Retail's Comeback Is Here
Lee & Associates’ first-quarter retail report highlights the commercial retail real estate sector's struggles and how its recovery is now well underway.Better Financing Starts with More Options$1.2M offered by a Bank at 6.0%$2M offered by an Agency at 5.6%$1M offered by a Credit Union at 5.1%Click Here to Get Quotes
Image by Viktor Bystrov from Unsplash.
Apart from hospitality real estate, few other property classes have felt the pain of the pandemic as acutely as brick-and-mortar retail properties. Two years ago, consumer spending plummeted to one of its lowest-ever levels in stores, while overall spending shifted dramatically to e-commerce transactions.
This led to notable challenges not only for retailers themselves but for commercial real estate owners. The impacts weren’t limited to shopping centers and big-box retail properties, either. They also affected mixed-use assets, which broadly rely on retail rental income.
Retail Absorption Up, Vacancy Down
From early last year, on-site retail spending has begun to recover, and retail leasing activity has picked up as a result. Lee & Associates’ first-quarter report on North American commercial real estate shows net retail absorption hit 23.4 million square feet in the first quarter. That's five times the absorption compared to the same time in 2021 and bit above the average of the other three quarters last year. At the end of the first quarter, vacancy fell to 4.5%, its lowest point since the beginning of the pandemic.
Vacancies varied across the country, of course. Seattle reported the lowest amount of availability nationwide in the first quarter, at 2.6%. At the other end of the spectrum, some markets had vacancies as high as 6.6% (Inland Empire) or 6.4% (Harrisburg, Pa.), based on CoStar data.
The biggest retailer involved in leasing space was Dollar Tree, which has massively expanded in recent years. Last year, the discount retailer signed leases totaling 1.7 million square feet. Overall, store openings have exceeded store closings, shifting a trend prevalent since 2014.
It isn’t just leasing activity taking retail space off the market, though. Following major bankruptcy announcements from retailers like JC Penney, Sears, and many others, some commercial property owners have converted retail assets to other uses. These uses include logistics centers, coworking spaces, and even multifamily properties.
Image by Tim Mossholder from Unsplash.
What’s in Store for the Retail Sector?
In looking at the retail sector as a whole, it’s important to look at how each type of asset is performing. A major shopping mall behaves very differently than a neighborhood retail center, after all. And neighborhood shopping centers appear to have had the largest success. They accounted for 9.3 million square feet of absorption in the first quarter alone. Discount stores like the aforementioned Dollar Tree made up the largest chunk of absorption alongside significant activity in grocery stores, fitness centers, and discount apparel centers. Burlington Coat Factory, for example, leased 1.4 million square feet this past quarter, second only to Dollar Tree.
That said, all five asset types covered in Lee & Associates’ report showed notable gains in leasing activity. These types, themselves, are not uniform, however. Consider shopping malls. While mall leasing activity picked up — leading to net absorption of 2.7 million square feet after four years of losses — it’s the Class A malls that are seeing gains. Older, suburban shopping malls continue to struggle as they had prior to the pandemic.
What are the key trends in retail real estate?
The key trends in retail real estate are shifting consumer preferences, increased foot traffic, and the conversion of retail assets to other uses.
Consumer preferences have been shifting towards in-person shopping experiences after being restricted to their homes for the past couple of years. This has led to an increase in foot traffic at most store types, reaching or even surpassing pre-pandemic levels.
Additionally, some commercial property owners have converted retail assets to other uses, such as logistics centers, coworking spaces, and even multifamily properties.
What strategies can retailers use to maximize their success in the current market?
Retailers can maximize their success in the current market by staying up to date on consumer preferences and trends, offering flexible leasing options, and investing in building technology. Additionally, retailers should assess their amenities compared to their competitors and maintain their property to ensure it stands out from the crowd.
According to Marcus & Millichap, core retail sales have increased by around 19% compared to pre-pandemic times, thanks to high job growth and easing gas prices across the country. With shifting consumer preferences, foot traffic has also increased at most store types reaching or even surpassing pre-pandemic levels.
Retailers should also consider investing in building technology to improve customer experience and increase efficiency. For example, retailers can use digital signage, interactive kiosks, and mobile apps to provide customers with a more personalized shopping experience.
What are the benefits of investing in retail real estate?
Investing in retail real estate can provide a number of benefits, including potential tax advantages, increased cash flow, and appreciation of the property's value over time. Tax advantages can include deductions for mortgage interest, property taxes, and depreciation. Additionally, retail real estate can provide a steady stream of income from rental payments, as well as potential appreciation of the property's value over time. Finally, retail real estate can provide a hedge against inflation, as the value of the property is likely to increase with inflation.
What are the challenges of investing in retail real estate?
Investing in retail real estate can be a challenge due to the uncertainty of consumer preferences and the potential for a looming recession. According to Marcus & Millichap, core retail sales increased by around 19% compared to pre-pandemic times, thanks to high job growth and easing gas prices across the country. However, the recent spike in oil prices following the Russian invasion of Ukraine may undo some of these gains. Additionally, fears of a looming recession could slow down consumer spending again in the near future. Therefore, retail investors must remain cautious until the uncertainty dissipates.
What are the best practices for leasing retail space?
The best practices for leasing retail space depend on the type of tenant you are looking for. Generally, it is important to have a clear understanding of the tenant's needs and to be flexible in terms of lease length and other terms. For example, you may want to consider offering shorter-term leases with the option to adjust the terms based on the tenant's needs. Additionally, you may want to consider offering incentives such as free rent or tenant improvement allowances to attract tenants. Finally, it is important to have a thorough understanding of the local market and to be aware of any potential risks associated with the tenant or the property.
For more information, please see 7 Tips to Keep Your Office Portfolio Recession-Proof.