Updated: Oct 26, 2020
Is Retail Slashing Prices or Holding Value?
Retail assets have been commercial real estate's proverbial "punching bag" for the past few years, even prior to the downward pressures of Covid. High profile bankruptcies in 2019 led the charge from names like Toys'R'Us, Sears, and Payless Shoes, to retail mall staples like Forever 21, Gymboree, and Z Gallerie. Retail was on the ropes as consumers shifted their habits from in-store grazing to online gluttony.
Then coronavirus happened.
It's easy in the current environment to dismiss neighborhood centers and regional malls as relics of the past, destined for the dust bins of "blue light specials". But to dismiss retail is to potentially miss opportunity as the retail industry reinvents itself. More than merely crawling out, dusty-eyed, from the post-apocalyptic landscape caused by the Covid crater, retail is being forced to evolve and mutate with emboldened predators rising in the e-commerce space. Before we dive into implications, let's take a look at the numbers nationally and regionally.
Retail sales dipped nationally in July and August as some of the most stringent lockdown protocols were starting to affect the consumer, yet September saw a welcome
rebound in advanced retail sales as back to school supplies buoyed some clothing and office supply retailers.
Likewise, consumer confidence continued its upward trajectory after hitting a trough in April and now sits at its highest level since March. Retailers are cautiously optimistic that holiday shoppers will continue to open their wallets in the upcoming season and save an otherwise dismal calendar year.
On a more positive note, September's rent collection figures for stand-alone and shopping center assets continue their upward trend, seeing significant improvements from the lows in April and May.
Another positive is that investors are flocking to triple-net retail investments as a hedge against volatility in equity markets and other real estate segments. With their long-term, corporate guaranteed leases, investors are driving demand and suppressing cap rates nationally. According to a recent report by the Boulder Group, "‘flight to quality’ have resulted in significant cap rate compression for strong credit and essential net leased assets". Cap rates nationally dropped 19 basis points to around 6.06 percent.
Portland retail has actually been a bright spot in terms of overall vacancy rate (3.7%) but deal volume, particularly for investment-grade quality, is conspicuously lacking. There has been only a few investment sales locally, with the largest being a NNN Albertson's investment in Lake Oswego trading for $420/per square foot. Otherwise, pricing discovery with a widening gap between buyer and seller expectations is putting a grinding halt on transactions.
Retail trade employment is rebounding but still not anywhere near the numbers we had pre-Covid as retail and service sectors are muted by state and local mandates for occupancy and distancing standards.
Sales and leasing volumes have cratered year-to-date along with new construction starts. Factor in negative absorption rates for the past 7 quarters and it's surprising that the Portland MSA continues to benefit from mostly stable vacancy and leasing rates, according to several sources. Most of this due to very conservative building in the past few years and rising population statistics.
It's easy to beat up on retail. Many retail and services sectors were already starting a slow downward decline prior to the Covid crisis. The pandemic essentially converted what would have been a slow multi-year decline into a forced, rapid industry evolution. E-commerce market share is rising and that is causing landlords and tenants alike to reconsider long-term investments in 'brick and mortar' structures. Still there are signs of hope. Concerted efforts to adaptively reuse retail for other purposes are actively being discussed, although there are limited instances of this being implemented. What's more likely is that retail will adapt, heeding to the new reality of consumer preferences and likely some blended version of in-store and online fulfillment sales.
Grocery-anchored retail seems to be holding steady and NNN leased investments are in high demand, perhaps lessening the blow in the asset class. Still, we won't understand a lot until national and state mandates are lifted and retail has the opportunity to get back on its feet.
If the holiday shopping season is muted, look for very disappointing numbers in Q4 and beginning of Q1 2021 as winter weather forces restaurants and retail indoors at limited capacity. There is a lot to shake out in this class, but pricing should decrease until investors feel enough risk has been priced into the asset. I think we are still a ways off.
About the author:
Michael Hironimus, CCIM is the Certified Investment Advisor and Principal Broker for Duckridge Realty specializing in commercial real estate investment portfolios for high net worth clients and institutions, focusing on market, financial and risk analysis. He is also a faculty instructor for the CCIM Institute, teaching professionals globally in the CI-102 Market Analysis Core Course.
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