Contrary to popular opinion, not all shopping centers and retail stores are headed to the graveyard. Although some such retailers are already dead or heading in that direction, our chart of the week shows that while the absolute number of net store openings has dropped, they are still positive and expected to outpace store closings. Additionally, the overall composition of retailers has changed over the years. Today, store openings are less flashy than they used to be and companies are more cautious in their plans for growth. We are seeing strength in the retail space from discounters such as TJ-Maxx; “fast-fashion” retailers like Zara and H&M; beauty brands such as Ulta and Sephora; and fitness companies like Soulcycle and Orange Theory Fitness.

So what does all this mean for real estate investments? The majority of retail exposure for real estate funds in the NCREIF-ODCE index is typically in community and regional centers with heavy foot traffic. This includes grocery-anchor malls and areas where store openings remain positive with minimal exposure to the large mall anchor stores that dominate the headlines. These investments should flourish in today’s market, as real estate investment managers anticipate future shopping patterns of the ever changing consumer.

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The retail sector has been under fire lately as a result of ecommerce trends leading to a large number of retailers filing for bankruptcy or closing stores across the nation. Brick-and-mortar sales are constrained by internet retail, which has increased because of shifting age demographics. Consumers — particularly the millennial generation — increasingly spend their money on experiences rather than goods. Experiential spending — perhaps in an attempt to take the perfect selfie and garner enough likes on social media — is experiencing significant growth.

But it’s not all doom and gloom for the retail sector. While the lower quality B/C malls are struggling to survive in this shifting marketplace (illustrated by vacancy rates in this week’s chart), A-Malls and lifestyle centers are still thriving. In fact, the retail sector represented in the NCREIF Property Index (NPI) was the second best performing sector in the first quarter of 2017 (+1.6%) and also posted a strong 1-year return of 7.6%. Real estate managers that are focused on the A-Malls and lifestyle centers should be well positioned as the trends within e-commerce and experiential spending continue to drive change within the retail sector. The higher quality retailers and locations with easy access in densely populated areas are less easily replaced by online shopping.

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Core real estate investments have flourished since the financial crisis. The NCREIF Property Index (NPI), since returning six consecutive double-digit annual returns through 2015, delivered an 8% total return in 2016. Despite lower projected absolute returns compared to what we have experienced over the last six years, real estate remains an attractive investment relative to other asset classes.

This week’s chart illustrates the historical 1-year trailing total returns of the NCREIF Property Index (NPI) going back to 1979 broken down by the three main components of total return: dividend yield, cap rate shift (also known as cap rate compression / expansion), and net operating income (NOI) growth. As seen in the chart, the slowdown in total returns since last peaking in the third quarter of 2015 has been dominated by the cap rate shift effect as cap rates level off at their current historically low levels. NOI growth, on the other hand, has been relatively stable since the slowdown and will be a critical component of future real estate returns going forward as overall fundamentals for the asset class remain strong. Despite lower projected absolute returns, real estate is still an attractive investment relative to other asset classes and should deliver positive returns to investors again in 2017.

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The S&P Dow Jones Indices and MSCI Inc. announced the creation of a new real estate sector, formerly included in the financial sector, within the GICS system which became effective August 31, 2016. The new real estate sector marks the 11th GICS sector and the first time a new sector has been added to the GICS classification since its inception in 1999. The creation of a separate real estate sector recognizes the growth in both size and complexity of the asset class. Real estate, which began as two sub-sectors, has grown over time to now contain a total of 13 sub-sectors.

These sub-sectors are an area of differentiation when it comes to public REITs vs. private real estate investments.¹ Private real estate investments typically fall into one of four main sub-sectors: industrial, retail, office, and multifamily. REITs, on the other hand, often carry significant exposures to “alternative” real estate which includes sub-sectors such as self-storage, hotel, and healthcare. Additionally, the risk and return profiles of the same sub-sectors between public (REITs) and private real estate can vary significantly — particularly from a risk perspective, as measured by standard deviation. The chart above not only shows the annual returns of each REIT sector — note the dispersion of returns between sectors each year as well as the annual volatility of each sub-sector — but the level of standard deviation over the nine years of sub-sector returns in the table. Critically, the private real estate risk (industrial: 6.3%; retail: 5.1%; office: 6.8%; multifamily: 6.6%) is materially lower than the equivalent sub-sectors from REITs (respectively: 44%, 31%, 28%, and 26% (residential)). So while both public and private real estate investments may appear to invest in similar assets, their respective risk profiles can vary significantly.

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¹Private real estate is measured by the NCREIF Property Index (“NPI”), a composite of real estate investment performance from a very large pool of individual commercial real estate properties acquired in the private market for investment purposes only.