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2017 Industry Observations

Thus far in 2017, the discussion continues to be about the impact of e-commerce on the shopping center industry. Recent store closing announcements from Sears and Macy’s and anticipated closings from JCPenney have been in the news, and we expect additional closings from these retailers. These announcements, while gaining a lot of attention in the press, have not come as a surprise to us. The closings from Sears have been expected for several years, as the company has continued to invest very little into their stores. We have believed for several years that this company will not survive in the short term, and we believe these closings will accelerate over the next year. While we believe Macy’s and JCPenney are significantly better retailers, they both operate in the difficult mall space we have identified for several years as being at risk of continued declines. While the “A” malls have performed well, we have seen continued deterioration of “B” and “C” malls. This creates opportunity for us as our dominant secondary and tertiary market shopping centers become a logical relocation opportunity for these malls’ remaining retailers. As anchors such as Sears, Macy’s and JCPenney close in these malls and foot traffic continues to decline, we believe there will be a continued exodus of small stores from the malls into open-air shopping centers that are less costly for retailers to operate within. While traditional department stores have struggled, many of our core tenants, such as TJ Maxx, Ross Dress for Less and Hobby Lobby, have shown increasing sales.

Despite the closings of the past year, the shopping center industry remains very healthy. As a recent Pew Research Center study showed, people prefer to buy from physical locations. Vacancy rates in 2016 declined to levels that are a full percentage point lower than pre-recession levels. This is particularly the case in high quality shopping centers such as the ones in our portfolio. Within our fund properties, we achieved average renewal rent increases of 14% in 2016. We believe brick and mortar retail will continue to be an important part of any retailer’s strategy and the successful integration of internet/mobile and physical retail will be critical for both traditionally brick and mortar retailers and traditionally online-only retailers. During this most recent holiday season, 70% of sales went to retailers with both a physical and online presence, according to ICSC. In fact, a recent study by Jones Lang LaSalle identified over 50 e-tailers that are developing brick and mortar strategies. These e-tailers have realized the benefit, from a distribution as well as a marketing standpoint, of having physical stores.Furthermore, physical retailers are utilizing their store footprint to their advantage. Best Buy has indicated that 70% of their online orders are picked up in a store or shipped from a store, and 70% of the US population lives within 15 miles of a store. This has allowed Best Buy to improve shipping and delivery times and gives them the ability to use their stores as product showcases for popular electronics brands such as Apple, Samsung and Microsoft with their own branded shops. JCPenney recently said that 92% of their e-commerce returns take place in a physical store. When those individuals come to the store, according to JCPenney, roughly 40% buy something else and typically what they buy is two times the cost of what they are returning. Add in reduced fulfillment costs, and it becomes clear why the omnichannel customer is more valuable than single channel customers, as a recent Harvard Business Review study of 46,000 shoppers found.

As we move into 2017, we continue to believe in our strategy of owning high-quality shopping centers in secondary and tertiary markets. As we have indicated, we believe owning a shopping center that draws from a large trade area is critical in today’s retail environment. Although retailers need a physical presence, they will need less stores within larger metro markets. As an example, 60% of the recently announced Macy’s store closings were within 10 miles of another Macy’s store. These dynamics, along with the continued lack of significant competition in our niche, give us great confidence in our strategy. As the retail landscape continues to evolve, we believe our properties are well positioned to be stable and successful.