Retail and Hotel Performance Quietly Gaining Momentum

While apartment and industrial properties have garnered a lot of investor attention over the last few years, retail and hotel performance has quietly gained momentum, according to John Chang, National Director of Research and Advisory Services.

A performance review for the retail and hotel sectors as well as office through Q3 was recently presented by Marcus & Millichap through its news video.

Looking at retail, a lot of old shopping malls have done poorly, and many have been converted to other uses or they were simply demolished to make space for new uses.

“That’s old news,” Chang said. “But the retail Armageddon highlighted by the media never happened. That was overblown.”

The third quarter national average retail vacancy rate is just 4.6%, about where it’s been for the past year.

That vacancy level is on par with where it was in 2018, and it’s the lowest level on record going back 23 years.

“Now that a lot of the vacant retail space has been upgraded to new mixed-use centers or converted to other uses like warehouse or storage, the overall sector metrics have improved notably,” he said.

New retail construction is averaging about 40 million square feet per year, which is a sustainable level, so it looks like retail properties are positioned to outperform in the coming year.

“Keep an eye on retail centers in smaller cities,” Chang said. “These have benefited most from the recent population migration trends.”

With hotels, generally, select service properties outperformed in 2023 with occupancy levels ending the third quarter at a trailing 12-month average of 67.3%, up 170 basis points compared to last year.

Revenue per available room, or RevPAR, is at an all-time high, up 2.9% on a year-over-year basis.

“We are seeing significant performance gains in the upscale, upper upscale, and luxury properties,” according to Chang. “Over the past 12 months, occupancy gains have been particularly strong for these segments.”

Upscale occupancy rates are up 260 basis points over the last year to 68.6%, while upper-upscale occupancy levels rose 510 basis points to 66.6%, and luxury hotel occupancy rates have increased to 66.7%, a rise of 260 basis points over the last year.

Meanwhile, economy, midscale, and limited-service hotel occupancy rates slipped over the last year.

“The more budget-friendly hotel occupancy rates had been leading over the last few years, so the falling occupancy levels are really just moving these segments back toward their long-term normal levels,” Chang said.

In net, the hospitality property segment has been performing well, with the average daily rate up by 3.5% over the last year.

“As for office what you see in the headlines doesn’t tell the whole story,” Chang said. Office-based demand, however, has structurally changed given today’s shifting remote and office work schedules.”

At the end of 2019, prior to the pandemic, the office vacancy rate was 12.4%. As of the third quarter of this year, the national average vacancy rate was 17.1%, up 110 basis points from the third quarter of 2022, and rents are basically flat.

“But when you cut under the surface, some really interesting information comes to light,” Chang said.

The downtown vacancy rate is 19.1%, significantly higher than the 16.5% vacancy in the suburbs.

When you cut the office vacancy rate by the age of the property, offices built in the 1980s have a much higher vacancy rate, 20.7%, compared to newer properties built in the last 13 years, which have a vacancy rate of 11.4%.

The vacancy rate of properties larger than 250,000 square feet is 18.5% compared to a 15.4% vacancy of properties smaller than 250,000 square feet.

When you blend these three segments, two extremes become apparent.

The vacancy rate of large 250,000-square-foot and larger urban office properties built in the 1980s is about 25%, while the vacancy rate of smaller, newer office properties in the suburbs is just 10.9%.

“Office properties still face headwinds but watch the performance of smaller properties in the suburbs and in smaller cities because those are the ones positioned to outperform,” Chang said.