Simon Property Group: Embracing Retail Dynamism

Simon Says Success?
Generating over $60 billion in annual sales through its 209 properties and 23,000 specialty stores, Simon Property Group (Simon) is a giant in the real estate space. Since its initial public offering in 1993, Simon has tripled in size to become the largest owner and operator of shopping centers in the U.S. Structured as a real estate investment trust (REIT), its portfolio includes traditional retail centers such as regional malls and premium outlets. Simon is known for its high-end tenants such as Louis Vuitton and Valentino and premier real estate locations in Boston, Las Vegas, and more. Despite its long history of retail success, Simon faces unprecedented new challenges as retail shifts to favour digital experiences.

The Fall of the Mall
While shifting consumer preferences for a convenient shopping experience have driven e-commerce growth, brick-and-mortar retail faces an uncertain future. Currently, Amazon dominates the online retail space, with individual retailers scurrying to catch up with their own improved online platforms. COVID-19 has exacerbated this trend by accelerating the shift to e-commerce by an estimated five years. With the rise of e-commerce, Simon and other commercial real estate companies are facing an existential threat: consumers no longer need to visit physical stores to purchase products. As a result, both foot traffic and occupancy rates are in decline. Simon’s occupancy rates had already fallen by two percent in the six years preceding 2020, and are now at risk of falling further. Beyond just Simon, 25 percent of American malls are forecasted to close in the next three to five years.

Simon’s malls are also threatened by their reliance on anchor tenants to drive foot traffic. Anchor tenants are prominent retailers that comprise malls’ largest leases. These tenants are typically situated at opposite ends of the mall and are mostly apparel-based department stores. Traditionally, these stores have been marquee attractions for shoppers, with smaller retailers capitalizing on consumers flowing between them. Given Simon’s heavy reliance on anchor stores, their impending closure could prove fatal to the REIT. Beyond losing major drivers of foot traffic, the departure of anchor tenants would likely trigger co-tenancy clauses within retail leases, which allow smaller commercial stores to bargain for substantial rent decreases or even a full dismissal of the contract. Despite these systemic issues plaguing antiquated retailers, Simon has doubled-down on the traditional retail experience, acquiring significant ownership stakes in Brooks Brothers and Lucky Brand during both companies’ Chapter 11 processes.

Pop-ups Popping Up
While anchor tenants and legacy brands are in decline, customers have been drawn to a new kind of emerging brand: direct-to-consumer (D2C) companies. Compared to legacy brands like J.C.Penney or Winners, these e-commerce players focus on maximizing control of their entire value chain, and often manufacture, market, and distribute their own products. These brands, which include Glossier, Dollar Shave Club and Casper, have been on an explosive trajectory and are forecasted to grow 24 percent on average in 2020 alone. Their specialized focus on a narrow range of products appeals to consumers’ desire for authentic brands that emphasize quality. Generation Z consumers in particular favour D2C brands: 50 percent of this younger demographic consider them more authentic than their legacy counterparts. Since D2C brands control the entire value chain, consumers can trust that products will be of higher quality. Further, the benefits of an integrated value chain extend to product pricing, with D2C brands passing along cost savings from the elimination of middlemen to consumers.

Despite the rise of e-commerce, online retail still does not fully replicate all the elements of in-person shopping that consumers enjoy. Among Generation Z consumers, 81 percent still prefer to shop in stores rather than online, with 73 percent stating that they like the experience of discovering new products in stores. To appeal to consumers, the most successful D2C brands have capitalized on the unique qualities of in-person shopping—interactivity, personalization, and most importantly trust in the product—to augment their online presence. The result has been a rise in pop-up stores, a new alternative to permanent physical locations. Unlike permanent retail locations, temporary pop-up stores last anywhere from a few days to several months. Their temporary nature enables brands to draw in new consumers by creating a sense of exclusivity.

The most successful pop-ups have not eschewed technology; rather, they have found new ways to integrate it into the retail experience. Given as many as 76 percent of Millennials have placed an order online while in-store, physical and online retail are no longer separate silos, but an integrated experience. Customers use technology most frequently to price-check, obtain additional information, and peruse customer reviews when shopping in person. This process of viewing products in-store and then purchasing these same items online is referred to as showrooming. Capitalizing on this trend, dedicated retail showrooms stock no inventory for sale, and instead offer a compelling experience for consumers to interact with merchandise prior to making a purchase online. Pop-ups are no strangers to showrooming, with mattress startup Casper running a pop-up showroom to offer napping sessions in one example. In another example, the meal-box brand Blue Apron created a pop-up offering grab-to-go meals and cooking classes. Ultimately, not only have online retailers that adopted showrooming and pop-ups benefited from the absence of overhead expenses, they also see a financial benefit: pop-ups generate 3x more revenue per square foot than traditional retail stores.

Simon’s Solution: A Cutting-Edge Flea Market
With the decline of the traditional mall, Simon must decrease its reliance on anchor tenants and find new ways to drive foot traffic. In contrast to the current rental revenue model where leases span several years, Simon should offer shorter-term rental agreements that suit the needs of D2C brands. The REIT should reimagine malls as a hub for constantly changing storefronts where e-commerce companies can host pop-ups and provide the in-person experience that consumers seek. This new strategy capitalizes on the increasing popularity of both showrooming and pop-up stores to combat falling foot traffic in malls. Furthermore, it creates an incentive for consumers to visit malls more regularly to discover new brands and build ongoing, personalized relationships with their favourite D2C retailers. At the end of the day, partnering with e-commerce brands can reduce Simon’s reliance on anchor tenants while providing emerging D2C e-commerce brands with a physical outlet without the hassle of operating permanent retail locations.

Simon should capitalize on the timed exclusivity of temporary pop-ups by offering three-to-six month lease options to D2C brands. While the shorter terms of these leases sacrifice the security offered by multi-year tenancy contracts, prioritizing temporary leases enables Simon to charge higher rental fees to tenants. Subsequently, Simon also can reduce its exposure to antiquated retailers facing impending closures. When implementing this strategy, Simon can subdivide its existing large-scale blocks leased to big-box retailers into several smaller units that can each be rented at a premium, further improving economics and diversifying risk.

Given the experiential nature of pop-up showrooms, D2C retailers would be responsible for designing, developing, and managing the shopping environment throughout the duration of their tenancy. E-commerce brands would be able to benefit directly from the interactivity afforded by physical retail while leveraging the strengths of the online retail model. The interactive elements of each showroom would be augmented by a kiosk to process product purchases, and retailers would be incentivized to use QR codes to facilitate online transactions smoothly.

Connecting E-Commerce Brands and Simon
One challenge posed by the short-term nature of Simon’s pop-up tenancies is the need to persistently recruit a variety of e-commerce brands to replace outgoing tenants. Fortunately, Simon can mitigate this issue on two fronts: first, by capitalizing its diverse geographic presence; and second, by partnering with a firm specializing in the management of landlord-tenant relations for prospective pop-up developers.

For one, Simon can build long-term partnerships with e-commerce brands by offering them an opportunity to cycle between properties when hosting pop-ups. This transition strategy enables brands to reuse existing assets to effectively target customers across multiple locations. Thus, the breadth, diversity and quality of Simon’s portfolio would enable e-commerce brands to maintain the exclusivity associated with temporary retail while building a long-term relationship with a single landlord.

Moreover, given the challenge of recruiting new e-commerce brands, Simon can leverage its existing partnership with Appear Here, a U.K.-based online marketplace for entrepreneurs and niche retailers looking for short-term rental units. Launched in 2012, Appear Here has partnered with over 200,000 brands and entrepreneurs, including Nike and Kanye West, though it primarily works with small independent businesses. Thus, the firm provides an opportunistic connection to a global portfolio of D2C brands that would benefit significantly from the premium real estate Simon has to offer. Furthermore, the collaboration would build upon an existing relationship that began with the two companies’ co-development of ‘The Edit’ in 2017, a curated and evolving selection of independent brands in Long Island’s Roosevelt Field Mall. Given Appear Here’s expertise on trending D2C brands, it is a prime candidate to mediate Simon’s relationship with these retailers for long-term partnerships.

When introducing this new offering, Simon should start with malls that have already lost their anchor tenants. One example is the Smith Haven Mall in Lake Grove, New York, which currently only has two anchor tenants out of four available locations. The departures of JCPenney and Sears in 2019 and 2020 respectively have left the mall in need of new ways to drive foot traffic. To tackle this gap, a potential pop-up partner could be Glossier, a D2C makeup brand that strives to create “beauty products inspired by real life”. Glossier has seen previous success with the pop-up model, with locations in London, Paris, Toronto and across the US. In New York, its showroom achieved $5,300 in sales per square foot, far higher than normal retail, and more generally, the brand’s retail sales have seen conversion rates as high as 50 percent for sustained periods of time.

Saving Simon Property Group
With declining foot traffic and floundering anchor stores, traditional malls and their retail tenants face a difficult path to sustaining their success. In contrast to legacy brands, D2C e-commerce companies have risen to the top, sustaining impressive growth in recent years. These brands have embraced new strategies such as pop-up shops and a showroom-oriented retail experience. In light of these changes, Simon should target D2C brands with short-term leases to host pop-ups within prime Simon mall locations. Not only will this strategy help Simon by establishing a new revenue stream in malls, but having limited-time pop-ups can help draw out new customers to increase foot traffic. With its commercial shopping centers ready and available, Simon Property is well-positioned to revitalize the in-person shopping experience and emerge from the COVID-19 pandemic as a stronger retail competitor than ever before.