5 Questions: Taking a fresh measure of retail real estate
- February 1, 2024: Vol. 11, Number 2

5 Questions: Taking a fresh measure of retail real estate

by Mike Consol with Scott Aiese

Is there a property type that has taken more body blows than brick-and-mortar retail?

For starters, retail has long been considered overbuilt in the United States. Then there is the fickle consumer whose preferences change quickly from formats such as department stores and shopping malls to big-box stores and outlet stores. When ecommerce came along — with all its convenience and discounting — some started ringing the death knell for traditional retailing and its physical stores. That was followed by the COVID-19 pandemic taking its pound of flesh out of the sector.

Little wonder that investors have been waving red flags over the property type.

Still, traditional retail has persevered and even prospered in some cases. Investors, it seems, have reason to give retail a fresh look — a notion that would find some encouragement from Scott Aiese, senior managing director of capital markets at JLL New York.

Why did retail fall out of favor as an asset class and how has it recovered?

Retail as an asset class fell out of favor with investors during the much-heralded retail ecommerce apocalypse of the 1990s and then a slew of bankruptcies that preceded the historic COVID-19 shutdowns. Valuations fell as liquidity dried up and new construction was severely curtailed.

Several factors have contributed to its resurgence, including strong consumer demand for leisure activities and the experience of shopping in physical stores. Retail centers now include entertainment, dining, fitness and services, diversifying income sources and creating more dynamic tenant offerings for consumers.

Those retailers that have successfully integrated ecommerce with their physical stores to create an omnichannel shopping experience are also now thriving — think in terms of Zara’s smartphone mannequins, or Steve Madden’s live chat customer service.

What makes retail attractive to investors in today’s complex financing environment?

Near peak occupancy levels, nominal new supply and an expansion-minded retail industry are creating unprecedented retail demand and rent growth across the country. It is an ideal pivot for institutions able to parachute into the asset class as lenders and investors and find general consensus around valuations as well as cap rates. Values remain significantly below replacement cost, the sector remains undersupplied, rents are low relative to increasing sales, and momentum points to favorable roll-ups on leases over the coming years.

Due to the retail sector’s high levels of occupancy and its undersupply of new development, current owners and investors are poised to capitalize on the sector’s strong fundamentals and long-term rent growth.

Are we talking all retail, or are there preferred assets that are attracting investors in the sector?

Within the overall retail sector, grocery-anchored centers are the most heavily transacted multi-tenant subtype by volume at $3.6 billion year-to-date. However, this growing confidence in the retail sector has led to an escalated interest from investors in power, lifestyle and other formats. Traditional gateway markets were the most liquid in the third quarter of 2023, with New York, Los Angeles and Washington, D.C., leading the pack.

Which lenders are most active?

Local banks and insurance companies have been active sources of debt capital, and CMBS lenders have reemerged as active participants. Retail has accounted for a larger portion of recent CMBS conduit securitizations, accounting for 16 percent of production between 2017 and 2019 versus 23 percent through third quarter 2023 year-to-date. CMBS lenders are looking to retail as a source of product diversification away from office loans, which have decreased from 31.4 percent between 2017 and 2019 to 21 percent through third quarter 2023 year-to-date. For large loans, the single-asset single-borrower (SASB) market is experiencing an even more pronounced shift away from office; where office represented 31 percent of SASB loans ($11.8 billion per year) between 2017 and 2019 versus 3 percent of SASB production ($400 million) through third quarter 2023.

What is your outlook for 2024?

Despite challenges in the broader credit markets, we believe the dearth of supply and strong consumer demand point to a long runway of growth and an opportunity for investors to take advantage of improving conditions. We expect to see more capital flowing into the space in 2024 as volatility persists in other property types, and debt advisory teams to remain busy across all lender types, risk profiles and geographies.

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