Retail - The Tortoise and the Hare

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Retail is improving fast or very slow, depending on where you look. Investment sales are hot, but there are still many properties that should be razed. Some retail centers are struggling for tenants and others are getting rents above prerecession levels. 

To get a better picture of the retail sector and what to expect this year, we discussed the sector on a recent episode of the Commercial Real Estate Show™.

Volatile but Improving

It’s always interesting to discuss real estate with Ryan Severino, the Senior Economist at Reis. While retail’s fundamentals improved in 2014, the sector was a mixed bag depending on subtype. Overall, retail vacancy declined throughout the year by about 20 basis points. 

“Asking rents grew 1.8%,” said Severino. “That’s just on par with inflation, but it’s the best we’ve seen since 2007, so while it’s not the pace we’d like, things are getting better.” For regional malls overall vacancy increased by 10 BPs, mostly due to Sears store closures. But, malls have lost some momentum in recent years.

It’s a tale of the ‘haves’ and the ‘have-nots,’ says Severino. Grocery-anchored neighborhood centers, urban infill, high-end class A malls and lifestyle centers are thriving, especially in coastal markets.

Non-anchored centers continue to struggle as do class B or lower caliber malls. These centers are still searching for demand, despite 5 years of recovery.

“One bright spot for this sector is the massive decline in energy costs.  It’s like a huge tax abatement for 100 million households, boosting consumer confidence.”

Severino estimated that for every $0.10 of sustained decline in the price of gasoline $13 billion of consumer spending is generated. This could translate into as much as $200 billion, a huge boost for retail. Plus the effect has a time lag; it’s materializing and will continue play out for at least six months after the drop in prices.

A lack of new construction has helped boost retail real estate fundamentals and therefore property values, just due to scarcity, and there is still not much construction on the horizon. In 2013 and 2014 we delivered about 7.0 million square feet, mostly neighborhood and community centers. No new traditional malls have been built from the ground up since 2006.

The Crystal Ball

For neighborhood & community centers, vacancy is expected to fall another .05% or about 40-50 BPs, a slight acceleration from recent performance. We expect asking rents to grow 2.5%, in excess of inflation for the first time since the recession.

Since vacancy has bottomed out in class A malls, any improvement in mall numbers must come from the lower caliber centers, which are suffering chain store closures like JC Penney, Sears and others. Thus any vacancy improvement is iffy, and rent growth will be mild. The class A malls may see rent growth since tight vacancy gives those landlords leeway.

Weak Wage Growth

Weak wage growth is one important factor, trending just under rate of inflation. It’s reining in the discretionary spending, holding retail back.  Any recent growth in wealth has accrued to a very small percentage of households, yet the majority of households in this economy are just treading water.

This is very much reflected in the state of retail malls: the class A dominant malls are scorching hot while the lower caliber malls are struggling to stay afloat.

Most economists expect wages to accelerate, given the better numbers from labor market. Better caliber of jobs are increasing, and we hope to see the results in wage growth, because that’s the kind of spending that really moves the needle on retail spending.

Sales Volume

Retail investment sales volume for 2014 will hit a post-recession high, somewhere between $25-35 billion, the highest since 2007, when retail was the darling of commercial real estate investors. Sales volume is trending up over time.

Cap rates in 2014 trended downward for all major subsectors. Consumer spending and recovery in the labor market is supporting interest in retail recovering.

Yet it’s a multispeed recovery: pockets of the market are performing better than others. You’ll find the best performance at the two extremes of the market while the middle isn’t seeing much discretionary spending.

Sample cap rates

Overall, cap rates are trending down, 7.5% 20-30 basis points to either side for neighborhood and community centers. Malls are split between the high-end centers in the 5.0%s or lower. There are very few of these malls, and they rarely come up for sale. Lower-criteria malls are trading in the high single to low double-digit.

This year we’re not expecting much compression, but cap rates will trend slightly downward, about 10-20 basis points, depending on which mall centers come up to trade, overall moderately declining cap rates. There is so little new supply coming online this year that construction won’t have a significant impact on the market.

There are a few aggressive entrepreneurs willing to go into markets with high vacancies and rebuild. By building something new they change the dynamic and draw new businesses. This risky strategy can work if the local economy supports it.

So it’s a mixed bag: while some retailers are even opening new stores while others are weighing which locations to close.

Tips for Investors

“Be wary of the siren song of a seductively high cap rate,” says Severino.  “Make sure you understand whether it’s a cyclical, temporary or a permanent impairment in the center.  There is always a reason why cap rates are high. You can find opportunity in these value-add centers, but you need to do your homework.”

The Consensus

I spoke to James Cook, National Director of Analytics for Xceligent to hear what brokers around the country are saying about retail real estate.

“We surveyed our board of retail brokers and asked them how the market is faring. About 43% felt the market is ‘moving at a good pace,’ 43% said ‘market will remain about the same.’ More than 53% said ‘vacancy rates will decline in the next 6 months.’”

Some national tenants are expanding. Wal-Mart’s same-store sales comps have been negative or flat for many quarters, explained Cook, the Supercenter concept is now saturated, so Walmart needs a new concept.

Meanwhile, neighborhood supermarket sales grew 5.5% last quarter. So Walmart has developed two new store types, the traditional Neighborhood market at about 43k sq. ft., and Wal-Mart Express, a large convenience store size unit. They’re opening out about 100 Traditional, and 70 Express shops. It’s a fascinating strategy for the big retailer, developing multiple models to fit the community, and the industry is watching.

Online sales as a percentage of all retail have been growing steadily every quarter. The smart ‘bricks and sticks’ retailers know they must embrace online sales in order to survive.  Growth in online is causing higher vacancy short-term, but in the long-term physical retail is more essential than ever.  Online retailers like Warby Parker and Amazon are moving into physical locations as they discover how it can grow their business.

What’s New in Development

For the developer’s perspective, Lori Kilberg, Partner at Hartman, Simons dropped by Studio One. Kilberg, the 2015 president of CREW Network, brings a unique attorney’s outlook on the evolution of retail.

“The retail development that’s happening now is unlike what we’ve seen in the past.  The primary forms of retail development are mixed-use projects and the outlet mall.

Outlet malls

No fortress malls are breaking ground, but the outlet mall is here to take their place. Middle and lower-income shoppers haven’t had a new concept in some time, yet they represent a huge market. Now those shoppers are beginning to feel some recovery.

These centers are filled with national credit tenants, making them readily financeable. An outlet mall is mostly apparel tenants, with the focus is on a fun tenant mix.  Exclusives are no longer relevant; in fact, co-tenancy is huge and tenants lease in packs. The managers’ new challenge is to create a unique profile for a center as a fresh retail experience, and to do that, they need that tenant mix.

Lease agreements have stipulations unique to the outlet center: such as kick-out options which allow tenants out of a lease if the center isn’t performing as promised after a certain time period. While that’s tough on the landlord, outlet tenants also have strict radius restrictions. To prevent drawdown of gross sales volume, a tenant cannot open another location within the trade area, which can be as much as 60 miles. 

But, the successful center is destination shopping and both the available space and the parking lots are filled to capacity. It’s a format that’s working right now.

Mixed Use Centers

Mixed-use development is really interesting, a trend adopted from the pro urbanization movement. It spreads development risk by mixing up the sectors. Our goal is to get lifestyle center caliber anchor tenants moving into these, like a Whole Foods.

At their best, mixed-use developments are ‘Place Makers’, where people gather together in community to enjoy cultural events, entertainment, and festivals that attract energy and excitement. Tenants want to look for management that is engaged and creative about bringing people in.

Retail tenants in mixed use need to be concerned about parking and access, garage space, and transit. Excellent signage is crucial.

Evaluate the site plan, making sure that roles and responsibilities are well identified. All parties need the right insurance in place. Make sure there is a sound shared facilities plan and agreement.

Remember these developments contain by definition mixed uses including residential, retail, office, maybe even a hotel. Your documentation and lease agreement must address how these disparate uses are going to work together. The master agreements are critical and must be flexible, because they will outlive their creators and govern business for years.

It’s interesting to see how retail, retail properties and retail development is evolving. Whether you prefer the tortoise or the hare, at least the race is on.


Michael Bull, CCIM, is the host of the Commercial Real Estate Show heard on 40 radio stations, iTunes, YouTube and the show web site www.CREshow.com. Michael is also an active broker and advisor with Bull Realty, Inc., a U.S. commercial real estate sales, leasing and advisory firm headquartered in Atlanta. Connect or contact Michael on Twitter and LinkedIn.