The era of easy, few-strings-attached financing in the years leading up to the pandemic is officially over, retail professionals say, pushing some brands that had relied on venture capital to rethink plans for brick-and-mortar expansions.

The combination of rising interest rates, a wobbly economy and a record pullback in venture-based funding has hit the retail industry with a powerful punch as companies have had to abandon the growth-at-any-cost strategy. The strategy that helped buoy retail landlords' tenant rosters leading into and through the early years of the pandemic was a topic of conversation in Las Vegas at the annual ICSC trade group conference this week.

Some investors have become increasingly focused on profitability growth. That has meant the pipeline of tenants some retail landlords had come to depend on is showing signs of drying up, analysts such as Neil Saunders say, a shift that is weeding out brands for which a physical storefront didn't make much sense to begin with.

"One of the problems is that a lot of the younger, often direct-to-consumer brands were not profitable then and still aren't profitable today," Saunders, a managing director and retail analyst at GlobalData, told CoStar News. "So even though they have opened a lot more stores, they're still reporting fewer sales. Any investor in a company, or anyone lending money to a company, will look at those numbers and just shake their heads."

It's a reversal from the venture capital boom years in which some firms invested hundreds of millions of dollars in a company with the hope of landing on a unicorn, or a startup that can quickly land a valuation of more than $1 billion, real estate executives say.

Alongside investments in companies such as Airbnb, Instacart and Robinhood, among others, venture capital-funded retail brands including Allbirds, Casper, Warby Parker and Outdoor Voices landed large financing rounds and opened dozens of stores in an effort to establish their dominance ahead of any competitors.

Fashion subscription startup Rent the Runway opened a handful of multilevel hubs in cities such as San Francisco and Chicago. Online consignment platform RealReal debuted large flagships in expensive retail markets such as New York before pivoting to smaller outposts in affluent suburbs such as Palo Alto, California.

"Before the period of higher interest rates, it was an easy money era," Saunders said. "Investors were looking at where to throw money and just assumed the payback would come. Money is now expensive and [those investors] are looking at the profitability and now turning down investments because they don't see a pathway to getting a return from them."

Within a decade, venture capital funding exploded, from $60 billion in 2012 to an astonishing $643 billion in 2021, according to data from industry tracker Crunchbase. About 30% of that funding was funneled into retail brands that fall along the intersection of e-commerce and consumer products.

Global venture capital funding rose annually by more than 110% in 2021 alone, according to data from analytics firm CB Insights, but came crashing down the following year when that figure dropped roughly 35% to $415.1 billion. The number of retail venture capital deals across the United States fell nearly 30% within that period, according to data from Pitchbook, and has continued to fall as interest rates remain elevated and many venture capital firms prioritize investments in areas such as artificial intelligence.

About $5 billion in venture capital funding was funneled into the retail sector in 2021, according to Crunchbase. By last year, that funding pipeline shriveled to roughly $130 million.

"The impact of interest rates is monstrously huge here," said Garrick Brown, vice president of real estate intelligence and business development at Gallelli Real Estate. "A lot of retail brands were fueled because money was cheap. A lot of venture capital-funded brands had a lot of buzz around opening as many as 50 stores a year, but the problem was investors all freaked out when things started to normalize post 2020. The boom a lot of retailers experienced then was unrealistic, so they're all now overcorrecting."

In other words, some retailers are now taking a microscopic look at the value of their real estate portfolios, tossing out any underperforming locations or getting rid of their physical presence altogether.

"Money isn't cheap anymore," Brown said. "Even though retail is in the best spot it has been in the past 20 years, brands are going to have to be a lot more careful in deciding how and where to open their stores."

Millennial activewear brand Outdoor Voices raised roughly $70 million since its founding more than a decade ago and has become a poster child for the brick-and-mortar pivot after it closed storefronts this year.

The direct-to-consumer retailer shut more than 15 of its locations across the country in a move to online-only operations, a stark reversal after pulling in big-name firms such as General Catalyst, Forerunner Ventures, Collaborative Fund and 14W that all invested to fuel its storefront growth.

Outdoor Voices, which was valued as high as $110 million in 2018, is part of a wave of once-high-flying brands that are now struggling with the tricky economics of physical retail and the decline in funding that had previously supported it.

"Venture capital had a bad year in 2022 and there has been a lot of pulling back since then," MJB Consulting President Michael Berne told CoStar News. "As it relates to retail, it’s not so much that they have deserted the space, it’s just that they are demanding more."

Footwear company Allbirds is expecting sales to slump by as much as 25% through the remainder of the year, even after it replaced its CEO and unveiled plans to close roughly a third of its national retail footprint at the beginning of 2023. The company reported a 30% drop in revenue to $39 million for the first quarter, a sign that additional closings could be on the table as it scrambles to cut back expenses and reverse an expansion plan that grew its store count to nearly 60 locations by the end of 2022.

The retailer had raised more than $200 million before its initial public offering in 2021, right before interest rates began their upward climb and investors — both venture capital firms and shareholders — started adding more pressure to companies that struggled to turn a profit.

Peloton, the exercise equipment and media company that catapulted to record amounts of business in the early years of the pandemic, has since shed a majority of a real estate portfolio that once held prime spots in malls across the U.S.

Clothing brand Everlane has pulled back on its store expansion plans and issued a round of job cuts at the beginning of the year.

Mattress companies Purple and Casper, both of which ramped up their store opening plans in the years leading up to the pandemic, are now reversing course, with Purple CEO Rob DeMartini telling analysts earlier this year that stores were the “toughest part” of the brand model. The company, which has about 60 physical locations, is halting future openings until its existing footprint becomes profitable.

“They’re great brand beacons, but they’ve got to make some money," DeMartini said.

The pullback in venture capital funding is expected to have long-term effects on how retailers evaluate their brick-and-mortar investments, analysts say.

Even so, the historically low retail vacancy rate, fewer store closings and bankruptcies, and ongoing demand for space have all meant the market probably won't have any problems filling spaces left behind by brands fueled throughout the venture capital boom, Saunders said.

What's more, there are also plenty of success stories with tenants such as Warby Parker that continue to roll out new openings and have figured out how to leverage its brick-and-mortar fleet to sustain profitable growth.

"A lot of brands got carried away by their success when everyone went online at the start of the pandemic, and while they may have been great brands and had the money to open stores, just because people liked them doesn't mean they needed a physical location," Saunders said. "Now they're all looking at what the math looks like, what the trajectory of the brand is and what the purpose is for all of their stores. It's not everyone, and there are some that are moving quite quickly to profitability."

The demand for retail space jumped by nearly 42 million square feet over the past year and by more than 200 million square feet since the start of 2021, according to CoStar data. Tenant move-outs have dropped by nearly 20% over the past three years, and competition for space is increasing as fewer availabilities hit the market.

All of that has meant the lineup of tenants that operate physical storefronts is far healthier now, Berne said, and retailers' balance sheets are much more stable.

"When money was cheap, things got really sloppy," he said. "You would have thought proof of profitability was a starting point, but there were a lot of businesses where the model was destined to fail. There are still plenty of brands expanding their physical footprint at a rapid pace, and if anything, going forward retailers will be more cognizant about how they're balancing their digital and brick-and-mortar growth."

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