By Taylor Williams
Heath Ledger, squaring off against Batman as The Joker, observed, “so this is what happens when an unstoppable force meets an immoveable object.”
The late great actor’s metaphor for the stalemate that ensues when entities of equal and opposing power collide could almost be used to describe the current state of the Boston retail market. For while the sector continues to see high levels of tenant demand and the locale retains an array of proven demand drivers, the lack of new supply means that a ceiling of sorts on the growth of the market as a whole is taking shape. And the factors that form the foundation of this ceiling are very unlikely to bend, much less break.
Minimal gains in new inventory have long plagued the Boston retail market, and the current scenario is no exception. According to data from CoStar Group, the market added 518,000 square feet of new space in the 12-month period that ended June 30 but absorbed approximately 1 million square feet of space during that time. Vacancy thus remains extremely tight at 2.3 percent.
In formulating its latest report on the Boston retail market, CoStar noted that Beantown retailers would “largely need to make do with the space they have, at least in the near term, as the construction pipeline is smaller than it has been since early 2011.” The report further noted that in 2023, new construction starts “equated to just 10 percent of the 15-year average, meaning the pipeline will continue to shrink in the months ahead.”
Although landlords are contending with their own inflationary obstacles — higher insurance and taxes, heftier allowances for tenant build-outs — the inability to add a sizable volume of quality retail space ensures that Boston retailers are the ones that remain at a disadvantage.
“In 23 years in the Boston retail market, I’ve never seen it as much of a landlord’s market as it is right now,” says Rob Robledo, executive vice president at CBRE’s Boston office. “Most of that stems from two decades of very little development. New England is a challenging area in which to develop due to the topography and zoning, and it’s simply an underdeveloped market for retail.”
“Things are looking great for landlords right now,” adds Matt Curtin, executive managing director at Newmark’s Boston office. “Boston continues to be a market of great interest to retailers from all over the country and world. We’re not unique in the fact our supply is down and rents are going up, but tenants really have to scramble to get their store counts up in this market.”
Joe Pierik, vice president of retail leasing and acquisitions at Carpionato Group, a development and management firm based in Rhode Island, explains that many of the larger forces that limit new development in the region are institutionalized and unlikely to change.
“The approvals and permitting and entitlements processes in New England markets are among the most challenging in the country due to land constraints, the historic nature of many buildings and the exceptionally dense population,” he says. “Plus, there’s heightened sensitivity toward environmental issues, whether coastal or inland. So it’s a tough place to develop.”
Demand Proliferates
As the heart of New England, Boston possesses almost every major demand driver that satisfies site selection committees: residential density, tourism, young consumers via the area’s 20-plus colleges and universities. The city’s office sector has struggled like every other in the wake of COVID, but it has to some extent been supplanted by a burgeoning life sciences sector that has created thousands of high-paying jobs.
According to CoStar, total leasing activity in 2023 was just under 3.5 million square feet, which exceeds the average of 3 million square feet per year over the last decade. The real estate research and data company did find, however, that leasing activity slowed in the early part of 2024 and that at the end of the second quarter, rent growth had only risen by 1.2 percent on a year-over-year basis. The average asking rent for retail space across the market as a whole appears to be holding steady at about $28 per square foot, per CoStar.
Demand remains especially strong within the core retail submarkets of Boston proper.
“Within the urban core and lifestyle centers around the city, the story is that demand is in some cases two to four times the supply,” says Curtin. “In years past, we’d put out surveys for tenants a couple times a week for Newbury Street, Harvard Square or the Seaport District that consisted of 12 to 15 sites per survey. Depending on requirements, today we’re sending out surveys with two or three sites and advising our tenants to act on them prior to even visiting the market.”
On that note, Curtin adds that he has seen cases in which tenants review the information on available sites and schedule tours six to eight weeks later. But by the time the tour date actually rolls around, some of those sites are no longer available. That’s how quickly the market moves when quality space opens up.
Robledo of CBRE agrees that the ways in which brokers conduct proposals and tours with their tenant clients have changed — and that these changes reflect the profound supply-demand imbalance.
“We do tenant tours and show retailers the same streets that everyone wants to be on, and it’s just super tight,” he says. “There’s no vacancy, and when something does potentially become available, you’ve got to be nimble and think outside prototypical deal parameters in terms of size or oddly shaped spaces or the ability to pay a little more. That means that retailers have to be as nimble and creative as possible to counteract the lack of vacancy.”
From a landlord’s perspective, there are still some pockets of the greater Boston area that are not completely going gangbusters. Unsurprisingly, these submarkets tend to be closely tied to office usage.
“If you’re a dominant owner in the Boston central business district, that’s a tough place to be simply because office hasn’t come back as we expected,” says Evan Eisenhardt, senior vice president and head of leasing at Linear Retail, an owner-operator based in metro Boston. “Rents in these markets have shifted, and some owners haven’t adjusted, so those can be tough pieces of real estate to own. But suburban, small-shop, convenience-oriented, necessity-based retail — that’s all very strong and seeing a lot of demand and not a lot of inventory.”
Landlords Call Shots
Sources say that these market conditions are prompting landlords to take harder looks at rent rolls within centers as a whole and identify weak links. In some cases, if a tenant is barely making rent, landlords will consider buying out the remainder of the lease. The ability to secure a tenant that can comfortably cover rising rents in the long run outweighs the loss of revenue and incurred costs of re-tenanting the space in the short run.
In addition, landlords are utilizing their leverage to increasingly focus on one key provision of lease structures: guarantees.
“Credit has become a bigger concern than ever for landlords; they are really focused on securitizing their leases,” says Curtin. “If the deal doesn’t involve an AAA credit tenant that’s fully guaranteeing the life of the lease — and there aren’t many of those out there — then landlords are looking for larger guarantees or letters of credit or security deposits.”
“In general, landlords and their lenders or capital partners agree that certainty of cash flow is paramount,” agrees Eisenhardt. “From our perspective as a landlord, a guarantee is debatably the most important aspect of the deal because it assures that certainty of cash flow. The pandemic exemplified worst-case scenarios in which if landlords didn’t have strong guarantees, tenants could walk away with no recourse, whether they were suffering or not.”
The need to guarantee leases, whether through personal, corporate or special-purpose entities, would seem to favor national tenants over mom-and-pops. After all, credit and depth of financial resources tend to be more prevalent in national chains than in local tenants, despite the unique appeal and character that latter users bring to centers. But sources point out that this isn’t a universal trend by any stretch.
“From a landlord’s perspective, you of course want credit underpinning any lease transaction, especially when there’s landlord investment and you have to get lender approval on some deals,” says Pierik. “But just because it’s a national tenant doesn’t mean it’s without risk, and you still have to do detailed analysis on the creditworthiness of national retailers to ensure the deal is underwritten properly.”
Eisenhardt makes the same argument from the opposite perspective. “Just because a tenant is a mom-and-pop doesn’t mean they’re not creditworthy,” he says. “It’s just a different type of credit. And if you structure the deal properly, it can be very lucrative so long as the operator is experienced and has smart capital behind it and is focused on the quality of the service or business.”
Indeed, after an easing of brick-and-mortar bankruptcy announcements in the wake of COVID, several major national retailers have made news lately for either pondering or declaring bankruptcy. These include Bob’s Stores, which exclusively operated in New England, as well as Big Lots and JoAnn Fabrics.
Time, Money Issues
Elevated costs of capital have been the story of commercial real estate for the past couple years. And even in a space like retail leasing where the impacts of the debt markets would seemingly be minimal, there are ripple effects of higher interest rates that hurt deal volume.
“It’s mostly construction costs and financing those. Whether it’s the landlord doing more build-outs or giving tenants greater tenant improvement (TI) allowances, it has to be addressed one way or another, and rents continue to go up because of it,” explains Robledo. “Landlords are paying close attention to operators’ track records and financials before they cut those TI checks, which dovetails with the cost of capital issues.”
“It’s costing landlords more to obtain that capital, so they’re being very careful with it,” he continues. “Ultimately the transaction hinges on who’s putting the money and work into the deal; that’s the variable we’re constantly having to solve for. There’s no question that the demand is at an all-time high, but the deals require more creativity to get done, and part of that is figuring out the distribution of construction costs.”
Between minimal space, higher costs of doing business and municipal staffing shortages that delay permitting and approval processes, deals are also just taking much longer to close, sources say.
“People in the industry have universally said that the time it takes to complete deals has increased significantly,” says Pierik. “Architects have to submit plans and drawings to municipalities to obtain building permits — both for landlords and tenants — and a lot of towns are very understaffed coming out of COVID. So what might have taken 10 business days to obtain a building permit might now be doubled.”
“Getting contractors and subcontractors on board also takes more time,” he continues. “When you combine those different components, you have a deal that might have taken three months now taking five to six months. And if there’s one consistent theme about real estate, it’s that delays are not advantageous.”
Other sources concur with this sentiment.
“Deal cycles are definitively extended in every sense of the word,” says Eisenhardt. “With the negotiating phase of a deal, especially with national credit tenants, the oversight and scrutiny from real estate and legal departments on these deals is heavier. Architects have longer lead times to get construction documents to tenants. The construction period has gotten better due to supply chain issues easing, but there are still delays, so the overall process has substantially increased from beginning to end.”
— This article originally appeared in the June/July 2024 issue of Northeast Real Estate Business magazine.