Moody's: All of Retail Isn't Dying, But Brick and Mortar Probably Is


We have continually reported on many of the sure-fire signs that brick-and-mortar retail, as a sector, is still feeling enormous pressure from online retail and is, for the most part, simply disintegrating. On top of a number of bankruptcies over the last year, including stores like Bon-Ton and Toys 'R' Us, retail department store space is also freeing up and landlords are having trouble finding tenants.

A new report out by Moody‘s, however, seeks make the argument that it isn’t all of retail that’s dying, just mainly brick and mortar. It also makes the point that e-commerce is what's primarily holding up "retail" in general. The first point we'll take with a grain of salt, the second we can concede a little easier. 

The article, which calls the decline in brick and mortar retail a "relatively minor change in the economy" noted that many of the employment shifts happening as a result of declining jobs in brick-and-mortar retail have been made up by big players in ecommerce:

In the aggregate, it’s true that employment has flatlined at brick-and-mortar retailers, which we define as NAICS codes 44 and 45 minus nonstore retailers. However, despite the weak recent growth, brick-and-mortar retail employment is still close to a historical high at 15.3 million, falling only 22,000 jobs below the peak reached in 2017.

The historically high number of retail jobs overall does mask one negative trend: The growth of retail has not kept up with the rest of the economy. At the peak in the mid-1980s, retail made up 11.8% of overall employment. By 2017, it had fallen to 10.4%. So is this the much trumpeted death of retail? This is overblown for two reasons.

The report notes that this only brings retail's share of the labor maket to the same levels it was at back in the 1970's. Somehow, the report uses this mined piece of data to come to the conclusion that the sector "isn't entering new territory" and that retail overall may not be in as bad of shape as everyone thinks it is. It continues:

Second, it’s useful to place this into a broader context by comparing it to two other industries that illustrate what a major structural change in the economy actually looks like: the decline of manufacturing and the rise of healthcare. As a share of employment, retail looks relatively flat over the past 50 years compared with these industries, generally fluctuating between 10% and 12%. In contrast, automation and globalization have pushed the manufacturing share of employment from 25% in 1970 to less than 9% today. On the other side of the ledger, the growth of healthcare spending has pushed healthcare employment from 5% of jobs to 13%.

The report also goes on to note that trends compared between sectors, despite not standing out too much regarding retail as a whole, have painted a bleak picture for department stores in general:

The decline in brick-and-mortar retail has been stronger among some segments, like department stores. However, this has not been mostly about a contraction in employment, but a shift to e-commerce. Employment gains in e-commerce are visible in warehousing and nonstore retailers, the latter of which includes e-commerce sellers like Amazon. Over the last decade, nonstore retailers have added 157,000 jobs and warehousing has added almost 369,000, which combined more than offset the job losses of 392,000 in department stores.

Moody's concludes with a much brighter picture than we have pieced together from our own findings, calling this shift a "necessary" one occurring in a "dynamic economy":

While e-commerce is undoubtedly growing and has been a factor in the closing of some retailers, the brick-and-mortar retail sector overall is not undergoing the kind of structural job loss seen, for example, in manufacturing. Instead, retail is undergoing a process of gradual change that is necessary in a dynamic economy, but it is not yet a major disruption or cause for concern.

We're not that quick to agree.

Recall, we recently reported on how mall properties were starting to turn up vacant at a higher clip than ever before. In addition to that, we reported that retail landlords were having difficulty bringing in income because brick and mortar stores were processing online returns, which was eating away at their sales figures that are used to make up a percentage of their rent.

As if the rise of e-commerce on its own was not enough to singlehandedly cripple brick-and-mortar retail, retail property owners are getting hit with collateral damage. Online returns being made in-store, which are then subtracted from a store's sales, are turning out to cost property owners "material" amounts of money. Many retail property owners are paid rent that is correlated to the amount of sales consummated on their property, but the convenience of being able to buy online and return in store has put significant pressure on these figures and - in turn - property owners' earnings. Bloomberg reported:

Mall owners, already squeezed by e-commerce and spending billions on property makeovers to draw shoppers, have a new headache: retailers deducting returns for items bought online from their sales figures.

David Simon, chief executive officer of Simon Property Group Inc., says a “significant number” of tenants are underreporting sales and that the company, the largest U.S. mall owner, is negotiating with them to find a solution.

For America’s beleaguered retail landlords, sales per square foot is a crucial metric, used by investors to gauge their financial health. In addition to the dollars lost themselves, a low number can damage a mall’s reputation on Wall Street.

The time and resources spent to audit these returns, as suggested in the Bloomberg piece, will also come at a cost, though maybe not as material as the returns themselves. Regardless, it is retailers and their landlords both trying to get the better of one another, and both trying to cauterize their respective wounds quicker than the other.

But this solution seems temporary in nature and unlikely to be big enough to replace the steady stream of cash that comes from larger corporate tenants. And the "returning in-store" model makes sense - when people are returning items, they want their credit or their money immediately, so they don’t mind making the trip up to the store.

It was just 2 weeks before that when we noted that the death of retail stores was continuing. We documented that over 77 million square feet of retail real estate has closed this year and that 2018 will easily pass 2017's record of 105 million square feet closed. The silver lining to the industry was supposed to be that property values would hold up. This argument was made by real estate investment trusts as well as activist investors and analysts who tried to put a positive spin on the death of brick and mortar retail. But instead the bid under former retail property is at risk of falling off as supply is starting to get far ahead of demand:

Real estate can put a floor under the value of a retailer and make it easier for the company to borrow. Maybe a particular store concept doesn’t work out as consumers’ tastes change, but in that case, investors can always sell the land and buildings to someone with a better plan. Long-term leases can be similarly valuable. But what if the problem isn’t that a particular store is out of fashion, but that consumers are just shopping less at brick-and-mortar retailers in general? As more storefronts empty, the valuation floor will look wobblier.

While the Moody's report goes on to make a compelling case that retailers aren't dead yet, we believe it’s worth noting that brick and mortar, as a sub-sect of retail, likely is on its way.