In the late 2010s, the demise of retail was top of mind for many investors: consumer spending had shifted to the internet, retail vacancies were at all-time highs, and the shopping mall was considered a dinosaur relic. Just five years later, retail has shown resiliency and is now among the top-performing sectors in investor portfolios. 

We explore how drop-offs in construction, shifting retailer strategy, and consumers’ desire to still experience brick-and-mortar stores has allowed retail to prove its durability.  

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A Right Sizing of Retail

One of the key drivers of the then-dubbed “Retail Apocalypse” was a surplus of retail space as consumers began to purchase more products online. The ensuing steep drop off in new retail development has reversed the tide – according to CoStar, over the past decade, the average retail space per capita in the U.S.’s 75 largest markets has decreased by 1.9%, falling to 58.9 square feet per person. This reduction reflects a broader trend where more than 60% of major markets have seen population growth that is outpacing the growth in retail space. This discrepancy is particularly evident in Sun Belt cities such as Austin, Dallas, Orlando, Jacksonville, Charlotte, and Nashville, where population growth has exceeded retail inventory growth by 5% or more.

This supply and demand trend can be seen in contrast with high-cost Coastal and manufacturing driven Midwestern markets, which have both experienced population stagnation or decline. Despite limited new development, these areas still have relatively high levels of retail space per capita. This surplus results from historical patterns of expansive retail development during boom periods, which now lead to higher vacancy rates and underutilized properties. The challenge for these markets lies in repurposing or re-leasing these surplus spaces.

Overall, we expect these trends to continue and development to increase in the Sun Belt markets over the next several quarters, while a conscious effort to repurpose space in the Coastal and Midwestern markets continues to be underway. We see the repurpose of space through the increase in specialty and non-traditional retail, as well as the redevelopment or repositioning of outdated malls and strip centers in these regions. We expect these factors to continue to support the overall growth of the retail sector as retailers and landlords continue to innovate and adjust to shifting trends. 

Redefining Retail   

Retail real estate subsectors have experienced a substantial transformation, particularly in the wake of the pandemic. According to a recent CoStar report, nearly 50% of all retail spaces leased over the past year were occupied by tenants outside the traditional retail sector. This shift reflects a broader trend where diverse types of businesses, from wellness retailers such as Glowbar, Skin Laundry, and Drybar, to experiential concepts such as F1 Arcade and Ace Hardware’s ‘Elevate’ concept, are occupying space.  This evolution is driven partly by a surge in consumer spending post-pandemic, which has heightened the demand and created a more efficient operating environment for a broader variety of tenants. To cater to these new consumer preferences, physical retail spaces are being redesigned to enhance the shopping experience, incorporating features like interactive displays, dining options, and wellness features. 

While the increased appetite from a new subset of users is a net positive for the retail sector, it is not without risks to owners and operators. These concepts may be relatively untested in a market or lack the credit quality of the major national retailers, increasing go-dark risks. These tenants may also seek shorter lease terms, which shortens weighted average lease terms (WALT) of properties and could adversely impact valuations. However, successful integration of diverse retail offerings can also drive foot traffic and positively influence the performance of other retailers within the investment, potentially offsetting some of these risks.

Pop-Up Activations and Shop-in-Shops

Pop-ups involve temporary stores that cater to short-lived trends and seasonal offerings – think Halloween stores – but may also be used by retailers testing out new concepts or evaluating a new market. These offerings create opportunities to temporarily backfill vacant spaces and can be used to generate short-term cash flow. 

Experiential Retail 

Unlike many other brick-and-mortar offerings, experiential retail stores’ primary focus isn’t sales of goods, but rather on selling opportunities to experience something engaging. This can include immersive “Instagram-worthy” spaces that are created with the purpose of offering users fodder for their social media feeds, as well as activity-based spaces like TopGolf. Experiential extends to more traditional retailers as 
well; brands have leaned into in-store events that capture customers for longer, create stronger brand loyalty, and promote visits beyond their normal purchasing habits. 

Grocery and Food Anchors  

Grocery-anchored retail centers continue to demonstrate remarkable resilience in today’s retail landscape, buoyed by evolving consumer habits and a robust demand for essential goods. Recent data underscores the sector's stability, with grocery-anchored centers enjoying a higher foot traffic compared to their non-grocery counterparts. According to a 2024 report by CBRE, these centers have experienced a 5% increase in average sales per square foot over the past year, attributed to the sustained necessity of grocery shopping and a resurgence in in-person shopping experiences.

What It Means for Investors   

The decrease in availability of space, as well as the multitude of new uses coming to the forefront, is positive news for investors. According to CRE Daily, the pace at which leases are being signed is at a 20-year low of just 8.5 months on average to find tenants for newly available shopping center spaces, with 80% of shopping center spaces being leased within 6 months. 98% of retail spaces are leasing within 9 months. 

While challenges remain, the adaptability and innovation within the sector are promising signs of its ongoing resilience. Retail spaces in growing population centers should continue to thrive with the strategic development and considerations for new space. While the successful integration of experiential elements, innovations, and thoughtful repurposing of space should allow for Coastal and Midwestern markets to remain steady. 

The sector’s ability to reinvent itself in the face of changing consumer preferences and economic pressures underscores its enduring strength. As retail continues to transform, we see the sector poised to remain a vital and dynamic component of real estate portfolios.

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Disclaimer

The information in this newsletter is as of September 13, 2024, and is for your informational and educational purposes only, is not intended to be relied on to make any investment decisions, and is neither an offer to sell nor a solicitation of an offer to buy any securities or financial instruments in any jurisdiction. This newsletter expresses the views of the author as of the date indicated and such views are subject to change without notice. The information in this newsletter has been obtained or derived from sources believed by ARA to be reliable but ARA does not represent that this information is accurate or complete and has not independently verified the accuracy or completeness of such information or assumptions on which such information is based. Models used in any analysis may be proprietary, making the results difficult for any third party to reproduce. Past performance of any kind referenced in the information above in connection with any particular strategy should not be taken as an indicator of future results of such strategies. It is important to understand that investments of the type referenced in the information above pose the potential for loss of capital over any time period. This newsletter is proprietary to ARA and may not be copied, reproduced, republished, or posted in whole or in part, in any form and may not be circulated or redelivered to any person without the prior written consent of ARA.

Forward-Looking Statements

This newsletter contains forward-looking statements within the meaning of federal securities laws. Forward-looking statements are statements that do not represent historical facts and are based on our beliefs, assumptions made by us, and information currently available to us. Forward-looking statements in this newsletter are based on our current expectations as of the date of this newsletter, which could change or not materialize as expected. Actual results may differ materially due to a variety of uncertainties and risk factors. Except as required by law, ARA assumes no obligation to update any such forward-looking statements.