The Stunning Disconnect Between Retail Space Demand and New Supply

Net absorption increased 12.6% quarter-over-quarter while deliveries fell 5.1%.
Retail is a kind of good news/bad news story right now. The good news is that retail is going gangbusters for most types of stores, but rents are rising. The bad news is there’s barely enough space to meet retail demand, and rents are rising. Whether this news is good or bad for you depends on whether you’re a store owner or a landlord.

The gap between demand for store space and new supply is stunning, JLL’s report on the U.S. retail outlook for 2Q 2023 reveals. The overall average occupancy for retail centers across the country is 95.4%, while development is less than 0.3% of total inventory. Indeed, net absorption increased 12.6% quarter-over-quarter to 10.8 million square feet – but deliveries fell 5.1% in the same period. Just 11.9 million SF started construction in 1Q 2023 – the lowest level since 2005, according to JLL.

“Availability – the amount of space available for lease, regardless of whether or not it is vacant – within non-mall multi-tenant retail centers dropped to 7.5% in June, a precipitous drop from 2020,” JLL stated. Spaces less than 5,000 SF have seen the highest demand, largely thanks to quick-service restaurant openings. However, spaces over 25,000 SF also show less availability. And this year, store openings are running well ahead of closings.

As a result, annual rent growth hit 3.6% across all asset categories, JLL reported. The rent increases were felt especially in primary Sunbelt markets like South Florida, Las Vegas and Austin, which saw increases between 7% and 8%. But they were even more notable in secondary and tertiary markets like Jacksonville (up 12.6% year-over-year), Phoenix (up 9.8%) and Omaha (up 9%).

Why is retail space supply not keeping up with demand? “Cost of capital and competing uses for land has hindered the justification for new development within the asset class. As a result , anchored shopping centers specifically are trading at 55% of replacement costs, on average,” the report stated. That compares to 48% pre-Covid.

One result of the lack of retail space has been to create a rush to take over space once occupied by big-box stores that have gone into bankruptcy, like Bed Bath & Beyond, which are generally in highly desirable locations.

“The persisting high occupancies, the lack of retail product deliveries over the past decade and the challenges preventing future construction starts have created the perfect storm for retail’s meaningful rent growth, as well as long-term value for investors,” commented JLL senior managing director Chris Angelone.

Toward the end of 1Q 2023, banks became less skittish about retail lending. Even so, year-over-year retail transaction volumes fell 57% to just under $19 billion, excluding entity-level transactions – 33% lower than in 2019. Lenders also seemed to favor smaller deals; the average interest rate on a retail CRE loan of less than $30 million hovered around 6.1% compared to 6.62% for larger deals. They also prefer shorter loan terms, JLL noted.

Investors are especially interested in open-air product types. Investment in grocery-anchored centers led the retail sector with $3.6 billion in sales year to date and an average cap rate of 6.9%. The runners up by type were unanchored strip centers ($1.7 billion) with a 7.1% cap rate, and neighborhood centers ($1.7 billion) with a 7.4% cap rate. The cap rate for power centers averaged 8.7%.

Power centers – large outdoor shopping malls that include several “big-box” stores – saw a 1.1 million SF rise in net absorption, while vacancy shrank 20 basis points to 4.2%, with equivalent rent increases. Absorption in community centers that house supermarkets and a variety of stores supplying household needs surged 121% from 1Q 2023. Fitness centers accounted for over 0.4 million SF. Neighborhood centers and strip centers also saw space gobbled up. Class A malls saw 0.2 million SF absorbed – but they were exception to the rest of the mall category, which saw net absorption fall by one million SF.

“Lenders and investors are no longer afraid of retail as an asset class given the strong operating fundamentals, and as such, we should expect to see more capital flowing into the space as the capital markets thaw,” JLL predicted.

Source: GlobeSt/ALM