REAL ESTATE

New Tenant Types Invigorate Retail Sector

BY Scott M. Holmes

The retail sector is making massive strides as companies re-engineer their selling platforms in a digitally oriented environment. As a result, multi-tenant construction is rising in conjunction with developer confidence, while total retail development remains subdued.

This year, retail completions are expected to stay on par with 2018, still at just a quarter of the last cycle’s high. Investors will continue to benefit from restrained supply growth as multi-tenant availability falls to the mid-6% range. Digital brands transitioning from online into physical locations will keep pressure on the vacancy rate. Furthermore, empty big boxes being converted to other property types like office space or industrial distribution centers will squeeze vacancy. Multi-tenant rents will realign with their pre-recession peak this year as space demand climb

As the new age of retail comes into focus, the sector continues to improve. Omnichannel customer engagement is taking hold with more online retailers discovering the need for a physical presence as it can substantially impact sales. Because of this, many digital brands are rapidly expanding their brick-and-mortar footprints, with Casper, Untuckit and Warby Parker spearheading these efforts.

Physical vendors are also adapting by establishing online shopping places, broadening their customer reach in response to evolving consumer preferences. Showroom-style layouts are the result of this shift to an omnichannel platform, giving customers the option to test a product in store and have it delivered to their homes.

Though numerous retailers have begun to transition to this approach, Best Buy has firmly embraced it, giving customers a true multi-dimensional platform. Grocery stores have found their niche by providing in-store pickup, car delivery, and home delivery options– trends that will likely increase in popularity. While the internet has historically struggled to find its place within physical retail, new omnichannel concepts are helping the two mesh, stabilizing the sector.

The changing retail landscape is benefiting from an increase in discretionary spending as the U.S. economy is showing signs of sustained momentum in 2019. A tight labor market will help preserve growth and job creation is expected to reach two million for the ninth consecutive year. This will cause wages to rise, benefiting retail sales as consumers use the extra income to make more discretionary purchases on both goods and services. Food, fashion, and entertainment brands should see strong sales gains this year, as should fitness centers and home furnishings vendors.

The consumer outlook has begun to recede from peak levels. International economies, for example, are losing steam, in part due to unresolved trade talks between the U.S. and China. The Federal Reserve is considering putting further interest rate hikes on hold as it adopts a wait and see approach to monetary policy. Considering these factors, economic expansion will moderate this year, producing GDP growth in the low- to mid-2% range. Though momentum is likely to ease, all-time highs of U.S. household wealth and disposable income are underpinning optimism in the economy.

Lenders are being more cautious and conservative than in prior years of the cycle. Active lenders include local, regional, and national banks as well as insurance companies, with sentiment driven by the high-profile decline of several big-box retailers. As a result, lending on tertiary assets and locations remains tighter, while net-leased assets and premier mixed-use structures are highly desired by lenders.

Investors have refined their investment strategies in hopes of obtaining necessary financing, and the adaptation of the retail sector into service- and experience-centric destinations has aided their process. Despite continued store closures and the erosion of product-based retail by online competition, retail center owners have repopulated storefronts with a variety of service-oriented businesses. As this transformation has gathered momentum, properties have stabilized and values have gained steam.

Retail investment strategies have begun to change, as well. In previous cycles, buyers chased rooftops to capitalize on household growth, but today investors are more aggressively following employers. Retail properties proximate to revitalized business centers provide opportunities through retenanting that caters to local workers and the addition of apartments in the vicinity.

The highly publicized challenge of dealing with big-box closures is somewhat overblown when considering the retail market as a whole. Most retailers are not candidates for large blocks of space, so demand for small footprints stays consistent when several stores shutter. Additionally, the creative use of big-box space has proved effective. Data centers, office conversion, healthcare, fulfillment centers, and even self-storage are alternatives that backfill dark space.

With the retail sector continuing to evolve, buyers are broadening their searches to bolster portfolio yields. Private investors consider smaller metros as an opportunity to acquire assets while increasing the spread between returns and the cost of capital.

The limited construction of new retail space in many secondary and tertiary markets has funneled space demand into existing properties. Investors are taking advantage of strong underlying fundamentals to expand their portfolios into assets that many consider undervalued relative to performance.

The fading idea of a retail apocalypse is beginning to show in many markets, intensifying the bidding environment as many investors now have the knowledge to create internet-resistant retail centers.

Scott M. Holmes, Senior VP and director of Marcus & Millichap’s retail division, has more than 25 years’ experience in commercial real estate investment.

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