Retail Is Suffering From Its Own Success

The 10 consecutive quarters of demand growth have pushed the retail market to its tightest position in nearly 20 years, according to CoStar data, and there is less space available for lease now than at any point since national tracking began in 2006.

“Retail is suffering from its own success,” CoStar said.

Retail tenants leased just under 59 million square feet in Q2, the lowest amount of space signed in a quarter in more than two years.

Just 4.9% of total retail space is available for lease as of September, a more than 1.5% decline from the pandemic-era peak and the prior 10-year average for retail availability, CoStar said.

This is weighing most in fast-growing Sun Belt markets, according to CoStar.

As well, retail construction was at record lows in the first half of 2023, and “it doesn’t appear that the pressure will alleviate any time soon, keeping prices high in primary locations for the foreseeable future,” CoStar said.

Deloitte found that despite several prominent retailers filing for bankruptcy over the past year, there is still healthy demand, and landlords remain optimistic they can still quickly fill vacancies and push rents higher.

“While other sectors have gone through supply-side booms over the past few years, new retail development is still structurally restrained due to limited new constructions and demolitions from widespread store closures during the late 2010s,” according to Deloitte’s most recent report.

Enclosed Malls No Longer Economically Viable

Mark Sigal, Chief Executive Officer at Datex Property Solutions, tells GlobeSt.com that retail leasing and brick and mortar retail in general is basic supply and demand.

“Lack of new retail inventory, amplified by a re-positioning of enclosed malls that are no longer economically viable, has created increased demand for open air retail, such as market-drug shopping centers,” he said.

“The net effect of this is that it’s a seller’s market, where landlords can negotiate better deals with more favorable economics and pro-landlord lease provisions, such as sales reporting and percentage rent clauses.

“At the same time, landlords can replace struggling tenants with better performing operators, with stronger balance sheets, in more durable merchant categories.”

Sigal said an auxiliary benefit of the strong market for retail landlords is that it puts additional pressure on existing tenants at retail properties to pay their rent timely since landlords in this environment have better alternatives for under-performing retailers.

“Towards that end, rent collection trends for the first three quarters of 2023 are outpacing 2022 numbers for the same period,” Sigal said. “That’s the good. The one potential fly in the ointment is that rent increases are outpacing retail sales growth, which is at least partially inflated by inflation.”

He said the net effect of this is that the merchant health ratio known as an occupancy cost, which is a measure of what percentage of sales at a given retail location are “eaten up” by rent and triple net reimbursables, has increased by 30% versus 2022.

“That’s a worrying number and begs the question of whether sales numbers will ultimately catch up with rising rental rates,” according to Sigal. “Or, if instead rising occupancy costs will translate to increases in default rates and create downward pressure on rental rates.

“My guess is that such challenges will be muted for the foreseeable future, as there remains an excess of growth-minded national retailers in top-performing categories, such as fast food, sporting goods, beauty supplies and specialty retail, that have the balance sheets to not only expand, but weather moderate turbulence in the larger economy.”

Class A Thriving, B & C Not

Peter Braus, Managing Principal, Lee & Associates NYC, tells GlobeSt.com that retail has seen a flight to quality, with class B & C malls emptying out in many markets.

“This has contributed to the decrease in overall square footage available,” Braus said.

“Class A malls, at the same time, have been thriving. Likewise, well-located and well-anchored open-air shopping centers (e.g. grocery anchored centers) have come out of the pandemic extremely strong, as they’ve shown definitively that they perform under both good and bad conditions.”

At the same time, very few shopping centers have been built since the financial crisis of 2009, according to Gary Glick, partner, Cox, Castle & Nicholson.

“The general view at that time was that there were too many shopping centers and too much space to fill,” he tells GlobeSt.com.

“However, since then, with the lack of any appreciable amount of new retail projects, most retail space has been absorbed leading to higher rents and less available space. Although many more vacancies exist after the pandemic, as the world has stabilized, those vacancies have largely been absorbed also.

“This is leading to difficulties for expanding retailers to find prime locations in retail centers. This is probably not the case for most regional malls or B and C properties, but definitely the case for A retail locations. At some point, more retail will be built but not in the current high interest rate environment. As an aside, some prime retail space does become available when large retailers fail like Bed Bath & Beyond and Party City.

“However, this space is getting absorbed rather quickly in the current environment where prime retail locations are not easy to find.”