This is part two of our series on How Inflation is Impacting CRE Occupiers, in which we explore the impact of inflation on specific occupier sectors. Alternatively, follow the links for insights on the impact of inflation on industrial and office.
Retailers are on the front lines of the battle against inflation as shoppers become more price sensitive amid higher costs for gasoline, food and other essentials. If they hope to maintain foot traffic and sales conversions, occupiers will need to be hyper-aware of their core customers’ shifting buying habits while elevating their brick-and-mortar stores’ sense of purpose. On the cost side of the balance sheet, rising operating expenses are making it difficult for firms to remain profitable in this inflationary environment. Retailers who are able to manage these costs effectively stand to boost share prices, thereby allowing greater maneuverability on price discounting and marketing initiatives.
Inflation Will Eat into Retail Profit Margins
Firms can pass along price increases to consumers, but only to an extent
Competing for Labor and Mitigating Rising Labor Costs
The predominant consideration for retail occupiers is rising labor costs. It has become increasingly difficult to attract and retain workers at previous wage rates, leading to annual wage growth of 7.4% in retail and 9.4% in accommodations and food services (as of Q1 2022) compared with 5% for all private sector workers. Retailers are not just competing with their peers but also against higher pay in other industries. Increasing pay helps but is not always enough; many retailers have also expanded benefits packages, offered sign-on bonuses, or enhanced perks such as employee discounts. Others are rethinking store layouts to include amenitized break rooms to enhance the work experience—much like office users have done.
Doubling down on technology is perhaps the most effective way to mitigate rising labor costs, so long as it does not detract from the customer experience. Retail stores have been incorporating automation and robotics in their operating models for years and that trend accelerated during the pandemic. Retailers with best-in-class websites and mobile applications are outperforming not just in online sales but also in-store foot traffic. All of these investments can be very costly up front, but they must be considered in the context of the costs associated with losing productive workers. The shopping experience hinges on having a high-quality workforce and seamless integration of technology. These can be make-or-break factors for sales and brand loyalty.
An Acute Focus on Sustainability
Materials price inflation is difficult for retailers to circumvent in the short term as retailers are largely at the mercy of market conditions. However, brands with an acute focus on sustainability will be better positioned to manage higher costs and to plan for periods of volatility. Consumers are more aware of sustainability initiatives than ever, so outlining and executing an environmentally responsible business plan is beneficial from both a supply and demand perspective. For example, many successful emerging brands, especially in apparel and footwear, employ the following strategies:
- Source recycled materials for their production process, thereby reducing raw materials costs while also promoting a consumer-friendly message.
- Seek out partnerships with domestic and local vendors to enhance community engagement, which has the added benefit of reducing exposure to costly overseas supply chain disruptions.
- Diversify vendor relationships across countries and regions, which can help importers remain nimble in the event of localized supply shocks.
The Impact of Transportation and Energy Costs
Transportation costs are a key consideration in how retailers adapt supply chain strategies. Reliance on long-haul trucking to a few central distribution centers may no longer be optimal for keeping up with evolving consumer requirements for direct shipping, buy-online pick-up in store (BOPIS) and online purchase returns. This could mean expanding the back-of-house footprint and taking up space in smaller distribution centers located near customers and retail locations. Because of higher shipping costs, incentivizing customers to pick up orders in retail stores can help reduce the cost burden for occupiers while crucially driving foot traffic and add-on purchases. One consideration for retail tenants in the market will be how hard landlords push to capture percentage rents on online transactions that are fulfilled at physical retail locations. This gray area is a growing point of contention between landlords and retailers.
Energy efficiency has been and remains a priority for occupiers across all types of real estate. Retail tenants seeking out newer energy-efficient buildings may pay higher fixed rental rates, but with the offsetting benefit of lower overhead utility costs that can fluctuate wildly and unexpectedly erode profit margins. Occupiers may also negotiate reduced operating hours into leases to accommodate their peak traffic times, which may vary substantially by category—for example, a restaurant tenant versus an apparel brand tenant versus a medical tenant. Landlords are likely to be more receptive to flexible hours based on the pandemic experience.
Retail on the Rebound
Retail rents are increasing on average nationally, but that is more reflective of recovery’s fundamental strength than recent inflation dynamics. While some markets are just beginning to emerge from the downturn—namely dense urban areas in coastal cities—limited availability of desirable retail space is driving up rental costs in most U.S. markets. Landlords are gaining negotiating leverage as a result yet remain eager to work with high-quality tenants and are generally not asking for escalation rates tied to actual inflation. For now, the price pressures retail occupiers face stem primarily from labor and input costs.