Which Way is the Retail Pendulum Swinging?
Although the pandemic wreaked havoc on the retail sector in general, the culling of weak concepts has left space for strong retailers to flourish. The retail industry is seeing an explosion in experiential retail, medical/dental space is ubiquitous and non-traditional tenants are jumping at opportunities to secure prime locations.
As a result, shopping centers have proven very resilient, says George Macoubray, vice president of retail brokerage with NAI Elliott in Portland, Oregon. “Today’s centers continue to evolve and to address what consumers need in terms of a place for people to congregate and participate in the activities that are important to them.”
The entertainment sector was hit hard by the pandemic, he notes. “But now those operators seem to be out looking for locations, and they’re seeing the light at the end of the tunnel. People want to gather. They want to be entertained. They want to go out and do activities. Those kinds of experiences are happening more and more often in shopping centers — and you can’t buy those activities on Amazon.”
Exciting new in-person experiences are helping to elevate shopping centers. “There’s an influx of experiential retail. From golf simulator experiences to ping-pong places to axe-throwing activities, people want to do in-person activities together,” Macoubray explains.
Food, beverage and other “indulgences” are capturing the imaginations of the retail industry. “The recent creation of breweries, tap rooms and cannabis retailers along with a very active restaurant sector and newly created franchises have absorbed a good majority of the smaller footprint vacancy,” says Michael Jacobs, principal at NAI Glickman Kovago & Jacobs in Worcester, Massachusetts.
Shopping centers provide the positive associations, the sense of safety and security and the amount parking “to allow people to get out and experience things together,” says Macoubray.
Underutilized shopping center spaces are also drawing medical tenants — urgent care, dental practices and outpatient clinics now choose these centers as their preferred locations, according to Macoubray and Jacobs.
Gas stations, convenience stores, new car wash concepts, banks, newly created franchises and some longstanding, well-known brands are all finding opportunities in the current market, especially in New England, according to Jacobs.
Mall spaces and big box stores that have gone dark over the past three to five years are also being converted into mixed-use projects that include residential, office, retail and entertainment, self-storage, multifamily and warehousing space — with some discount retailers snapping up big box spaces. Macoubray even describes one instance where a former shopping center space has been converted to a swim school.
So the Pendulum Swings: The Impact of Inflation and Increasing Interest Rates?
Although retail is rebounding from the pandemic, the fear of economic downturn in the next six to 18 months is cooling retail ambitions nationwide — to a degree.
“I think it’s universally anticipated among my colleagues that we’ll see some adjustments and a likely slowdown in certain sectors. With interest rates creeping up and this angry growing inflation, it’s only logical that a course correction will follow. People’s discretionary income will take a hit,” Jacobs says. “Without a crystal ball, we assume a softer landing than the 2008 financial crisis, but we don’t know for certain.”
Jacobs does not believe that the retail brokerage landscape has begun to react to rising inflation and increasing interest rates just yet. He anticipates those economic factors will change the New England retail industry’s outlook in the next year or so — and will negatively impact the fortunes of smaller operations, in particular.
Still, Jacobs notes, one of the benefits of real estate is that there are always opportunities regardless of how the economy swings. The key is knowing what to look for and how to manage economic reversals.
Looking at both sides of the inflation coin, Macoubray says that national tenants with fixed rent increases are benefitting from pre-determined rent schedules while landlords are struggling with the inflation. New leases are currently being redesigned or reconfigured with this tension in mind. He also notes that ballooning construction costs are impacting developers, and he predicts that rents will rise to compensate. All this is occurring as supply chain insecurity and labor shortages create general uncertainty for retailers.
As for retail investment sales, Jacobs says the market has not slowed down yet. But he predicts “cap rates will follow interest rates upward over the next nine to 12 months, which will ultimately impact values and possible deal volumes. The fact is that cap rates have remained compressed. In 2021, the lowest average cap rates occurred in the fourth quarter — meaning activity and demand increased coming into 2022.”
It will be interesting to see how 2022 plays out. Will the retail rebound continue, with retailers overcoming challenges created by the pandemic, supply chain issues and labor shortages — or will new challenges in the form of rising interest rates and inflations curtail the rebound? While these new challenges worry the industry, the fact remains that existing tenants who have made it through the second quarter of 2022 are resilient. And new concepts entering the retail space are being built and customized with the trials of the recent past in mind. Even as the retail pendulum swings, the retail market is proving its strength.