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There’s a Bad Moon Rising Over Retail: Deal flow is falling at a faster rate than any other major real estate asset class
- August 1, 2017: Vol. 4, Number 8

There’s a Bad Moon Rising Over Retail: Deal flow is falling at a faster rate than any other major real estate asset class

by Paul Fiorilla

Growing concern about the long-term prospects for in-store retail is creating a slowdown in the sale of shopping centers. Retail property sales in the second quarter of 2017 fell 45.9 percent year-over-year, and first-half sales are 26 percent below 2016, according to preliminary data from Real Capital Analytics. Sales declined in several segments of retail, led by lifestyle/power centers, single-tenant and drug stores.

Transaction volume for all of commercial real estate is down this year, falling by about 20 percent to $177 billion in the first half of 2017, compared to $221 billion in the first half of 2016. Even so, in the second quarter of 2017, shopping center deal flow fell at a rate greater than any other major asset class, fueled by concerns about the changing face of retail and whether individual tenants will be able to withstand the impact of e-commerce. More than 5,000 store closings have been announced year-to-date, putting the industry on pace to easily surpass the record set during the 2008 recession, when more than 6,000 stores closed.

That retail is changing is not a novel concept, but attention on the issue has crystallized to a large degree over the past year, fueled by the spate of closings and discussions about technological trends.

Jim Costello, senior vice president at RCA, noted that property owners have little incentive to sell at a price that discounts the value of current income, unless they need access to cash or are facing a liquidity event, especially given the dearth of replacement properties available.

Uncertainty about the impact of future trends can have a huge influence on the transaction process. Sellers want to price based on traditional cash-flow metrics, but buyers might want a discount that takes into consideration the possibility of some tenants leaving, or the need for capital expenditures to bring in new tenants or to renovate centers to keep up with shoppers’ demands.

The whole concept of retail is being redefined, with questions such as how much retail space will be needed as younger generations weaned on the Internet comprise a bigger portion of the consuming public. In addition to the 15 percent annual growth of e-commerce, some believe delivery services and driverless cars will eat into demand for space.

Related concerns include the prospect of rising interest rates eroding asset value, and uncertainty about the potential impact of the new administration.

Debt remains available for retail properties, although at more conservative levels than borrowers might expect. Like investors, lenders generally want to leave themselves a buffer for all but top-quality retail. And the uncertainty facing retail real estate is not going to change anytime soon.

What is certain is that investors will express their views by what they are willing to pay. High-quality properties will continue to be in demand and fetch top value, but owners that want to transact will probably have to accept higher acquisition yields for secondary- and tertiary-quality assets.

 

Paul Fiorilla is associate director of research at Yardi Matrix.

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