It's no secret that the growth of online retailing during the past decade has captured market share and shifted retail spending patterns among American consumers. This trend has not only put pressure on sales and profits for some retailers, but dampened sentiment and performance for retail real estate investment trusts (REITs)—the publicly traded entities that own retail shopping malls and strip mall centers.
However, we believe certain retail REITs have advantages that will allow them to remain viable and grow amid this increasingly competitive environment, even as the market recently has been uniformly punishing the stocks of all but a handful of them.
In particular, we have been focusing on retail REITs with property ownership in prime locations—those near dense and affluent populations. In these locations, in-store shopping traffic and sales growth generally has been growing steadily in recent years. Over the long-term, we believe REITs that have been focused on maintaining and enhancing their real estate portfolios in these types of premier locations represent attractive long-term investments. At the same time, we have been avoiding REITs with properties concentrated in less-populous, less-affluent locations, as these strike us as especially vulnerable to weak productivity and store closings.
Our view is that brick-and-mortar retail real estate is not going away. Sales growth among brick-and-mortar retail stores has been positive every year since 2009, and was up 2.0% year-over-year in 2016 (see chart). Retail real estate has been changing to reflect new shopping and entertainment trends. Successful malls and shopping centers have increasingly been prioritizing experiences over buying "things." This includes securing leases with experience-based tenants such as restaurants, movie theaters and other entertainment venues that are far less vulnerable to online sales competition.
Certain REITs are also able to benefit from another trend in the marketplace—predominantly online businesses (such as Amazon.com, Warby Parker, and Bonobos, among others) that have started opening physical stores to showcase their products and provide hands-on experiences for customers. It's another way in which certain retail REITs are adapting to the changing landscape.
Meanwhile, we believe the weakened sentiment for retail REITs in general has been overly punitive for many of the better-positioned companies. Depressed valuations for certain retail REIT stocks provide attractive opportunities going into 2018, as we look to distinguish between the potential "winners" and "losers" in the marketplace.
While our portfolios have generally been underweighted in retail REITs relative to their respective benchmarks, we have been prioritizing those we believe are positioned well to address the competitive threat of e-commerce. Our focus: retail REITs that own the highest-quality, best-located properties; that are attracting the right mix of tenants; and that are trading at undeservedly cheap valuations due to investors' skepticism about the future of brick-and-mortar retail.
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