Source: Retail, United States, CoStar Group Data, January 2024.
Continued appetite for spending improved overall retail market fundamentals. The National Retail Federation reported that consumers broke records with increased holiday spending in 2023 compared to 2022. Roughly 200 million people shopped over the five-day holiday weekend from Thanksgiving through Cyber Monday, which was up 5.6% as compared to 2019.33
Source: National Retail Federation, November 2023.
Spending patterns vary across categories with an increased appetite for budget-friendly options over discretionary spending due to the sticker shock caused by higher and sticky inflation. While we expect people to mimic similar spending patterns in H1 2024, we also anticipate a general slowdown in spending because consumers feel the pinch of low consumer savings rate and increasing reliance on credit card debt, especially for low-income consumers. Many media outlets highlight that credit card debt has hit a 10-year high. While overreliance on credit cards has increased, the average delinquency rate (2.98% as of November 2023) remains below the long-term historical average (3.8%, according to Dr. Peter Linneman’s Fall 2023 letter). The resuming of student loan payments is another factor that may pull back spending. But while we expect the average consumer will be more cautious about where their dollars are spent, a forecast by JLL revealed that luxury shopping is resilient and will continue to increase in 2024.34
Based on Q3 2023 reporting by CoStar, retailers occupied more space than they vacated for 11 consecutive quarters, with an already low vacancy tightening to the lowest rate since before the Great Recession. Additionally, a few new retail centers are under construction, representing only 0.5% of the sector's total inventory. CoStar notes this is 40% lower than the historical average for under-construction square footage.
Driven by strong underlying fundamentals, the retail sector set a record high for asking rents, which increased annually by 3.3% nationally in 2023. Rent growth is expected to moderate to around 2.5% nationally for H1 2024, but we expect rent growth to vary based on location, with high-traffic areas and markets with strong buying power demanding higher rents, particularly in Sunbelt markets.35
We believe certain retail real estate centers are well-positioned for steady growth in the years ahead, particularly for product types such as grocery-anchored neighborhood centers, free-standing luxury brand stores, and high-street retail in bustling urban locations. Given the limited new supply in the pipeline, we believe the demand for these retail spaces will continue to moderately outstrip supply.35
Opportunities in retail vary depending on the center type, location, and performance. But particularly in today’s high interest rate environment, one of the first things to consider is math. Based on data by MSCI’s Real Capital Analytics, the average cap rates for retail deals that closed over the 12 months leading up to October 2023 stood at 6.7%, up 40 bps from a year earlier.36 Depending on the type and vintage or age of the retail property, higher overall cap rates may make some deals viable candidates with the potential to achieve positive leverage at acquisition.* When considering investments in the retail sector, we will likely continue to prioritize this aspect as it is a differentiator for retail real estate in a high-interest rate environment. Also, the Triple Net (NNN) nature of rents may help limit the effect of spiking insurance, maintenance, and tax costs, as these are traditionally passed on to the tenant.
Due to their sustained performance over the last few years, we continue to consider grocery-anchored and community centers or strip centers, as opposed to traditional shopping malls or second-tier big-box stores.37 The non-discretionary nature of grocery shopping helps to keep the fire burning for this industry. We will typically consider centers with anchor tenants such as Whole Foods, Sprouts, ALDI, H-E-B, Publix, and similar prominent or discount brands that have the potential to boost the center’s earnings with potential with their typically higher traffic.
Lastly, we are also tuning in to emerging opportunities to invest in high-street luxury retail if discounted to levels that make it viable. The repricing of these assets, combined with the financial health of the luxury shopper, makes it a unique opportunity today.38 Historically, luxury retailers have chosen free-standing locations on main or high streets and also in high-end malls. Our interest is specific to retailers on busy thoroughfares and prime corridors that attract high traffic. The United States has one of the largest luxury markets, according to a recent report by JLL. Many of the luxury retailers in the U.S., such as Louis Vuitton, Dior, Fendi, Tiffany & Co, Loewe, Bulgari, Balenciaga, Gucci, and others, are experiencing “robust growth” and are expanding locations, especially in Sunbelt markets, with New York and California as the two top markets experiencing the most store openings in the last few years - with Miami, Atlanta, and Las Vegas following suit.34
* Positive leverage occurs when the debt costs less to service than the cash flow received from the leveraged portion of the project (negative leverage is the opposite when the debt service exceeds the cash flow on the leveraged portion of the project). Another way to tell if leverage is positive is when the operating cap rate from a deal is greater than the interest rate of its debt.
