Appraising Retail Properties in the "Amazon Jungle".

Author:Ross, Franz H.


Changing buying patterns for retail goods and the impact of Amazon and other e-commerce have made retail perhaps the riskiest property type. Predicting which properties will "go dark" necessitates thorough market analysis. For owner-occupied properties, appraisers should ideally analyze the store's financial statements but at a minimum analyze historical revenues. In appraising hotels, nursing homes, convenience stores, and other property types, revenues are the primary measure of captured demand, and going concern appraisals are the accepted practice. The profession should be consistent in using the financial information of the going concern (at the store level) particularly in analyzing freestanding retail properties, and to the extent possible, all retail properties. This will improve the reliability of the highest and best use analysis and the forecast of durability of the current use. In this article, the "durability of the current use" relates to the likelihood of vacancy under the current highest and best use of the real estate, not the brand name occupying the space, with vacancy caused by deficiencies in location, functional aspects, or demand.


Blockbuster had revenues of nearly $5 billion in 2000, with sales increasing at a compound growth rate of 13.9% in 1996-2000. With 51 million active movie rental accounts in the United States and Canada, one in six persons had a Blockbuster account. The 5,191 US stores allowed Blockbuster to achieve dominance by putting at least one store in virtually every small market.

Meanwhile, three-year-old Netflix saw promise in its online movie rental and mail delivery service, although streaming would not be available for seven more years. In 2000, Reed Hastings, the Netflix founder, offered to merge Netflix into Blockbuster at a price of $50 million, (1) as Netflix was losing money, with sales then in the $35 million range. Blockbuster CEO John Antioco declined the opportunity of a lifetime. Netflix grew to $11.7 billion in sales by 2017 and had market capitalization of $145 billion by October 2018. Blockbuster sales peaked in 2004 at $6.1 billion, but storm clouds were gathering, as Walmart and other discounters were taking market share by selling movies rather than renting. Blockbuster took a $1.5 billion impairment charge in 2004, and its sales and prospects deteriorated quickly. Netflix introduced streaming video in 2007, and Amazon had become a major competitor. Blockbuster filed for bankruptcy in 2010; in 2012 the last 300 corporate-owned stores were sold to Dish Network for $320 million, or about four cents on the dollar compared to the $8.4 billion Viacom paid for Blockbuster in 1994- Dish's $320 million investment proved to be essentially worthless. As of October 2018, only the Bend, Oregon, franchise remained.

Blockbuster's 10-K reports typically would begin with a market analysis showing total industry revenues and explaining how Blockbuster would continue to dominate the at-home video market. Obviously, the market analyses by Viacom in 1994, by John Antioco in 2000, and by Dish in 2012 were greatly flawed. They failed to recognize changes to the market--that streaming would become available was predictable. Over 5,000 Blockbuster stores closed over the space of a few years, including fee simple and leased fee properties. Of the hundreds of Blockbuster store appraisals done during its 2004-2010 decline, how many got the value right? Probably very few.

The Blockbuster story is not an isolated case. Sears dates to 1886 and was the Amazon of the early- to mid-twentieth century, as the company's sales were driven by a 500-page mail order catalogue rather than traditional stores. Sears sales topped $1 billion in 1945 (equivalent to $14 billion in 2018 dollars) and continued to lead US retail as it morphed into a department store model. By 2000, there were 863 department stores plus 1,200 specialty and smaller stores. The company was no longer the leading retailer when it was acquired by KMart in 2005 for $11 billion. The combined company (Sears Holdings Corporation) had 3,500 stores. Growth by Walmart, other retailers, and the increasing influence of e-commerce resulted in a Chapter 11 bankruptcy filing by Sears Holdings on October 15, 2018. Upon completion of recently announced store closings there will be approximately 700 KMart and Sears stores. The stock share price was $51 in mid-October 2013 and by mid-October 2018 it was just $0.40.

Other examples of retailers closing stores due to e-commerce competition include Payless Shoe Source, which closed 700 mostly mall-based stores in 2017, and Gymboree, which closed 300 clothing stores the same year. Drive through a retail corridor in most communities, and more examples can be found.

Daniel J. Radek's description of the retail market as bifurcated is complementary to the recommendations made in this article. He described the market's overall improvement as of the end of 2017 as follows: "This overall improvement belies a bifurcated market with better positioned and managed properties significantly outperforming other retail properties that are poorly located or undermanaged." (2)

E-commerce is Growing, Spending Patterns Are Changing

Retail real estate has become perhaps the riskiest property type. How much of this is due to e-commerce? Exhibit 1 graphs e-commerce against traditional store retail sales, (3) while Exhibit 2 shows that the impact of e-commerce on some retail goods is far greater than for other types of retail products. For some retail goods such as liquor, the

impact of e-commerce is zero, while for GAFO retail businesses (4) the e-commerce penetration is now one out of every four dollars spent, as shown in Exhibit 2. Growing e-commerce in GAFO spending is impacting retail real estate throughout the United States.

The millennial generation, which includes some 71 million persons, (5) is entering strong earning years, while the baby boomers are spending less on retail as they age. The higher likelihood of millennial ordering products online will continue to grow e-commerce. A study by the International Council of Shopping Centers (ICSC) monitors spending patterns for millennials, and forecasts that their historical higher spending on health care and education, and diminished spending on clothing and footwear will become even more pronounced as they age. (6) has grown from a small online bookstore, with first full-year sales of $16 million in 1996, to a behemoth offering most retail products, with 2017 sales of $178 billion. Amazon's revenues were 100% from e-commerce until its 2017 purchase of Whole Foods, a supermarket chain with $16 billion in sales. Amazon's growth (including international revenues) has been impressive:

* Revenues grew from $610 million in 1998 to $3.93 billion in 2002, a compound growth rate of 59%.

* Revenues were $10.7 billion by 2006, a 2002-2006 compound growth rate of 28%.

* Revenues were $34.2 billion by 2010, a 2006-2010 compound growth rate of 34%.

* Revenues were $89.0 billion by 2014, a 2010-2014 compound growth rate of 27%.

* Revenues were $177-9 billion by 2017, a 2014-2017 compound growth rate of 26%.

Exhibit 3 shows that Amazon's share of US e-commerce grew from 5% in 2004 to 28% for the first six months of 2018. (7)

In summary, e-commerce is driving US retail, and Amazon is driving e-commerce. Seismic changes are occurring in how money is spent, and e-commerce is now having substantial negative impact on retail stores for certain goods, with the GAFO group being hit especially hard. Appraisers, therefore, should perform thorough market analysis to forecast the future demand for all retail properties, whether leased fee, fee simple, freestanding, or multitenant.

You Can't Get the Value Right If You Get the Market Analysis Wrong

This article suggests that an analysis of the degree of favorability of the land and improvements to the current occupant, combined with an analysis of the financial success of that occupant, should be done early in the appraisal process. This analysis can determine if a re-leasing of the property and new tenant improvements will be necessary within the next several years. If there is a better alternate location for a business, or if the improvements lack functionality, the occupant is not likely to extend the lease. If the property is owner-occupied, the ownership may search for a better location and/or improvements. However, even if the location and improvements are ideal for the occupant, the property will likely "go dark" if the occupant's business is failing at that site. (8)

The preceding statements conflict with the 2009 Appraisal Journal article, "You Can't Get the Value Right If You Get the Rights Wrong," by David C. Lennhoff. (9) In that article, Lennhoff states that a fee simple appraisal must consider that "[t]he cost to build and worth to the initial owner or tenant well exceeds what the property would be able to command on the market for either lease or sale." (10) He further states that the appraisal of a fee simple interest must consider a sale of the property to a second-generation user. This article disagrees, as did writers of the "Letters to the Editor."

This article argues that only after a thorough market analysis, combined with a highest and best use analysis focused on the success of the current use, can an appraiser opine who the likely buyer will be and the value to that buyer.

As Lennhoff noted, one reason a discount is needed for the assumed sale for a second-generation use is because many owner-occupied properties are build-to-suit. The Dictionary of Real Estate, sixth edition, does not define build-to-suit, but it does define first-generation space and special-purpose property.

First-generation space. A building or space designed to be functionally and economically efficient for the original tenant or a similar class of tenants over a period of time, during which...

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