allowing them to get ahead of their competition by fusing elements of e-commerce together with physical space à la the in-store pick up option when buying online.

Other brands that are pursuing tech and e-commerce to ensure survival include Starbucks and Domino’s. Starbucks now does a great deal of business via its grab-and-go app orders, and Domino’s intuitive online pizza ordering system and customizable “Pizza Tracker” are examples of engagement with credible interface.

“I do think we are seeing the confluence of technology and common spaces,” said Scharf of the e-commerce-meets-retail phenomenon. “We will get to a point where drones will deliver food to row two, seat 15 at a baseball game with the click of a button. Everyone will have apps, and as technology costs come down, mom-and-pops and smaller retailers will be able to bring tech into their daily lies and become more successful.”

But retail’s battle for rent survival is an uphill one. A rising interest rate environment is going to make 2019 planned refinancings and new financings extremely difficult—and big name retailers like J. Crew, JC Penney, and Sears are hanging on by a thread.

“I don’t think we’ve seen the worst yet,” said Scharf. “I continue to believe that we haven’t hit rock bottom, and I don’t think we will hit rock bottom until we get some very significant repricing.”

However, Scharf’s hypothesis for an inevitable rock bottom will give way to the aforementioned bounce back in the retail sphere, even with industrial infringing on brick-and-mortar retail’s space and business. After all, a large portion of consumers are still of the older generation and prefer to purchase products in-person rather than online, so brick-and-mortar likely won’t become obsolete for at least another 75 to 100 years when these consumers are no longer active.

“My grandchildren will have grown up with nothing but being able to feed the hungry monster of instant gratification through the Internet,” Scharf said of the generational gap in consumers. “But I still like going to the store, smelling my produce, and picking the expiration date on my milk. I think that consumer behavior is still out there—and that will matter.”

In short, the retail apocalypse is not one of zombies and hysteria. Rather it’s one with an end in sight, albeit one that demands a great deal from existing brick-and-mortar entities. To use a Darwinian term, it’s about survival of the fittest and adaptation—and only the brands that are able to adapt to the new digital landscape and make it their own will survive.

“The consumer has many senses that need to be activated that physical retail can appeal to,” Scharf concluded. “So ultimately, we’re going to start seeing retail differently. We may see retail in office buildings that have people living upstairs or in gated residential communities. It’s all adaptation of space, and it’s all essential for survival.”

Technology has required adaptation from all of us since the advent of the Internet years ago. For brick-and-mortar, it’s no different—but Amazon’s mere existence is certainly no death sentence. Sure it’s new and sure it’s something that requires a necessary revolution, but those who adapt and survive will be stronger for it. And once the smoke settles, eager consumers will be itching to leave their house and their online shopping cart behind for the next buzzworthy thing in retail.

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