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A Decade Of Demolition Without Substantial Development Has Reset Retail

Posted By: BISNOW on April 28, 2024.  For more information, please click here to read the source article.

A great recalibration of the country’s retail footprint has been underway for years, as bankruptcies have roiled some of the most beloved stores and restaurant chains. Now, as other sectors of CRE stumble and slow, retail has stabilized as a result.

Retail spaces in the U.S. have clocked record-low vacancy rates for more than a year, most recently settling at 4.1% in the first quarter, according to CoStar. That means happy landlords after years of uncertainty, but it could also stunt growth for retailers seeking space in a historically tight market.

“We’re tearing down the old stuff, all of the old Sears and the old Kmart and other big-box stores which really don’t have attendance in today’s market,” CoStar Group National Director of U.S. Retail Analytics Brandon Svec said. “We’ve been rightsizing those, putting up apartment buildings, putting up hotels, shrinking retail.”

Retail space has been razed at a rapid clip since the time of the “retail apocalypse,” with some 155M SF disappearing from the market over the last five years alone, CoStar reports. The country’s net retail inventory increased just 500M SF in the last 10 years to 12B SF to start 2024.

“If you’re a tenant looking for space in the market today, there’s actually not been less space available at any point in time since before the Great Financial Crisis,” Svec said. “Retail market conditions are incredibly tight. We’re hearing from tenants saying, ‘Hey, I can’t find the space that I need, or I can’t find the space I need at a price that I can do the margins that I need to do.’”

CoStar puts the national retail vacancy rate at 4.1% as of Q1, up slightly from 4% the quarter before, but well below the pre-pandemic peak of around 10%. The company forecasts slightly higher vacancy rates in the coming years, but no more than 4.2% by mid-2027.

“From an occupancy standpoint and a rent growth standpoint, both have been record highs for us over the past two years,” said Vestar Vice President of Development Ryan Ash, whose company is a retail landlord and developer.

Nationwide asking rents are up by 2.9% over the past year to a new record high of $25 per SF, CoStar reports.

“Currently, our portfolio of 30M SF is about 96% leased, and depending on the size of the space, we’re seeing nearly double-digit rent growth, which is phenomenal,” Ash said. “Multiple tenants are competing for any spaces that come available. We’ve transitioned from what has been a tenants’ market over the past 15 [years] into a landlord’s market, which is refreshing.”

The transition to a tenants’ market didn’t happen overnight, Svec said, but was the result of the absorption of space over the last three years and a longer-term dearth of retail development paired with the increase in retail demolition and conversion.

“First and foremost, we stopped building, really since the Great Financial Crisis, with retail construction activity falling off by two-thirds since then,” Svec said. “That’s been a big part of it. We’ve also demolished space.”

Retailers closing locations has also moderated, leaving less space available. Retailers left over 400M SF per year in 2018 and 2019, with a peak of 418M SF in 2020, according to CoStar data. As consumers started spending more in 2021, retailers stayed put, and departures have decreased year-over-year.

Finally, Svec said, there has been an uptick in recent years in occupancy by nonretailers in former retail space, typically healthcare users, that remove space from the market.

As supply growth slowed, retailer demand bounced back after the worst of the pandemic ended, Ash said.

“Overall, national retailers emerged from Covid in a strong condition, and they’ve come out with aggressive growth plans,” Ash said. “Look at their forecasts and Wall Street projections. They’ve promised extreme growth over the next few years. That’s why we’re seeing a lot of these big national tenants, particularly in the junior anchor box space, all competing for very limited supply.”

The upshot for retailers, including some of the larger credit tenants looking to continue to expand nationwide and especially in strong markets, is that retailers won’t be able to grow as much as they want in the next few years.

“It’s creating a bit of a lid on how much expansion we can see,” Svec said. “Costs are rising substantially across the board, whether that’s operational costs or the actual tenancy costs of real estate taxes and insurance and rents. That’s starting to have an impact on expansion plans and the level of activity we’re seeing.”

Only 62M SF of new retail space came online nationwide over the last 12 months, CoStar reports, 40% less than average deliveries over the last 10 years. Most of the recently developed space was single-tenant build-to-suit or small spaces in mixed-use developments. Three-quarters of the new retail space over the last five years opened with a tenant already in place.

ooking ahead, CoStar forecasts that quarterly deliveries of new retail space will drop below 10M SF by the end of this year and stay there at least until 2028.

Interest rates and construction costs are important factors in holding back retail development, along with shadow inventory, Beta Retail partner Richard Rizika said. Even in a relatively strong market for retailers, some will continue to fail for various reasons, and their space will often be competitive with anything new.

“A lot of lenders are just very cautious because of the time it takes to develop new retail and then build it,” Rizika said. “You had your Bed, Bath and Beyonds coming into market, or now 99 Cents Only or other struggling merchants on watch lists, so those are going to be factored in. You might find that you’ve got competitive product that’s coming to market.”

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