How COVID led to a Great Bifurcation in retail real estate

CEO of Hazelview Investments unpacks the wants-based vs. needs-based divide in retail, and why e-commerce isn't the last word

How COVID led to a Great Bifurcation in retail real estate

With lockdowns and social distancing rules choking off in-person economic activities, the COVID pandemic crisis was a challenging time for the commercial real estate space. Still, some segments managed to weather that period remarkably well.
“During the pandemic, many non-essential retailers were really restricted from carrying on their business,” says Ugo Bizzarri, CEO of Hazelview Investments. “We saw leasing activity really come down; there were a lot more short-term renewals and lease extensions, and retailers were really forced to rely a lot on emergency rent subsidies and rent abatements during the pandemic in order to keep open and continue to operate.”

While that pandemic lockdown atmosphere put a lot of downward pressure on returns and revenues, Bizzarri says it also accelerated a bifurcation within the retail sector. Consumer activity around wants-based retail shifted to online channels. Meanwhile, needs-based retail – spaces that included grocery-anchored shoppers, hardware stores, and pharmacies – performed very well during the pandemic.

At the same time, rising construction costs curtailed the possibility of additional spaces being built, which allowed real estate investment firms to buy needs-based retail spaces below replacement costs, then implement some value-added initiatives.

Bizzarri estimates that sales in the entire retail sector declined by 25% through COVID. Meanwhile, sales at grocery-anchored properties increased by 30%. Needs-based retail businesses also proved resistant to the threat from e-commerce, as they saw sales creep up by 3% even as other sectors saw declines.

“I think that through the pandemic, household savings rates grew substantially. You also had a lot of pent up demand for the in-store shopping experience,” he says. “You're seeing a dramatic recovery in the retail market right now as more and more restrictions are being lifted. At most malls across the country today, you’ll see parking lots are full again, and foot traffic and sales have recovered to normal pre-2020 levels.”

For years, e-commerce has been a powerful headwind for the retail sector. But from where Bizzarri sits, the pandemic has taught the world that consumers still have an appetite for the in-store shopping experience. They might find products they like online, but as lockdowns ease, they’ll be more inclined to try them in stores rather than wait for delivery.

“I think there's going to be a fragmentation of quality retail versus non-quality retail,” he says. “Higher-end retail focused on the shopping experiences will continue to perform well, but lower end retailers such as fast-fashion or lower quality products will suffer at the expense of e-commerce.”

Still, the post-pandemic shot in the arm to retail demand can only go so far. With inflation at multi-decade highs and interest rates on an upward trajectory, Bizzarri sees a real possibility of a downturn in consumer confidence.

Based on an optimistic view of needs-based retail, Bizzarri says Hazelview actively bought more retail assets during the downturn than they would have at any other time, which made for strong investor returns. But as rates start to shoot up, he says commercial real estate investors are adopting more of a “wait and see stance” today.

But through the lens of inflation hedging, he says needs-based real estate is looking relatively attractive. Many tenants to grocery-anchored commercial real estate, he says, pay rent that’s indexed to inflation and also as a percentage of sales, which allows investors to reap healthy yields. On the other hand, the outlook isn’t as rosy for assets that do not have the ability to increase their cashflow in-line with inflation.

Of course, that doesn’t mean wants-based retailers are standing still. Since customers may be more inclined to try products at the store, then order them online, fashion brands may not have to carry as much inventory as they needed to before. That means many wants-based retailers may go to a smaller floorplate, and big-box retailers may eventually see reduced costs of construction and operation as they shrink in size.

“I think what you we've learned through the pandemic is the only thing that's constant is change. And everyone has to be adaptable,” Bizzarri says. “If you're very static in your thinking, I think that's where you get hurt.”