American Real Estate Society

The Effects of Technology on Retail Sales, Commercial Property Values and Percentage
Rents
Author(s): John S. Baen
Source: The Journal of Real Estate Portfolio Management, Vol. 6, No. 2 (2000), pp. 185-201
Published by: American Real Estate Society
Stable URL: https://www.jstor.org/stable/44154441
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 The Effects of Technology on Retail Sales,
Commercial Property Values
and Percentage Rents

by John S. Baen*
Executive Summary. This study examines the impact
of e-commerce and the effect of technology on traditional
retail sales , commercial property values and percentage
rents. This study analyzes standard retail leases and Introduction
seeks evidence of retailers shifting on-site sales to off-site
e-commerce and catalog operations. The results indicate E-commerce is causing a leakage of retail sales
that of those surveyed, most shopping center owners, traditional retail locations. That is, many e-
managers and leases contain no provisions for these commerce sales are occurring at traditional retail
sales, which have value implications to owners. In ad-
locations and are recorded as catalog sales or com-
dition, this study presents both theoretical concepts and
puter sales for next day pickup or delivery directly
empirical results that suggest commercial leases need to
to customers' homes. The sales information is often
be altered to account for online and catalog sales. Alter-
native uses for vacant bank buildings and retail spaces logged off site at the tenant's national data center,
are suggested as well as specific recommendations to although the physical retail center was the procur-
owners / tenants to reduce the threat of e-commerce to re- ing cause or point of contact for the sale. The re-
tail centers. sults are loss of on-site sales information, reduced
tabulation of gross sales per square foot reported
to the property management company/ owners and
potential loss of percentage rents.

The potential effects of e-commerce on traditional

retail property values could eventually be profound
and be a result of two primary aspects: (1) more
off-site retail sales resulting in less foot traffic,
lower impulse sales by non-anchor tenants, lower
profit margins due to comparative web shopping,
greater competition, lower profit margins for ten-
ants and eventually higher vacancies; and (2) more
on-site retail sales that are accounted for as off-
site or catalog sales or computer orders.

It can be assumed that every Internet sale equates

to a loss of gross sales revenue reported to or at-
tributed to traditional retail property and/or a re-
^University of North Texas, Denton, TX 76203-0410 or
baen@unt.edu. duction of catalog sales. This assumes that at any
given time, there is only a finite amount of retail
This article is the winner of the Retail Real Estate category
(sponsored by the International Council of Shopping sales or catalog sales and disposable income per
Centers)
household
presented at the American Real Estate Society Fifteenth An- and that traditional retail sales can only
nual Meeting. be maintained if the economy expands at an

Journal of Real Estate Portfolio Management 1 85

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John S. Baen

increasing rate, faster than the growth of e- finding major changes in the perception of the tra
commerce. ditional sticks and bricks approach to retailing/
marketing. Another example is:

Literature Review "There's oodles and oodles of business-to-

business success stories, however," says
The implications of technology and the predicted
Steven Johnson, director of e-commerce at
downsizing of the various commercial and residen-Consulting in Chicago. "Our
Anderson
tial real estate professions (Baen and Guttery,
studies show that companies such as Dell
1997) have not noticeably occurred exceptComputer,
in the Charles Schwab and Cisco Sys-
lending/banking and title insurance areastems,
(Power,
companies that have moved aggres-
1998). Mergers and technological efficiencies have
sively toward e-commerce models, are en-
contributed greatly to increasing vacant branch
hancing revenues (generally by 10 to 20
bank facilities either within malls or on pad sites cutting costs (20% to 45%) and
per cent),
within the immediate area of major retailreducing
proper-working capital and physical in-
ties. Alternative uses of vacant retail centers and
frastructure requirements (20% to 60%),"
bank buildings have become common topics in the Calgary Herald, November 10, 1998.
main stream press (Brown, 1998) and has become
a priority topic for funded research (ICSC Priority
The e-commerce battle is not just between retailers
Research Topic 1999).
and landlords but major manufacturers are also
going online and bypassing distributors, wholesal-
Major national retailers are either closing stores
ers, and retailers. The Wall Street Journal (July
and moving to the Internet (Halkias, 1999) or mak-
29, 1998) reports, "Chaotic Battle Looming - If
ing major moves to begin or expand online sales
various merchants can't separate themselves from
within existing retail operations (J. C. Penney,
the pack, they are likely to transform most online
Wal-mart, Radio Shack, etc.).
markets into low-margin commodity businesses.
Price cuts will become the main weapon in a cha-
While the trend is occurring faster than the tra-
otic battle for market share."
ditional academic journal articles can be pub-
lished, the main stream press is full of references
that are causing real concern to shopping center
owners, retail leasing agents and property man-Historical and Contemporary
Overview
agers. Examples are:
1. REIT Interest - Will the Internet Kill All the The traditional retail center or mall is made up
Shopping Centers? (Martinez, 1999). five major components of which the physical re
2. Rural Residents Find Internet Closer Than estate itself (the sticks and bricks) is but one (see

Malls (Associated Press, 1998).
3. Price War! Dozens of New Web Sites Want to
Help Online Shoppers Compare Prices -analyst's
to the Irritation of Retails (Woolley, 1998).
4. Why Real Estate Should Fear the Future (Rei-
fenberg, 1997).
The countless similar main stream press refer-
Exhibit 1). The sword of technology and the retail
property (see Exhibit 2) has clouded the real estate
Much vision to project future rents, percentage
rents and therefore property values. Percentage
rents have traditionally been a hedge against in-
flation and often form the upside potential for ne-
gotiating higher base rents at the end of a lease
term.

ences have added significant anxiety to traditional

retailers and property owners. Prestigious real es- In the past, retail center planners, investors and
tate and e-commerce consultants however are financing firms have concerned themselves with
monitoring profits and cost savings for clients buildings that would:
and

186 Vol. 6, No. 2, 2000

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 The Effects of Technology

Exhibit 1
The Retail Center/Mall Concept Under Fire by Technology
1. Physical Retail Center

2. Center Anchor Tenants 4. Center/Major Profit Sources:

Smaller Tenants
■ Shift to e-commerce and
catalog onsite sales in stores. ■ At risk to less foot traffic.
■ Target for other new e- ■ Customer shift to competing
commerce firms and virtual off-site e-commerce.
discount malls.
■ Declining quality of customer
service and sales clerks due to low
unemployment rates and low pay.
■ Fewer clerks on commission.

3. Property Managers and 5. Shoppers - Consumers

Leasing Agents ■ Targeted for e-commerce sales
■ At risk to competition of and catalog sales at their homes
and offices.
on-line leasing
marketing/brokerage websites. ■ Compute-based comparative
■ Increasing total square shopping for major items will
divert mall foot traffic to other
footage managed per manager
locations with lower rents,
due to technological
efficiencies. operating costs, etc.
■ At risk to lower leasing ■ The drive to lower prices and
commission, brokerage fees home delivery convenience.
and performance-based ■ Large improvements and
efficiencies in off- sit deliveries
management fees due to
potential decrease in retail (FedEx, USPS, UPS, etc.).
center annual revenues and
percentages rents.

1. Lease to tenants with the value-added upside These basic objectives of retailing evolved from
and inflation hedge of percentage rents based central city locations and migrated to the suburbs
on gross sales at the point of purchase. of most metropolitan areas in the United States
2. Offer a tenant mix and design that enhanced over the last sixty years (see Exhibit 3). The blos-
both destination and impulse buying. soming of the suburban retail centers has most of-
3. Offer visitors a pleasant and entertaining activ- ten been at the expense of inter-city retail tenants,
ities to create the atmosphere of a visit to the property owners and loss of tax base for the central
retail center as an event rather than an errand cities.
or occurrence.

4. Offer easy and safe access, parking More recently,

andsuburban
pleas-regional malls have over-
ant shopping experiences. built with multiple malls within one region com-
5. Cash flow and appreciation of the sticks and peting for a finite amount of disposable income dol-
bricks through property management, facilities lars within that region. The battle of the bigger,
maintenance, marketing of the retail center andbetter, newer, greater number of tenants mega
upside prospects of rents (contract and malls have also been met with a discount malls
percentage). and discount retailers' war with Wal-mart, Sam's

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John S. Baen

Exhibit 2
The Sword of Technology
Technology and Retail Property: The Good, The Bad and The Ugly
Rents
% Rents

The Good Property Value The Bad

Efficiency in transactions and Layoffs, fewer employees, fewer foot-

manufacturing traffic shoppers

More informed shoppers on Lower profit margins and profits to

quality & price tenants

E-commerce has lower overhead and Gross sales will be reduced; demand
requires less and less expensive real may drop for traditional space
estate

Exploding computer literacy in the U.S. Decrease in traditional marketing at

retail centers

More online shopping K Faceless buyers/sellers; no customer

ti service

More home-based businesses and B Further displacement of urban concept

employment & and locational factors

No salesperson pressure for consumer No chance for add-on sales

The Ugly

Retail, catalog and e-commerce are

merging

Downward spiral of prices

Increasing competition

Enhancement of distribution

Robotic order filling

188 Vol. 6, No. 2, 2000

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 The Effects of Technology

Discount Stores, etc. The American shopper and Exhibit 4

mall developers have been confronted with high Threats to Retail Values

dollar demographics/location/prices vs. discount Traditional Threats

warehouse retailing. ■ Recession

■ High interest rates /credit cards

■ Unemployment
The evolution of retail sales to e-commerce has
■ Competing centers
added a third dimension to competitive product ■ Reduction in consumer spending
viewing and retailing that goes far beyond the
■ Changing neighborhoods/demographics/crime/etc.
■ Building obsolete /refurbishment
physical and locational factors of the traditional re-
■ Lack of available financing
tail location (see Exhibits 3 and 4) combined with
■ Major vacancies in a center (bank, branches, anchors, etc.)
a downward movement of prices to a single Technology
world
price for many items, accompanied with smaller
■ Telemarketing /call centers in other states
■ E-commerce
profit margins. There are new threats to ■retail
Consumer auctions
property values as a result of technology (see Ex-
■ Efficient delivery systems of products
hibit 4). ■ Absolute lowest price information

Early indications are that the following tenant pro-

files have been most affected by e-commerce giving
them technological efficiencies that will changebeen the
seriously affected to date by technology and
potential tenant mix and profitability fromtherefore
tradi- their profitability and ability or willing-
tional spaces leased to this type of retailers. ness
Ten-to pay rents are:
ants, retailers and service providers that have
1. Bookstores - Amazon.com
2. Travel Agencies - Sabor /American Airlines/
Southwest Airlines
Exhibit 3
3. Record, Tapes and CD Stores
Changing Retail Perspectives
4. Automobile Dealerships
1 880-1 980s Historical Retail Perspectives 5. Banks - Non-Banks (branch closings due to
Location: Central Cities - Superior Market
Location: Central Cities - Suburban Mix mergers, ATM machines, etc.)
Location: Suburban - Superior Market 6. Stock Brokerage and Investment Firms (E-
1 990-1 999 Contemporary Retail Perspectives trades)
7. Computer Stores
Battle of the bigger, better, greater number (Dell Computer)
of tenants largest regional malls vs. Wal-
mart, Sam's Discount Stores, etc., for:
8. Flower Shops
Demographics /Location vs. Price - 9. Up and Comers
Dominate Regional Mall a. Grocery Stores
Demographics /Location vs. Price - Multiple
Malls in One Region
b. Drug Stores and Pharmacies
c.
Demographics /Location vs. Price - Super Electronic Stores/Radio Shacks, etc.
Malls and Freeway Outlet Malls
Retail real estate owners must be on guard not to
2000 + Beyond Future Retail Perspectives
Product viewing locations with productunderestimate the effects of e-commerce on tradi-
website ordering address on every tional retailing. Potential short-term value and
product. Website location & 1 global price,
FedEx, UPS, etc.
commercial real estate professional's employment
■ Malls implications using conservative e-commerce gross
■ Airports sales figures appear to be significant (see Exhibit
■ Consumers /Users (walking ads)
5). Typical deadly retail owner perceptions col-
■ Media (TV radio, print, etc.)
lected from recent interviews with members of the
■ Traditional retail locations become places
to pick up, return and receive repair International Council of Shopping Centers (ICSC,
service for products ordered on Internet.
November 1998):
■ More traditional retail space dedicated
to storage, warehouse, repair areas and
customer service.
1. "Technology is no threat to my portfolio. It's my
tenant's problem."

Journal of Real Estate Portfolio Management 1 89

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John S. Baen

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1 90 Vol. 6, No. 2, 2000

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 The Effects of Technology

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Journal of Real Estate Portfolio Manageme

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John S. Baen

2. "The web will never replace the need for human Online sales are also occurring in shoppers'
contact." homes after being viewed in retail centers. It
3. "Excellent customer service and property man- would be difficult if not impossible to capture
agement will protect my centers from the income from these home e-commerce sales that
'threat' of technology." were showcased in malls unless entrance fees
4. "My retail center's web page will maintain a were charged or leases were also based on the
fresh flow of visitors to our mall and our retail number of shoppers entering the facilities.
tenants." 2. The convenience, selection of goods, downward
5. "My retail tenants would never make electronic movement of prices and faster home delivery
purchases for customers that would registersystems available through online sales will in-
sales 'off the books' to avoid percentage rents."creasingly compete with traditional retail sales.
3. Customer service at traditional malls has been
Approximately 111 commercial retail professionals
and owners that attended an International Council
dwindling. The quality, vitality and enthusiasm
of sales clerks have been declining due to low
of Shopping Centers (ICSC) meeting in November
pay, high U.S. employment rates and lack of
1998 on the subject of "The Future of Retailing"
training. Many sales clerks are order takers at
completed a questionnaire (see Appendix A). The
best and many actually offend shoppers with
results (see Appendix B) were both interesting and
poor manners and service. Landlords and re-
important in terms of the attitudes of those per-
tailers need to form alliances to improve cus-
sons perhaps closest to ground zero of the impli-
tomer service throughout the retail center
cations of e-commerce on retail property. Respon-
through new training and incentive-based sales
dents' perceptions and retail center technology
programs. However, with falling profit margins
levels are apparent. Their conclusions as to the fu-
(due to e-commerce comparative shopping ser-
ture of shopping centers as investments at pre-
vices) this may prove uneconomical.
vailing CAP rates are startling. It should be noted
4. Malls need to become more family oriented with
that 58% of the respondents were retail property
free computer rooms for games and/or home-
managers and leasing agents (24% and 34%, re-
work rooms for children of shopping parents.
spectively) with 24% being developers and only 3%
Perhaps the commuters might not be connected
being investors/owners.
to the Internet to eliminate comparative shop-
ping or ordering online.
5. Improvements in customer service and infor-
Long-term Value Implications: A mation desks need to be accomplished through
Theoretical Illustration
better, faster, more efficient information such as
Appendix C and Exhibit 6 presents excerpted sales (actual
work sales), community information,
by Cruickshank and Baen (1999) that involves community demographics and special services
simple assumptions but drives home the point that for mall visitors.
the present value of a theoretical retail center los- 6. Posted prices in traditional retail stores are be-
ing either percentage rents and/ or retail rental in- coming negotiable by shoppers carrying online
creases due to e-commerce, technologies, etc., is comparative price lists by competitive store or
substantial. e-site by name and location. Store managers of-
ten match the lowest price on the list (Mclntyre,
1999). At least one major retailer (Barnes & No-
Observations/Areas of Concern and ble) is practicing this e-commerce leakage tech-
Recommendations
nique. This may turn American retail centers
into oversized Mexican markets or Middle East-
1. Online sales and ordering are occurring at ern bazaars where everything is negotiable.
physical retail centers that are the procuringGross sales figures and percentage rents may
cause of the sale. Owners must restructure increase while tenants go bankrupt due to su-
leases to capture some portion of theseper sales
competitive e-commerce pricing and crash-
and at the least, the gross sales information.ing merchant profit margin. Wireless, customer

1 92 Vol. 6, No. 2. 2000

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 The Effects of Technology

hand-held comparative price shoppers are cur- profitabili

rently being tested on the East Coast. Mclntyre estate will
(1999) reports the story of one woman. "When and innovations. Retail tenant leases should in-
she's in the market for a bestseller, she searches clude or capture some percentage of catalog and/
online book sites like Amazon.com, prints up or e-commerce sales.
the best price and then marches into Barnes &
Noble to get them to match it. If a salesperson Additional research is needed in the areas of mon-
balks, not to worry. She asks to see the store itoring gross sales, on-site e-commerce sales, profit
manager, who invariably okays the deal. The margins of retail tenants and improvements in
cashiers are often amazed. They'll say, 'I had no mall activities/customer service. If efforts of retail
idea we did that!"' center owners and their tenants are not successful
in countering Internet sales, while maintaining
profitability and rents, major research in the area
Conclusion of alternative uses of retail shopping centers will
Traditional malls
be the hot research topic of the future. a
lenged by e-comme

Appendix A

Research with ICSC Members

International Council of Shopping Centers
1998 South Central Idea Exchange
Westin Galleria Hotel, Dallas, TX
November 12-13, 1998

Please complete the attached survey anonymously to assist in further research of the topic: T
of Technology on Retail Sales, Commercial Property Values and Percentage Rents by John S. B

Would you like a copy of the survey results? Yes

(If yes, please provide your busine

What is your primary position: (c

How long have you been in commercial real estate?

What is your annual income per year?

1. Please state your opinion of the t

0 1 2 3 4 5
Worthless Important
2. Is the threat to retail cash flows:
0 1 2 3 4 5
Overstated Potentially Important
3. Do your retail leases contain provisions for on-site (at the sto
warehouse? Yes

Yes

Journa

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John S. Baen

4. Do your individual shopping centers have a web page? Yes

things are on the web page?

Do any of your leases include clau

a. Catalog sales? Yes

b. E-commerce sales? Yes

Do you monitor the number of hits per month? Yes

How many hits do you have per month: Total

Can people order items from your website? Yes

How often is your center's web page updated?

Do you believe these retail center web

Yes

5. Please offe
traditional sh

6. How can ow
commerce is

Please offer s
your shopping

(Please indica
7. Do you thin
Yes

8. Do you th
significant p
Yes

9. Do you thi
liquidity of commercial real estate? Yes

10. Do you think that m

of shopping center investments? Yes

11. Would you currentl

prevailing CAP rates? Yes

194 Vol. 6, No. 2, 2000

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 The Effects of Technology

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198 Vol. 6, No. 2, 2000

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 The Effects of Technology

Appendix C vices will help ease these fears, however, it will

take some time before the majority of the Internet
A Theoretical Illustration population feels comfortable giving credit card in-
formation online.
Based on the projections of future Internet com-
merce previously mentioned, this example pro-
vides a fairly conservative estimate onThis howexample
retail(see Appendix C) is for presentation
real estate values could be affected by a changing purposes to estimate the potential effects online
retail industry. Using the underwriting shopping could have on the underlying value of a
assump-
tions for each prospective case, a dramatic change general shopping center. It assumes a fully occu-
in value is calculated. In Case 1, normal under- pied 100,000 sq. ft. shopping center with current
writing standards of today are used to calculatelease rates of $10.00 per sq. ft. net. Expenses are
the value of the shopping center. Using these gen- assumed to be $3.00 per sq. ft. growing at a pro-
jected
eral policies, a value of $10,373,634 is calculated. inflation rate of 3.0% annually. No capital
In Case 2, the potential effects of online shoppingexpenses or tenant turnover are assumed. The
are introduced, larger vacancy rates and reduced analysis estimates the value of the center by dis-
rent growth, indicating a value of $7,799,103. counting back the estimated future cash flows at a
Therefore, under these general assumptions, the discount rate of 11.0%. The property is assumed to
current value of the shopping center is reduced bysell at the end of the tenth year at a 9.0% cap rate
25%. on year II's net operating income.
Case 1: Traditional underwriting assumptions.
Are these projections and calculations on the effect Rental Rate: $10.00 per sq. ft. increasing
of online shopping a real threat to the retail real at 3.0% annually.
estate industry? In observing what has already Vacancy Rate: 7% of gross potential
happened to the stock brokerage, travel and bank- revenue.

ing industries due to Internet communications, the Case 2: Potential underwriting assum
answer is yes, and it is only a matter of time. The effect of online shopping.
primary holdback to online shopping today is con- Rental Rate: $10.00 per sq. ft. re
sumers' fears about transmitting credit card infor- flat throughout the term due
mation between computer terminals. Industry par- rental increases and/or percenta
ticipants are attempting to reduce these fears by due to growth of e-commerce.
emphasizing the safety of online transfers in com- Vacancy Rate: 15% of gross pote
parison to the accepted method of verbally furnish- enue. Vacancies increase due to a theo-
ing credit card information over the telephone. It retical 8% loss of tenants due to e-
is assumed that new technology and security de- commerce, travel agencies, bookstores,
music stores, etc.

Journal of Real Estate Portfolio Management 1 99

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John S. Baen

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 The Effects of Technology

Martinez, B., Will the Internet Kill All the Shopping Centers,
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Journal of Real Estate Portfolio Management 20 1

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