Retail Economics: Supply, Demand and Consumer Dollars

The retail sector has been robust, but will it remain so? Experts discuss demand, supply, and consumer spending with Connect CRE in this second of five articles. The first article in the series, “Understanding the Retail Sector: Where We’ve Been and Where We Are,” is available to read here.

During the COVID-19 shutdown, physical retail was considered at death’s door, even as online sales expanded.

What a difference four years makes. Bricks-and-mortar centers are benefiting from higher foot traffic (and expanding sales). This is prompting retailers to seek out new space to meet that consumer demand.

However, 2Q 2024 metrics from Colliers reported continued reduced retail supply, leading to 4.1% vacancy and increased rent growth. Experts in the sector supported the statistics, telling Connect CRE that retail space across most usages remains tight. “Retail demand and retailer demand are outstripping retail supply, which remains very low,” commented Darrell Palasciano, a broker with The Providence Group. Added Providence Group Colleague and Principal Melissa McDonald: “There are multiple LOIs on most spaces. The lack of vacancy is seen across all of the size categories, including shop and anchor space, as well as outparcel space.”

Demand and Supply

In the days of the pandemic, the predictions were that e-commerce would trump physical commerce. But that hasn’t happened. Certainly, consumers still shop online. However, “the cost of customer acquisition online has become untenable for many retail brands, whether digitally native or otherwise,” said Douglas J. Green, principal with MSC.

Another aspect is that an online pitch doesn’t have the same “oomph” as one that’s in-person. “The online process means retailers can’t authentically ‘story tell’ about their brands and make a true connection with potential customers,” Green explained. “This has driven unbelievable demand to brick-and-mortar and injected an incredibly diverse array of tenants into shopping centers and urban districts.”

Meanwhile, lack of space continues to be a challenge. JLL Executive Vice President and National Agency Retail Lead Chris Wilson explained that in 2005-2007, 215 million square feet came online, with the annual new retail delivery pace at 50 million square feet between 2017-2024. “In 2024, 14 million square feet will be delivered,” Wilson explained.

Reduced space isn’t being helped by high land and construction costs and higher-for-longer interest rates. “With high construction costs, there’s been little construction activity to build new shopping centers over the past ten years, constricting the supply of suburban retail locations,” said Robert F. Myers, Phillips Edison President. He added that it could be close to a decade before retail construction returns to where it was 20 years ago. McCarthy also indicated that the low vacancy rates could continue for five years.

Yet retailers continue pursuing aggressive expansion plans. Myers indicated that tenants in grocery-anchored centers are negotiating deals well into 2027. Additionally, “Now that retailers have figured out online consumers, the biggest factors we’re seeing is expansion by big-box retailers like Walmart, Target and Home Depot, companies that haven’t expanded significantly over the last 12 to 15 years,” said Dave Cheatham president, X Team Retail Advisors and Velocity Real Estate Group.

Discount retailers are also in the mix. Palasciano pointed out that this sector has been “forced to spend more on real estate to stay ahead of trends and keep growth numbers up.” Furthermore, consumers have had more money to burn, and are less likely to spend what they have at the discounters, causing some problems.

Still, Palascino said, if these retailers hold on until the economy slows down, “the dollar stores and discounters will be well-positioned. Customers could come back and start ‘trading down’ again.”

Speaking of which . . .

Consumers are Still Spending – But for How Long?

According to the Bureau of Economic Analysis (BEA), consumer spending in May 2024 increased by 0.5% from the previous month, a slight bump from the 0.3% reported in April 2024. While this doesn’t suggest massive buying sprees, it does mean that people continue to spend.

Still, the experts sounded notes of caution. “The biggest threat to retail owners today is a potential consumer recession, driven by the Fed’s commitment to slowing the economy, continued higher interest rates and ongoing inflation in construction costs, labor, cost of goods and energy,” Wilson said. Primestor Director of Leasing Rhiana Lindsey agreed, pointing out that inflation and interest rates can erode purchasing power and spending. “This could cause consumers to shift their spending to prioritize essential purchases over non-essential ones,” she observed.

Another concern is the rise of consumer debt, even as consumer spending supports today’s retail sector. Matthew Hammond, Coreland Companies principal, stressed the need to monitor credit card debt; in Q2 2023, credit card balances surpassed $1.12 trillion as credit card APRs increased 30% in 18 months. “This, coupled with rising inflation, will adversely affect consumer spending and start to play out in the marketplace in various ways,” he said.

In addition to the above, Providence Group’s McDonald pointed out that “consumers are uncertain about the upcoming election and the economy, despite the positive performance this year.” This could also stall consumer spending in the future.

Palasciano explained that some debt forgiveness and other programs are providing consumers with a false sense of security, which is encouraging them to spend more. Though retailers like the notion of more spending, it’s not a good thing over the long term.

“It will increase inflation or continue to contribute to it,” Palasciano said. “Eventually, those dollars will stop flowing, and consumer spending could take a nosedive in the next couple of years,”

Still More Challenges

Velocity’s Cheatham said that efforts to slow inflation with Effective Federal Funds Rate (EFFR) increases have cooled the economy somewhat, but overall prices have yet to come down. James Chung, founder and principal of the Econic Company, added that inflation and high interest rates continue to exert influence. Though inflation is far from the 9.2% of June 2022, “it negatively influenced deal-making as landlords were trying to protect current and future positions and tenants were working to cap future increases,” Chung said. He added that additional issues like fixed-cost increases (think insurance rates) also impact gross rents.

This continues to spur concerns about what retail landlords can do about those costs. JLL’s Wilson said there are ongoing discussions with retail landlords about whether they can continue increasing rents and pass costs through triple-net lease arrangements. But even NNN solutions are costly as “these are increasing 10%-20% annually,” Wilson said.

As landlords and their retailer tenants continue to navigate the changing – and yes, uncertain – landscape, Primestor’s Lindsey stressed the need for open communications between the parties. Both are focused on rising operating costs and the potential for a spending slowdown. As such, “the retail leasing landscape remains dynamic, and both leasing and landlords must remain agile and responsive to the evolving trends and challenges,” Lindsey said.