Retail Real Estate Market Condition: Scarcity Offers Investment Prospects
Jared Feldman serves as the executive chair of First National Realty Partners, spearheading their high-caliber property acquisitions. current retail real estate sector is brimming with opportunities due to retailers' struggles in securing lease spaces. Landlords now hold the upper hand, swiftly filling vacated areas and boosting new rents above previous rates. This shifts the lease-negotiating power equilibrium, indicating a robust context for retail investors. With demand surpassing availability, especially in thriving sectors like grocery-anchored shopping centers, investors can capitalize on escalating rental rates, robust lease conditions, and long-lasting stability within this resilient asset class.
Our Journey
Before the Great Recession, developers constructed new retail properties at an alarming rate, resulting in a considerable oversupply. Following the 2008 financial crisis, there was a sharp decrease in new construction initiatives, but retailers also dialed back their expansion plans and shuttered some stores. Consequently, tenants could demand concessions from landlords effectively. Over the ensuing years, supply gradually diminished, but not until 2019 did market analysts admit that the U.S. no longer bore an oversupply of retail space. Since then, retail vacancies have witnessed a substantial decrease, reaching a five-year low and outperforming other commercial real estate categories.
With retail spaces consistently occupying under 5% for a few years, retail real estate now experiences record occupancy rates. Positive net absorption has been sustained for 15 consecutive quarters, while vacancies have remained around 4% throughout the year. However, the available retail spaces for both new entrants and expanding businesses often fall short of these figures.
Driving Forces
The retail real estate market's supply shortage is primarily attributable to several factors:
• Limited construction: The high costs of inflation-driven capital, labor, and supplies deter developers from investing in new retail ventures. As a result, net deliveries of retail space are approximately 40% lower than the 10-year average. This challenge has been compounded by the demolition of existing spaces to the tune of 155 million square feet over the past five years. Moreover, most new spaces are pre-leased by construction completion.
• Eagerness for convenience: As consumers seek to expedite transactions, properties with drive-through facilities have become highly sought-after. Quick-service restaurants expand their formats, banks seek more drive-through facilities, and retailers request curbside pickup support from landlords.
• Mergers and acquisitions: Large players in the retail sector, such as national banks, have acquired regional banks. These entities often opt for prime locations, prompting landlords to reposition existing spaces.
• Consumer behavior alterations: The pandemic led consumers to cook at home instead of dining out, boosting grocery sales. This boost in foot traffic encouraged people to visit grocery-anchored shopping centers, while hybrid and remote work models increased local retail footfall. Additionally, consumers' budget-conscious shopping habits shifted some market share from department stores to discount stores, favoring necessity-based retail.
Booming Demand Zones
Grocery-anchored neighborhood shopping centers in densely populated regions enjoy particularly strong demand, including from big-box retailers establishing smaller stores. CoStar data reveals that strip and power centers have high occupancy rates, while malls see declining popularity. This trend is primarily driven by retailers' preference for open-air centers with high foot traffic and locations that facilitate curbside pickup services.
High-demand retail sectors in today's market include food and beverage, discount and off-price, and experiential stores, coinciding with our firm's observation of heavy demand from big boxes, discounters, gyms, quick-service restaurants, and banks.
Overcoming Challenges in Retail Space Management
Although the retail space scarcity generates opportunities, it also poses difficulties for landlords. These challenges can be managed effectively:
• Allocating capital wisely: Prudent investors should carefully analyze tenant mix and the associated improvement costs to ensure a high-performing rental portfolio.
• Tenant lease negotiations: Landlords must strive for favorable lease terms while negotiating with tenants. Exclusive agreements can limit flexibility, so landlords must weigh the long-term implications carefully.
• Waivers needed for desired tenants: Lease contracts occasionally restrict the type of tenants permitted. Landlords should weigh the benefits of negotiating lease extensions or renouncing restrictions in other locations against the added flexibilities offered by a waiver.
Advantages For Investors
The market's tight supply and high demand create an ideal context for investors to reap the following benefits:
• Higher rental rates: Limited retail space creates a platform for landlords to significantly boost rental rates, often surpassing previous lease costs. JLL estimates that backfilling a vacated space under an expired 10-year lease agreement could result in market rents elevating by 32% of the initial lease rate.[1]
• Faster lease-up periods: Vacant spaces are quickly occupied, minimizing downtime and ensuring steady cash flow.
• Favorable lease terms: Retailers are investing heavily in tenant improvements, lowering capital expenditures for landlords. As a result, overall returns are enhanced.
As consumers are expected to continue frequenting neighborhood shopping centers and construction remains limited, retail spaces capable of catering to high demand will likely continue to command top rents. This unique market dynamic presents a compelling argument for investors to invest in grocery-anchored retail, a sector least impacted by broader environmental factors and projected to deliver consistent performance.[1]
The information offered here does not constitute financial, investment, or tax advice. Consult a licensed expert before implementing investment strategies.
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- Given his experience and leadership, Jared Feldman, as the executive chair of First National Realty Partners, has played a crucial role in securing advantageous retail properties during a time when the upper hand shifts towards landlords.
- In the past, tenants could demand concessions due to an oversupply of retail space, but now, with a significant decrease in retail vacancies and a high demand for convenience shops, investors like Jared can capitalize on outperforming rental rates, robust lease conditions, and long-term stability on account of the resilient asset class.
- As landlords face challenges in securing tenants in this tight market, Jared and his team must negotiate favorable lease terms to ensure a high-performing rental portfolio, while also considering waivers if desired tenants require specific accommodations.