Understanding the Retail Sector: Where We’ve Been and Where We Are

This is the first of a series of articles focused on commercial real estate’s retail sector.

The commercial real estate retail sector has had a wild ride over the past 15 years, undergoing everything from a massive economic downturn to technology disruptions to a “black swan” event. “The last decade of retail hasn’t been without excitement,” observed James Chung, founder and principal of the Econic Company.

Despite the common theme of the “retail apocalypse” following each event, none of the dire forecasts have come true. Retail bounced back and continues to be strong today. Connect CRE reached out to experts to better understand how past events influenced today’s retail space.

Back in Time

The experts agreed that three factors impacted retail within the past ten years.

#1: Recovery from Recession

Until around 2012, the retail situation wasn’t so rosy. “A decade ago, we were slowly digging out of the hole from the Great Recession,” said Dave Cheatham, president, X Team Retail Advisors and Velocity Real Estate Group. Mid-size box category consolidations meant that big-box space ended up a casualty of the period, meaning that “the development of big box retail sites virtually came to a standstill as Walmart, Target and Home Depot, worked to figure out how to build and operate omnichannel programs,” Cheatham said.

On the other hand, the Great Recession led to the rise of “treasure-hunting” consumers gravitating toward value. This drove the quick expansion of traditional discounters. “These discounters absorbed a high percentage of the vacant big box space,” said Coreland Companies’ Principal Matthew Hammond. Department stores also expanded off-price brands as “we saw stores like Bloomingdales Outlets, Nordstrom Rack and Saks Off 5^th absorbing space,” Hammond said.

Hammond also explained that pop-up retail stores and food trucks gained momentum during the mid-2010s. “These were a less risky way to test products. With social media, it was easier to spread the word and create buzz about new concepts,” he said.

By the middle of the decade, things were more or less back to normal from the recession. By 2014, “we saw a lot of new construction,” said Darrell Palasciano, broker with The Providence Group. “We saw retailers growing. We saw new concepts being created.”

He said that low interest rates meant developers were willing to take on larger products and more risks. “Though construction costs were insane through 2020, the interest rates were so low that projects still penciled and worked,” Palasciano pointed out.

#2: The Rise of E-commerce

Though the mid-2010s did find retailers digging free from the recession, another disrupter came along: E-commerce.

“A decade ago, brick-and-mortar stores dominated, with e-commerce accounting for less than 5% of total U.S. retail sales,” said Primestor’s Director of Leasing Rhiana Lindsey. Internet shopping wasn’t new. However, growth in mobile devices and the increased prevalence of retail-specific apps helped lead the charge to online buying. Additionally, “the convenience, vast selection, and competitive pricing offered by online giants like Amazon fueled an e-commerce boom, with the channel’s share surging to 18% by 2020,” Lindsey said.

This, in turn, generated the first so-called “retail apocalypse,” as brands like Sears, Circuit City, Toys ‘R’ Us and RadioShack tried to adapt and, when they failed, went dark.

“Many retailers and analysts had concerns about the impact of online retail as it related to bricks and mortar,” said The Providence Group Principal Melissa McDonald. Looking back, those concerns now seem misplaced. “Household products, some grocery categories, small electronics and some appliance types benefitted from the online retail explosion,” McDonald said. “The thinking that online sales would eliminate bricks and mortar wasn’t correct.”

#3: The Pandemic

A “black swan” is an unpredicted, unexpected event with typically severe consequences. Society’s black swan event was the COVID-19 pandemic. It was also retail’s.

“If you look at the retail landscape during the pandemic, where consumers were unable to visit stores, retailers had to find a way to accelerate sales and deliver their product,” Cheatham said.

Lindsey said that many did so by increasing digital activities and omnichannel strategies. The lockdown and growing use of smart devices and social media platforms to order goods disrupted the traditional retail model. “Customers could browse, research and purchase products seamlessly from their mobile devices or directly from their favorite social media platform,” Lindsey noted.

A year or so after the lockdown, during much of 2021, lockdown restrictions were slowly removed, and retailers cautiously re-opened. Meanwhile, thanks to government-backed stimulus programs, consumers had plenty of money to burn. “People couldn’t wait to get out of their homes and spend money,” Palasciano said.  

Consumers returning to brick-and-mortar stores meant sudden demand for more retail space, leading to more construction. Commented Palasciano: “Interest rates were still at historic lows in 2021, and the industry was just on fire.”

Another trend, courtesy of the pandemic and the growing “want-it-now” consumer mentality, is a growing desire to shop closer to home. Douglas J. Green, principal of MSC, explained that people are more comfortable going to their neighborhood centers these days. “This change, combined with the more acro trend of the urbanized suburb, places a massive amount of demand on neighborhood-oriented retail and accelerated the growth of the mixed-use town center,” he commented.

Understanding the Present Scenario

Here’s what’s happening now. “Retail currently exists in one of the best operating environments we’ve seen in over 20 years,” commented Bob Myers, Phillips Edison President. Resilient consumer demand and steady foot traffic mean that retailer demand for space is also at an all-time high. Furthermore, “retailers remain aggressive with growth plans, planning further out than ever before,” Myers said, adding that many are negotiating deals into 2027.

Furthermore, big-box retailers, including Walmart, Target and Home Depot, are brushing off expansion strategies. The result is “development activity that hasn’t been seen since the Great Recession,” Cheatham said.

The downside, at least for retailers, is limited supply, higher rents and increased TI costs. “There are multiple LOIs on most spaces,” Providence Group’s McDonald observed. “The lack of vacancy is seen across all the size categories.”

Increases in land values and construction costs are not helping the scenario, while “interest rates have held back from new development or redevelopment,” Hammond commented. Then there is inflation. Though the rate has decreased significantly from its June 2022 high of 9.1%, “there is still inflation, and it still remains at levels significantly higher than its average,” Palasciano said.

So, retail is in another position of change as it grapples with limited supply, uncertain economics and additional headwinds. But Econic’s Chung said that the 10,000-view tells a different story of the sector.

“Despite how volatile the sector has seemed, there hasn’t been that much variability,” he said. “When you combine the pandemic and prior, what was labeled as the ‘retail apocalypse,’ it’s amazing to think that retail is now the darling asset class in CRE.”