Experiential Real Estate Passed The Ultimate Test

Consumer facing real estate has been on a roller coaster over the last decade.  

Throughout the 2010’s, the threat of eCommerce taking market share from brick and mortar stores was a constant headwind for retail properties.  

According to CNBC, February 2019 was the first month ever that online sales surpassed general merchandise sales from physical stores.  

Because of this, a growing theme amongst real estate investors in the 2015-2019 period was “experiential retail”.  

In this article, I’ll explain the unique strengths and weaknesses of this under appreciated asset class. Odds are you’ve spent a good amount of your own hard-earned money at experiential real estate without even knowing it.

As the “Amazon effect” took hold, companies focused on traditional retail such as shopping malls, open air outlet centers, convenience stores, gas stations, dollar stores, and drug stores were seeing their valuations fall.

On the other hand, those focused on providing the consumer with a unique experience, such as treasure hunting shopping (e.g. discounters like TJ Maxx), movie theaters, restaurants, fitness centers, and family activity centers, like Top Golf were experiencing an influx of investor interest.

This created an interesting phenomenon among real estate investors. Experiential assets were becoming viewed as a hedge against the rising eCommerce threat. They provided a growth avenue for real estate owners whose tenants were losing market share to big-tech behemoths like Amazon (AMZN).  

Let’s be honest, do you want to compete against Jeff Bezos? I certainly don’t.  

Experiential assets provided the real estate sector with a breath of fresh air. For the first time, publicly traded Real Estate Investment Trusts (REITs) specializing in this area garnered real attention from retail and institutional investors alike.

A (COVID-19) Shot Across the Bow

But you know where this story is headed. Change is the only constant, and 2020 reminded us of that lesson.  

The COVID-19 pandemic and associated government policies shut down commerce in unprecedented ways.  

In 2019, words like “theater” or “recreational retail” were must-haves in quarterly conference calls among real estate companies. By mid-2020, those same companies were scrambling to divest from these once darling assets.

Experiential retail was shuttered due to social distancing regulations and its landlords were put in a tough spot. Their tenants were no longer legally permitted to generate cash flows.  

Poor cash flows resulted in record rent delinquencies, hurting the bottom lines of the REITs, private funds, and individuals that owned those assets.  

2020 (and 2021 in some areas) were brutal years for landlords that had been riding the experiential growth trend.

We’ll use the most well-known publicly traded experiential REIT as an example. EPR Properties (EPR) is a pure play in the experiential REIT space who’s entire $6.8 billion portfolio is dedicated towards theaters, eat & play businesses, skiing, theme parks, cultural learning centers, fitness and wellness centers, casinos, resorts, and private schools.

EPR’s adjusted funds-from-operations (AFFO), the best metric to measure real estate companies’ cash flow, fell by -65% in 2020.

For comparison, Realty Income (O), a large-cap REIT with a portfolio centered around retail that was deemed essential (things like grocery stores and drug stores), saw its AFFO rise by 2% during 2020.

You can guess how EPR’s stock price faired, and you’d be right. But those dark days didn’t last long. The government might have forced doors closed, but it didn’t kill consumer demand. And that’s what drives business, and therefore investor returns, long-term.

In what was termed “revenge spending”, Americans flooded back into experiential properties as lockdowns were lifted.

You can guess how EPR’s stock price faired, and you’d be right. But those dark days didn’t last long. The government might have forced doors closed, but it didn’t kill consumer demand. And that’s what drives business, and therefore investor returns, long-term.

In what was termed “revenge spending”, Americans flooded back into experiential properties as lockdowns were lifted.

EPR’s bottom-line bounced back by 72% in 2021 and then posted another 50% growth in 2022.

The combination of direct government funding to citizens and the lack of spending opportunities during lockdown periods led to what a 2023 Bloomberg report called “windfall” savings for US consumers.  

Yet, the report notes, inflation has eroded those savings for roughly 40% of Americans in recent years, meaning that the strength of the US job market will determine discretionary spending moving forward for a large swath of consumers.

Another recent report by the Federal Reserve Bank of Boston concluded that roughly 25% of pandemic-related savings had been depleted by the end of 2022, signaling a potential slowdown of discretionary spending.

But, even after a couple of very strong growth years post-pandemic, EPS’s AFFO is still not back up to its pre-pandemic levels.

In 2018, EPR posted an all-time high annual AFFO per share of $6.17.  

In 2023, that figure came in at $5.22 per share. Higher borrowing costs due to higher interest rates didn’t help, but the fact is it took a long time to recover from such a blow to its business.  

Yet, in recent weeks, we’ve seen financial results which point towards the fact that while the “revenge” spending may be over, consumer demand for meaningful experiences remains high.  

That may be good news for those own on experiential retail…it signals more growth prospects ahead.  

We’ll always do our best to give you both sides of the story, so let’s start with a recent bearish report.

On April 30th, Starbucks reported its second quarter earnings which showed that global same-store sales had fallen by 4% and that the overall transaction count was down by 6% on a y/y basis.

While far from a disaster, less people were stopping by Starbucks for their caffeine fix.  

That report has caused SBUX shares to fall by roughly 17.5%. But other data indicate that the consumer isn’t dead just yet.

Booking Holdings (BKNG), a pure-play travel company, reported its Q1 result on May 3, 2024, which showed a 9% year-over-year increase in room night bookings.  

Booking’s sales were up by 17% and its operating income rose by 76%.

Those results caused BKNG shares to rally. Consumers might have shifting preferences in today’s inflationary environment, they’re still dropping a lot of money on travel.

Don’t Fight The 800 Pound Gorilla

Amazon continues to post record quarterly retail sales results. In recent years we’ve seen the rise of other competitors in the eCommerce space, such as Alibaba, Shopify, and even companies like Carvana, which are attempting to revolutionize specific niches within the retail sales space.

Furthermore, traditional retailers, such as Walmart, Target, Costco, and Kroger have embraced the digital economy, becoming global leaders in the eCommerce sales race.  

There’s no doubt that competition is rising in the retail space.  Because of this, landlords are looking for tenants that offer alternative sources of growth.  

Once again, experiential retail plays are looking like a potentially attractive hedge for property owners.  

The market seems to agree. EPR shares have outperformed Realty Income shares by double digits during the past year.  

The major players in experiential real estate withstood the pandemic and years of restrictions in some states. It wasn’t easy, but they survived. If the old adage “what doesn’t kill you, makes you stronger” is correct, this asset class is here to stay.

Nothing in this blog is or should be construed as investment advice or an offer or solicitation of offers of investments. Both Real Estate Investments and Securities offerings are speculative and involve substantial risks. Risks include but are not limited to illiquidity, lack of diversification, complete loss of capital, default risk, and capital call risk. Investments may not achieve their objectives. Investors who cannot afford to lose their entire investment should not invest in such offerings. Consult with your legal and investment professionals prior to making any investment decisions. All Securities are offered through North Capital Private Securities, Member FINRA/SIPC.

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