REBusinessOnline

Philadelphia Retail Market Embraces Change in ’20s

Short Hills

E-commerce-resistant tenants like Short Hills Retaurant & Deli, Starbucks and Wells Fargo Serve as the anchors of Short Hills Town Center, located in the Cherry Hill submarket of suburban Philadelphia.

As our economy fades out of one decade and cruises into the next, a look in the rearview mirror reveals more than 10 years of expansion and 10-year GDP growth in excess of 26 percent.

Sean Beuche,
Marcus & Millichap

The Philadelphia and Northeastern retail investment sales markets should be both thankful for progress made and road bumps navigated and mindful of several current trends affecting transactions and challenges looming on the horizon for owners and tenants of single and multi-tenant retail assets alike.

Savvy Investors enter 2020 with the wind at their backs in many respects while also facing some familiar and unconventional challenges ahead. The 3.7 percent unemployment remains near a 50-year low, meaning that consumers are gainfully employed with money to spend.

Mixed-use developments that capture the live-work-play lifestyle are ubiquitous and keep placemaking everywhere they spring up. Millennials and baby boomers alike are demanding walkable communities and opportunities to spend more of their money closer to home via dining out, signing up for memberships at  gyms and fitness centers. Both these groups are enjoying the experiential retail that every landlord desires in their centers and portfolios.

Stocks of publicly traded retailers like Target, Walmart, and Home Depot are trading at all-time highs while meeting  — and beating — forecasts. The average publicly traded corporate valuations are more than two and a half times their 2009 levels. The overhaul to the federal tax code created opportunities for investors to immediately expense substantial building improvements and benefit from bonus depreciation, which has led to surging demand in auto service and car wash segments of the market.

Drive-thru retail locations for quick-service restaurants, as well as coffee purveyors like Dunkin’ & Starbucks remain in high demand. Gas and convenience stores like Wawa and Sheetz have overtaken drug stores as the darlings of the single-tenant net-leased marketplace. Retailers that have survived this long in the e-commerce era have learned that they need to adapt to changing consumer tastes and alter their brick-and-mortar experiences to maintain and grow their bottom lines.

How Financing Has Changed
The process of financing retail investment sales has matured tremendously in the last 10 years, having learned from the mistakes of the previous recession.

Debt underwriting has taken a much more cautious approach that is focused on the asset’s fundamentals, and lenders are placing intense scrutiny on the potential for financing at loan maturity. Traditional lenders most prefer centers with lease rates in line with or below current market rates, tenants with healthy sales and credit and of course, internet-resistant business models.

While trophy assets still command attractive financing from life insurance companies and CMBS lenders there has been an increased supply of capital from debt funds. These capital sources have stepped in to fill the gaps on lower-quality real estate, including value-add and distressed centers that don’t meet many of the aforementioned criteria. Many of these debt funds do not specialize in financing retail assets, which leads to loans that are structured with higher interest rates, longer engagement-to-close timeframes and myriad other restrictions.

Migration of capital from historically low-yield New York City and Northern New Jersey into secondary and tertiary markets in South Jersey, The Lehigh Valley, Philadelphia’s collar counties and Central Pennsylvania is a trend that we expect to continue in this environment of compressed cap rates due to rent growth normalizing in many top-tier markets along I-95. In the last recession, the average multi-tenant retail property owner experienced vacancy growth of 400 basis point, and these landlords are not interested in repeating that in the next decade if they buy and finance at a premium.

Cautious optimism remains an essential trait for today’s retail investor as 2019’s yield curve inversion has historically predicted (with 80 percent accuracy) that a recession will arrive within the next 18 months. Even with nonfarm employment growing by over 24 million jobs since the last recession, the labor shortage has led to significant challenges in staffing both retail centers and the third party logistics companies (3PL) their tenants rely on for inventory distribution.

Impacts of Labor Shortage
The labor shortage translates to rising wages across the country, which is straining many tenants and influencing staffing requirements. Philadelphia is the only city in the Washington, D.C.-to-Boston corridor on par with the national minimum wage after New Jersey passed legislation to increase wages from $8.85 to $10 per hour, with plans to elevate to $15 per hour by 2024.

As costs of staffing retail centers and standalone properties grows, the ability to increase rents and provide growth to investors becomes more challenging. For this reason, many brick-and-mortar retailers are exploring various options to sell more goods and services with less staff.

These considerations are leading the most sophisticated retail investors, lenders and tenants to dig deeper than most brokers and appraisers have traditionally needed to dig to take deals across the finish line. Pro forma returns are more subjective than ever, and as smarter capital has access to more inventory than ever, the bid-ask gap on exclusively listed assets is rapidly expanding. The exceptions to this rule involve core-plus and trophy assets, true value-add, internet-resistant concepts and consumer-conscious tenants.

Final Thoughts
Looking back on the strides that were made in the 2010s, it is remarkable how much the single- and multi-tenant retail industry of the past has evolved. There have been many casualties to over-leverage, e-commerce, dated business models and failures to adapt to a dynamic consumer base.

Studying market participants that were less disrupted by retail’s evolution, we find that landlords that are more engaged with their tenants, educated on various debt sources and structures, and understanding of the consumers that make these properties solvent, have not only survived but thrived in a changing market.

Looking forward, there are numerous uncertainties related to international trade agreements, including stock market fluctuations, Coronavirus, the continued growth of e-commerce, the impending 2020 Presidential election, upward pressure on historically low interest rates and the evolution of the more discerning value-conscious consumer. Whether or not the economy will continue its bull run is beyond anyone’s control, but studying the past and remaining present to the evolution of the consumer’s retail experience will determine who participates in further disruptions or a possible recession in the 2020s.

— By Sean Beuche, Regional Manager at Marcus & Millichap. This article originally appeared in the January/February 2020 issue of Northeast Real Estate Business.

Get more news delivered to your inbox. Subscribe to France Media's e-newsletters. Click here.



Related News

Webinars on Demand


Conferences


Read the Digital Editions

Heartland Recent Issue

Northeast Recent Issue

Southeast Recent Issue

Texas Recent Issue

Western Recent Issue

Shopping Center Business

California Centers

Ancillary Retail

Student Housing Business

Seniors Housing Business

Featured Properties