Despite the talks of turmoil throughout the industry, retail sales are on an upward trajectory.
1. A Tight Labor Market Led to Steady Growth
Consistent job gains and one of the lowest unemployment rates since 2001 have aided in driving sales. In many cases, midlevel workers that were left behind during the economic growth that occurred after the recession are now finding high-paying positions with e-commerce retailers.
Thanks to these strong economic fundamentals, retail sales are anticipated to grow 3.8% this year, which is up from 3% in 2016, Cushman & Wakefield reports.
2. Bankruptcies Ruled the Headlines in Q3
This quarter was not without strife, however. A number of bankruptcies and store closings due to poor financials were announced including Perfumania, Vitamin World and Toys R Us. Though some emerged from the depths of bankruptcy, in most cases this followed significant store closures. Payless ShoeSource was the first to surface in August after closing 673 stores, while Rue21 followed suit shortly after shuttering 420 stores.
By the end of the year, Cushman estimates more than 10,000 store closures will have occurred. This is more than twice the number in 2016, which saw 4,000 closures.
3. Single-Tenant Concepts Thrived
During Q3, builders favored single-tenant concepts and focused primarily on fast-food restaurants concepts, pharmacies, dollar stores, fitness and grocery retailers.
New construction has been consistently attracting tenants over the past few years and reflects a market preference for new space over pre-existing stock. The majority of new projects are being delivered with occupancy rates of 80%, according to Cushman.
4. Rising Household Formation Spurred Demand
A high level of household formation created demand for a wide spectrum of retail products. Almost 1.5 million households have been formed already in 2017, which resulted in rising demand for categories such as furniture and building materials, both of which are essential for people beginning to renovate and rebuild homes, according to Marcus & Millichap.
“Florida and Texas are our two strongest-performing markets in terms of population growth. This certainly has helped to boost sales for DIY retailers like Home Depot and Lowe’s and certainly will boost furniture sales as insurance money lands there,” Brown said.
5. Vacancies Remained Flat
Net absorption slowed during the quarter. The 3.6M SF absorbed in Q3 brought the year-to-date total to 17.1M SF. This is significantly lower than this time last year when retailers absorbed 31.7M SF.
“While we see continued growth from food retailers [such as] grocery and restaurant chains, consolidation from sporting goods, office goods, apparel, department stores and a slew of other categories has mitigated this growth. [But] dollar stores, clicks-to-bricks concepts, automotive retail and food halls also have added to the growth tallies," Brown said.
"The long and short of it is while a large number of retailers and retail categories are contracting, others are still growing and those two trends have largely canceled each other out,” Brown said.
6. 1031 Exchange Still in Question
The status of the 1031 exchange has also been a factor affecting the sector in Q3, Marcus & Millichap reports. The exchange makes up a large portion of the net-lease marketplace and in 2017, more than 40% of the retail transaction volume involved exchange-related buyers. This means the future standing of the tax provision will play a large role in determining how deal flow and investment demand will be moving forward.
The 1031 market accounts for nearly $800B in total transactions annually. Taking it away would have little to no impact on the Blackstone’s of the world or most institutional investors. It would, however, be devastating to mom-and-pop investors. This factor has encouraged buyers to more carefully seek out properties that are in prime locations and backed by tenants with strong covenants.
7. Rents Expected to Remain Flat
Year-to-year rents declined in Q3, now hovering around an average of $19.77/SF on an annual triple net basis. This rate was sitting at $20.03 a year ago, but is expected to remain relatively flat over the course of the next 12 months. While Class-A retail space may experience some semblance of growth in the coming months, Class-B and Class-C product are expected to pose challenges for landlords attempting to lease the space.
An estimated 9,000 major chain closures took place in 2017 and this number could rise to as high as 13,000. “While some of that will be bankruptcy-driven, I suspect that we will see more strategic closures next year as well. This is overwhelmingly hitting Class-B and C properties. Class-A properties are holding their own with rents or even posting modest increases. The result has been flat to slightly negative rents, and we expect more of the same next year,” Brown said.