Investors, Stores and Restaurants: An Increasing Mix

This is the third in a five-part series about the commercial real estate retail sector. The first three articles, “Understanding the Retail Sector: Where We’ve Been and Where We Are,” “Retail Economics: Supply, Demand and Consumer Dollars,” and “Just what IS the Best-Performing Retail,” are live.

The just-released Gross Domestic Product (GDP) report noted an annual rate increase of 2.8% in Q2 2024. “The increase in the second quarter primarily reflected increases in consumer spending, inventory investment and business investment,” the Bureau of Economic Analysis said.

With ongoing consumer spending, the commercial real estate retail sector continues to be robust. As a result, experts in the field told Connect CRE that retail space now takes the top spot as the “darling” of real estate investment.

“The tables have quickly turned for the retail sector as a viable investment option,” observed Dave Cheatham, president, X Team Retail Advisors and Velocity Real Estate Group. “Just five years ago, many wrongly thought the sky was falling, and a retail apocalypse loomed.” In hindsight, those predictions proved incorrect. “Retail has survived and problem resilient, despite the conditions or challenges it has faced,” Cheatham said.

But Why Retail?

First, a little common sense amid the euphoria.

According to JLL’s Q1 2024 retail report, U.S. retail investment activity was still subdued due to capital markets dislocation, the result of higher-for-longer interest rates. This put downward pressure on transactions while reducing deal sizes.

Despite this, JLL noted that the retail sector was the highest investment performer across all asset types.

Meanwhile, Cushman & Wakefield’s Q2 U.S. Shopping Center Report explained that the retail market has been tight from a leasing perspective and will remain so into 2025 due to “a resilient U.S. economy, diverse tenant demand and subdued new construction.”

Because of these and other fundamentals, “retail, in many areas of the country, is the only vertical showing rent increases,” said Chris Wilson, executive vice president and national agency retail lead for JLL. MSC Principal Douglas Green agreed, explaining that other asset classes face headwinds. Multifamily is overbuilt in several markets. Meanwhile, the industrial market continues pulling back on rents.

While disruption among regional enclosed malls is diluting the issue, “investors have finally come to realize the stability of well-located open-air centers and the current supply/demand imbalance we’re seeing in the asset class has pushed many new investors into retail,” Green said.

Digging Beneath the Generalizations

As has been consistently mentioned, retail is a broad term for commercial real estate from which goods and services are sold to the general public. This sector encompasses everything from a neighborhood AutoZone or McDonald’s to a massive one-million-square-foot regional mall.

So, while retail is being dubbed as the “darling of investors,” it’s not all created equal – and not all investors are treating it as such. Wilson said many investors like suburban spots and luxury retail for their portfolios. Meanwhile, Melissa McDonald, principal with The Providence Group, explained that others are shying away from power center retail because of a growing lack of available creditworthy backfill tenants. “There is very little available ‘value-add’ retail product to purchase,” she added. “Most investors seem to be more comfortable with multitenant retail strips or grocery-anchored centers.”

Adding to the issue is the fragmentation of ownership for many retail types. For example, Phillips Edison President Robert Myers explained that the ownership composition with grocery-anchored retail is fragmented, with over 60% of the 5,800 available assets owned by private real estate companies or individuals. As a result, while many of the centers go through the brokerage community when it’s time to sell, “we regularly reach out to owners directly to encourage them to sell and to make sure we’re top-of-mind when they decide to do so,” Myers commented.

Pricing and Capital

Nor is the retail sector free from those two dreaded words among investors: “pricing disconnect.” But once again, this depends on the type of space under consideration.

“There’s a binary view on retail,” explained Rhiana Lindsey, director of leasing with Primestor. “Aggressive on grocery-anchored assets, but cautious on pricing for non-grocery-anchored plays.” As a result, when it comes to pricing and terms, “there is a wide 200 to 300 basis point spread in debt pricing between these two buckets,” she added.

Econonic Company’s Founder and Principal, James Chung, agreed with the issue of the pricing disconnect. On the one hand, he said, dry powder still awaits the right opportunity. On the other hand, there is a “limited inventory of desired product types, like grocery-anchored shopping centers,” Chung observed.

Against this backdrop, the competition among investors for that perfect retail space is fierce. There are the usual players, of course. Then there are the newcomers. “Organizations that have historically not been in the retail space are now interested,” said The Providence Group Broker Darrell Palasciano. “We’re starting to see a lot more non-retail companies get into the area more and more.”

The Future View

Given muted construction and continued consumer spending, the experts believe that retail will continue to attract investors in the near future. Chung said he anticipates that the debt markets should settle while lending behavior calms down. Additionally, “private capital is leading the charge over institutional investors. Retail will continue to be desired as the fundamentals remain strong,” he said.

From Lindsey’s perspective, as long as consumers continue to flock toward in-person shopping experiences, investors will continue clamoring to add retail to their portfolios. This could be a boon for experiential retail, like food, entertainment and community spaces. “Retail that combines these with great locations in dense transit-oriented areas are the strongest, from our perspective,” Lindsay said.