Declining Occupancy, Rent Growth Spreading to Top Tier of Best-Located US Retail Properties
Vacancy Rates for Malls, Shopping Centers Expected to Tick Up in 2018 Despite Robust Retail Spending, Economic Expansion
The largest investment sale transactions of the fourth quarter included Albertsons' $721 million sale-leaseback of 71 properties across 12 states, including this Safeway property in Florance, AZ.
Even the best performing and most well located U.S. malls and shopping centers are beginning to feel the pinch of flat-lining rent growth and a vacancy uptick as e-commerce continues to take market share from brick-and-mortar retailers and the retail sector enters the late stages of the real estate cycle.
Despite a relatively strong finish for retailers in the final three months of 2017 buoyed by improved consumer spending and an expanding economy, demand for U.S. retail property was generally lackluster for the year, according to market highlights presented by CoStar managing consultant Ryan McCullough and director of U.S. research Suzanne Mulvee in the Fourth Quarter 2017 State of the U.S. Retail Market.
"All told, we are seeing some signs of a slowdown in the retail market," said McCullough, noting that retail absorption totaled about 69 million square feet for 2017, down about 30% from 2016 and 2015 levels, with developers expecting to deliver roughly 80 million square feet of new retail space in 2018 as demand from retail tenants begins to soften. "Given the slowdown in demand and some uptick in supply, we might anticipate the national retail vacancy rate, which went flat in 2017, to start to rise modestly in 2018," McCullough said.
Reflecting slowing investment sales volume observed by CoStar analysts across all commercial property types, retail investment fell to just below $20 billion in the fourth quarter, its lowest level since mid-2014. In addition to a diminished appetite among cautious buyers, many sellers are also pulling properties off the market after failing to achieve pricing that meets their expectations, McCullough said.
One sign of the softening market conditions is a moderate rise in vacancies and flat-lining of rental rate growth in recent quarters at the country's top located and most productive Class A malls, urban luxury centers and shopping centers. These properties have consistently logged the highest location quality scores, as ranked by CoStar’s proprietary formula measuring the combined effects of demographics, density of surrounding commercial property and market competition on individual retail centers.
While retailers are readily absorbing some new supply entering the market, especially spaces of 20,000 square feet and below, larger boxes in certain centers that are ranked in the top 10 percentiles of location quality are in many cases taking longer to lease up, reflecting broader weakness among U.S. power center tenants.
Meanwhile, at the opposite end of the quality spectrum, the number of "zombie" power centers with vacancy rates of 40% or more has increased 60% since 2016 due to a spike in store closures by Kmart, Toys R Us and other big-box retailers and grocers. The closures and bankruptcy filings are mounting weekly and likely will not abate any time soon. Toys R Us plans to close another 200 stores and lay off corporate personnel, in addition to 170 previously announced store closures, the Wall Street Journal reported Thursday. On Wednesday, Northeast supermarket chain Tops Markets LLC filed for Chapter 11 bankruptcy protection.
In contrast, the neighborhood grocery anchored retail segment has continued to see good demand growth and falling vacancies, the CoStar market analysts reported. Even these reliable performers, however, may be facing some underlying risk due to over-retailing and tenant competition in coming quarters.
"Because many developers and landlords still consider the grocery anchored sector to be a safe defensive play against e-commerce that brings foot traffic, we are continuing to see more absorption and development that could perhaps lead to issues with oversupply," McCullough said.
While total retail space per capita has decreased by about 5% since 2009, the amount of anchored space per capita has increased by the same amount during that period amid competition from big-box chains that have added food and groceries to compete with grocery chains.
"We're seeing increasing delinquency rates in CMBS issuance among centers with mid-market grocers such as Albertsons, Winn Dixie and even Publix as a large tenant," McCullough said.
Overall U.S. retail rents increased another 1.7% in the final three of 2017 to $20.67 per square foot. However, the growth rate has slowed over the past 12 months from the average 3% growth seen over the past three years as asking rents have moderated in New York City, San Francisco, Miami, Boston and other core markets.
Demographics are again driving rent growth, with Atlanta, Charlotte, Las Vegas and other high-population-growth metros recording some of the strongest rent growth in 2017 as homebuilding and commercial construction have finally picked up, while markets with stagnant or even negative population growth such Hartford, Long Island, Chicago and New Orleans logged very few rent gains. Rent growth has also started to decline in retail centers with a location quality scores above 90 in recent quarters.
In spite of the threat of online competition and store closures, total monthly retail sales grew by an average 0.5% per month last year from an average 0.2% in 2015 and 2016, with gains driven by increases in health-care and personal care and building materials and supplies reflecting the growing strength in the housing market. On the other hand, apparel and furniture sales lagged in 2017. The decline in clothing sales particularly worrisome as apparel tenants occupy an estimated 64% of mall and department store space, Mulvee said.
Despite hitting a soft patch, overall U.S. retail sales continued to trend in the right direction at about a 4.2% annual increase in January, according to U.S. Census data released last week. Increases in personal income and the positive impact of tax cuts could position 2018 as a stronger year for consumption, Mulvee said.
The retailer distress that has pressured comparable-store sales and fundamentals has affected the capital markets. The U.S. Retail Index of the CoStar Commercial Repeat Sale Index (CCRSI) began to decline in 2017, though it rebounded in the second half to end the year with a net 10% gain from 2016.
Investors are generally seeking highly productive assets with high location-quality scores and capitalization rates are now trending upward on sales of lower-quality assets, Mulvee and McCullough said. While well-performing Class A mall are trading at a premium compared with past cycles, an average of $387 per square foot compared to $347 in 2005-2007, B and especially C malls are trading at a sharp discount of up to 50% compared with the 2005-2007 boom years.
Investors are also rewarding in-place tenancy, with triple-net lease deals comprising nearly 20% of total retail sales volume in 2017, an increase of about 9% over the 2009-2012 period, McCullough said. The largest transaction of the fourth quarter was the sale-leaseback by Albertsons of 71 stores across 12 states to Cardinal Capital Partners, Inc. for $721 million at a 6.5% cap rate.
Some well-located power centers also changed hands in 2017, including the 426,000-square-foot Centerton Square in Mount Laurel, NJ, sold by Black Creek Diversified Property Fund, Inc. to Prestige Properties & Development Company, Inc. for $129.6 million, or about $303.93/SF, at a 5.8% cap rate.
McCullough noted that location score for Centerton, which was fully leased to Costco and Wegman's at the time of the sale, ranks a solid 95 due to its affluent demographics and a significant nearby office and hotel presence.