By Steven Levine, Managing Director, Investments, Hyperion Realty Capital
Retail has been put through the ringer multiple times over the last decade, and has proven resilient. First the sector began to lag other property types in 2010 due to the global financial crisis, then by 2012 the fear of e-commerce’s impact on brick-and-mortar (the so-called “Retail Apocalypse”) continued the trend, and most recently, COVID-19 unsuccessfully took its swipe at retail. Darwin’s adapt or perish theory of evolution by natural selection of organisms is apropos to the retail sector. Retailers that have adapted and evolved with changing consumer behavior have been more resilient and more likely to succeed, while retailers that remained stagnant have been less resilient and more likely to fail. An abbreviated history of the retail sector (outlined below) is emblematic of the evolve-or-perish dichotomy.
Retail Renaissance – The U.S. is no Longer “Over Retailed”
Following the initial pandemic shock on retail real estate – resulting from mandated store closures and stay-at-home orders – the sector has continued its two-and-a-half-year winning streak through Q2 2023. Against a backdrop of recent macroeconomic uncertainty, the asset class continues to exhibit operational resilience and strength as exhibited by nine straight quarters of declining availability (vacancy plus immediately available space) across the U.S.[1] The end of the first quarter of 2023 marked the lowest availability rate in almost two decades[2] – dipping below 5% – further swinging the balance of power from tenant to landlord and providing retail landlords with leverage to increase asking rents by almost 5% nationally year-over-year.[3] Similarly, retail deliveries fell to a new quarterly low in the first quarter of 2023, with the rolling 12-months being the second lowest on record, behind only the second quarter of 2022.[4] U.S. retail real estate is benefitting from the simple forces of Economics 101 – strong demand (i.e., declining vacancy) and constrained supply (i.e., declining new supply).
Despite retail real estate fundamentals remaining strong, inflation pressures are starting to weigh on retail sales, with the CPI index hitting a high of 9.1% in June 2022[5]. Although the year-over-year comparisons in inflation are softening, the price of core necessities like food and electricity remain high. Consumers have responded to persistent inflation by shifting money away from discretionary goods purchases in favor of groceries and other key necessities. Grocers and discount-oriented retailers are currently winning a disproportionate share of consumer dollars, as real disposable income wanes.
With that said, retailers (especially discounters and grocers), continue to expand as store-based spending – that which excludes sales online and at restaurants and bars—reached an all-time high in the first quarter of 2023[6]. In 2022, retail tenants absorbed nearly 76 million square feet of space, the highest level since 2017, and nearly twice the square footage absorbed just prior to the onset of the COVID-19 pandemic in 2019.[7] Further, total retail absorption was more than twice the amount delivered in 2023, the fifth consecutive quarter in which demand outpaced supply.[8] Even in the face of an economic slowdown and a potential recession, many retailers have publicly announced lofty expansion plans for 2023. The most active expanding retailers are discounters, such as TJX Companies (150 new stores planned), Burlington (90 new stores planned), Five Below (200 new stores planned), Dollar General (1,050 new stores planned)[9], Dollar Tree (1,200 stores planned)[10], Ross Dress For Less (100 new stores planned)[11], and Ollie’s Bargain Outlet (45 new stores planned)[12].
[1] Retail Real Estate Remains Resilient, U.S. Retail Figures, CBRE, Q1 2023.
[2] Ibid (Footnote 1).
[3] MarketBeat: U.S. National Shopping Center, Cushman & Wakefield, Q1 2023.
[4] Ibid (Footnote 1).
Grocery Resilience – Retail’s Safe Haven
Within the retail real estate ecosystem, grocery-anchored shopping centers continue to perform particularly well compared to other sub-asset classes due to its resilience, stability and income growth prospects, and are arguably the most highly sought-after retail format for tenants to operate their businesses within. Small-shop retailers will pay a premium to benefit from the increased consumer activity resulting from the foot traffic generated by grocery stores, which is the highest of any retail category.[13]
Similar to off-price retailers, grocers have continued on a strategic growth path. In 2022, Aldi (49 stores, 803,600 SF), Publix (25 stores, 1,175,000 SF), H-E-B (12 stores, 1,200,000 SF), Grocery Outlet (28 stores, 700,000 SF), Sprouts (16 stores, 384,000 SF) and Whole Foods (11 stores, 418,000 SF) led the way as the fastest-growing grocers in the U.S.[14] Further, Aldi recently announced big U.S. expansion plans for 2023, with a goal of 120 new stores.[15]
Grocery sales hit an all-time high in 2022 and show no sign of slowing with a strong first quarter in 2023.[16] Following a period of outsized growth in e-commerce adoption resulting from the Covid-19 pandemic, more food shoppers are returning to the grocery store to shop having driven up foot traffic by 22% year-over-year.[17] In 2022 e-commerce adoption also returned to its pre-pandemic moderated trajectory,[18] and assuming the current pace of adoption continues going forward, it is projected that e-commerce will grow from the current 11.2% of total grocery sales to only 13.6% by 2027.[19] With almost 90% of grocery sales occurring within brick-and-mortar locations for the foreseeable future, it is clear from our perspective that e-commerce will continue to merely supplement in-person grocery shopping with programs like click-and-collect, rather than supplant it.
[5] United States Retail Outlook, JLL, Q1 2023 (Data from Bureau of Labor Statistics).
[6] Spending on Stores a Bright Spot Amid Decline in Overall Sales, Marcus & Millichap Research Services, March 2023.
[7] United States Retail Outlook, JLL, Q4 2022.
[8] Ibid (Footnote 1).
[9] Ibid (Footnote 5).
[10] Via direct discussion with Dollar Tree at ICSC Las Vegas 2023.
[11] Discount chains Ross, T.J. Maxx and Burlington are planning to add more than 300 stores, Business Insider, March 8, 2023.
[12] Pennsylvania Retailer to Expand Rapidly: Exciting Plans for 45 New Stores in 2023, Newsbreak.com, June 13, 2023
[13] Food & Beverage Tomorrow: How Grocers are Approaching 2023, CBRE, February 7, 2023.
[14] Grocery Grow Formats Big and Small, JLL, February 2023.
[15] Aldi Details Big 2023 U.S. Expansion Plans for 2023, Chain Store Age, May 2, 2023.
Capital Markets – Retail Real Estate the Next Belle of the Ball
In the face of positive macro-operational market fundamentals, retail real estate presents certain unique attributes from a capital market perspective, especially when compared to other commercial real estate asset classes. With inflation running at four-decade highs, the Fed took bold steps in 2022 through Q2 2023 to combat inflation; embarking on its most aggressive tightening policy in four decades, the Fed has pushed the Federal Funds Rate from 0.25% in March 2022 to 5.25% in May 2023.
Unlike other commercial real estate asset classes – namely industrial and multifamily – even in the wake of a high interest rate environment, retail generally still offers positive leverage at (or shortly after) acquisition. Retail real estate cap rates remain higher than industrial and multifamily, and at “current” cap rates, with two-year rent growth carried out indefinitely, CBRE projected unlevered yields of industrial properties would take 23 years to surpass retail yields, while multi-family would take 38 years, making retail relatively more enticing on a risk-adjusted basis.
[16] Advance Retail Sales: Grocery Stores, Seasonally Adjusted, U.S. Census Bureau.
[17] Q4 2022 Consumer Trends Report: Grocery Shopping Trends & Predictions, Gravy Analytics, February 23, 2023.
[18] Ibid (Footnote 5).
[19] Online Grocery Sales Will Increase at 12% Annual Rate Over 5 Years, Grocery Dive, January 31, 2023.
[20] Green Street CPPI: Sector-Level Indexes, June 6, 2023.
Further, Strip Retail property values are estimated to be down by 13% year-over-year (as of June 2023).[1] Typically, when valuations are down – especially when due to a rising interest rate environment – owners either do not want to invest capital back into their properties (as return on capital will be lower than desired) or do not have the requisite capital to do so. In an environment where liquidity is lacking – due to higher interest rates that will continue to weigh on banks’ balance sheets – refinancing options are more limited, meaning well capitalized buyers potentially have a unique opportunity to buy from distressed or undercapitalized owners.
Conclusion
A uniquely positive “perfect storm” has been created in the retail real estate ecosystem: (i) retailers are as strong as ever (and growing), (ii) a supply/demand imbalance in favor of the landlord exists, and (iii) properties have been devalued placing strain on undercapitalized and/or inexperienced owners, yet creating opportunity for well capitalized buyers to acquire properties on a favorable risk-adjusted basis. As we look in the rearview mirror and recant the Retail Apocalypse and initial pandemic distress, it is readily apparent – at least to us – that retail is not dead… bad retail is dead. Good retail is alive and thriving.
