Philadelphia Retail Market Establishes Its Resilience

by Taylor Williams

By Taylor Williams

No matter your size, market and scope of operation, for retail owners and operators, there is no such thing as total immunity from the likes of e-commerce, COVID-19, inflation and interest rate hikes. But there is such a thing as absorbing those socioeconomic hits in stride, learning and evolving from them and re-emerging on significantly more solid ground.

And that is largely the path that the Philadelphia retail market has traversed over the past few years. The timing of the pandemic dismantled the launch of Fashion District, the redevelopment of the former Gallery at Market East Mall that should have ushered in a new scene of experience-based, locally merchandised retail in Philadelphia. Retailers and restaurants along Center City District’s main shopping corridors quickly devised solutions to the global healthcare crisis and were returning to normalcy when bad timing once again intervened. This time, it took the form of the Delta variant, which delayed plans to reopen existing stores or launch new ones and erased some of the positive momentum that landlords and tenants had recouped.

For their part, suburban retail properties, many of whose performances were bolstered in the short run by pandemic- driven population influxes, are now in the precarious position of introducing new uses to combat the natural deterioration of America’s regional malls. Some of these shopping and dining districts with proximity to office clusters are also dealing with the fallout of a work-from-home trend that only seems to be becoming more deeply ingrained in the fabric of society with each passing fiscal quarter.

And yet, for all these disruptions, bad breaks and uncontrollable obstacles, the Philadelphia retail market is healthy overall. According to second-quarter data from CBRE, the market’s direct vacancy rate of 7.5 percent is the lowest of the post-pandemic era and is the culmination of six straight quarters of compressing availability. The last time the vacancy rate posted a quarter-to-quarter increase was in late 2021, when the Delta variant was peaking.

Today’s data must be assessed in the context of interest rate hikes, and against that backdrop, the Philadelphia retail market has predictably struggled in terms of investment sales volume — yet not as much as other sectors. According to CBRE’s data, while the total volume of commercial transactions in greater Philadelphia declined by 57.6 percent year over year during the first quarter, the volume of retail transactions fell by just 33.1 percent. This finding suggests that investors have shifted their views on retail from a hazardous space to one that, with the right demographics and tenancy behind it, can generate healthy and reliable returns.

“Retail has taken so many body blows in recent years, and while they’ve knocked us down, we’ve gotten back up from all of them, including the most recent one of the cost of money going up,” says Steve Gartner, executive vice president at CBRE’s Philadelphia office. “But the biggest impact of rate hikes has been the slowing of new development. With high barriers to entry for new development, conditions in the retail market have been fairly level and predictable. It’s been a nice, productive year thus far.”

Landlords seem to agree.

“The Federal Reserve has been raising interest rates in an effort to tamp down inflation, which was largely a result of the trillions in stimulus that was pumped into the system following COVID-19. That stimulus money not only helped carry retail through, but also made retail stronger than it was pre-pandemic,” says Jeff Fischer, vice president of regional leasing at Federal Realty, a retail landlord with an extensive presence in the Philadelphia area. “Less-relevant players and concepts have been weeded out, and those buried under mountains of debt have finally called it quits.”

“Pre-COVID, there was real concern that the online presence was going to steal considerably from brick-and-mortar retail, maybe even rendering it obsolete,” he continues. “That doesn’t seem to be the case at this point; we’re seeing a return to brick-and-mortar amid logistics issues and the expensiveness of last-mile delivery via online shopping. People clearly want to go out and shop and dine and socialize and do things they were denied during COVID, reinforcing the need for brick-and-mortar to exist.”

CBRE tallied the second-quarter volume of retail product under construction in the Philadelphia area at 534,000 square feet. Joe Coradino, CEO of Pennsylvania Real Estate Investment Trust (PREIT), notes that this lack of new development has played a part in fueling the market’s stability and resilience in the face of macroeconomic and geopolitical headwinds.

“We have continued to see really strong demand across the portfolio, which we attribute to a few factors, including the availability of quality space and our proactive effort to revitalize our properties with a diverse array of uses,” he says. “This has occurred even as increased cost pressures on consumers due to inflation has created a real bifurcation in performance for retailers.”

PREIT has indeed been making large-footprint changes at its suburban malls and developments. At Willow Grove Park Mall, entertainment concept Tilted 10 has opened a 103,000-square-foot venue with bowling, laser tag, bumper cars and more than 150 video and arcade games. Coradino says that this move “restores the mall to its amusement park roots and offers more reasons for shoppers to visit.” Dick’s Sporting Goods has also opened a 90,000-square-foot store under its “House of Sport” brand at PREIT’s Viewmont Mall in Scranton.

As for entirely new uses at PREIT properties, Cooper University Health Care plans to open a new facility in the former Sears location at Moorestown Mall in Southern New Jersey later this year. The facility will feature a café, a community wellness information center, over 90 pod-like exam rooms, collaboration areas and smaller work areas for telehealth visits. PREIT is also working to secure zoning and other necessary approvals to develop apartment complexes at its Plymouth Meeting Mall on the city’s northwestern outskirts.

Other sources agree that the lack of new development has some positive impacts for the market.

“While certain deals simply don’t work in this environment, the lack of new construction has led to greater demand within the existing portfolio,” says Fischer. “As a result, we have multiple operators vying for a limited number of spaces in Philadelphia, especially on the anchor front.”

Much of the new supply is inclusionary as part of multifamily or life sciences projects that are predominantly consuming what land remains within the urban core.

“In the city itself, retail [supply growth] is usually a ground-floor function of high-rise properties, and the high-rise properties that are actually coming out of the ground now were funded prior to rate hikes,” adds Larry Steinberg, senior managing director at Colliers’ Philadelphia office.

“Plus there was a huge flight to get approvals prior to the end of 2022, when the tax abatement structure for new development changed,” Steinberg continues. “We had a 10-year tax abatement prior to that for real estate taxes, which changed in 2023 and became 50 percent of that, so there was a rush to get projects approved.”

No Commitment Issues

Sources say that when tenants and landlords — and their brokers — are negotiating deals for existing spaces, the issue of lengthy time commitments has largely dissipated. The willingness of tenants to do long-term deals is another tried-and-true indicator of investor and user confidence in the long-term health of the market.

“Deal structures have begun to come back to normal in terms of length, though landlords are kicking in more tenant improvement money than they would have a few years back,” says Steinberg. “Landlords are rolling the dice on tenants being successful and that the amortization of all this extra money they’re spending will be a good payoff for them.”

“For the first year or two after coming out of COVID, we didn’t know whatvthe future held and didn’t want to loc into long-term commitments,” adds Fischer. “However, some deals that are more capital-intensive need additional term to amortize costs and just don’t work without a long term commitment.

As the fundamentals have improved, tenants seem more willing to commit to longer-term deals, which allows some of these capital-intensive deals — including tenant improvement and construction costs — to pencil out again.”

Steinberg adds that even landlords with larger vacancies to fill, such as those that own centers that formerly housed Bed Bath & Beyond stores, are embracing more unusual strategies to ensure that long-term deals get done. For example, his team recently represented Insomnia Cookies in a 26,000-square-foot deal to backfill a former three-story Walgreens. The tenant devised a plan in which it would have its corporate office on the top floor, devote the second floor to research and development and operate the ground floor as a retail space.

“Landlords are doing deals they didn’t think they’d be doing in 2019, but those that are willing to be nimble and creative are the ones doing deals and filling up their spaces,” says Steinberg. “And for these larger spaces, tenants are committing for 10 years or more.”

Gartner notes that spaces formerly occupied by Bed Bath & Beyond throughout the Philadelphia area are generating tremendous interest from a range of users.

“Those spaces were very well-located in regional shopping districts, and although each space has its own nuance, all have had a lot of eyeballs on them by replacement tenants simply because of their irreplaceable locations,” he explains. “Any tenant that has a big need for space, can pay rent, has good credit/staying power and isn’t in conflict with any other tenants can go there.”

Gartner adds, however, that owners of these larger vacant boxes are being patient and thorough in terms of evaluating tenants. Above all else, they seek to avoid having to subdivide the spaces and to be able to lease the entirety of the box to a single tenant.

With backfilling these spaces, the excessive cost of subdividing the space into smaller units isn’t borne by tenants, so landlords want a tenant that takes the whole space,” he explains. “A landlord might be less discerning about the tenant if they can avoid the seven-figure cost of dividing the space. But for those that are still empty, it’s not an indictment of the area, but more likely a peculiarity with that particular space and the landlord wanting to get it right.”

F&B Leadership

The CBRE report also highlighted strong sales growth across a variety of categories, particularly the all-important food-and-beverage (F&B) sector, which posted a year-over-year increase of 6.5 percent in the second quarter. This figure indicates that consumers are still spending healthy amounts of disposable income within an industry that continues to display highly visible signs of inflation.

In July, national retail sales increased 0.7 percent over the prior month, according to the U.S. Commerce Department, marking the best monthly gain since January. Sales at food service and drinking places rose 1.4 percent. On a 12-month basis, retail sales overall increased 3.2 percent, which is in line with the annual increase in the Consumer Price Index, reports CNBC.

The news outlet also notes that shoppers have increasingly relied on credit cards, the balances of which exceeded $1 trillion for the first time in the second quarter of this year.

“We’ve seen some really interesting food-and-beverage deals that we didn’t anticipate in Center City lately,” says Steinberg. “Several fine-dining, white-tablecloth restaurants are taking ground-floor spaces of residential high-rise buildings that are under construction, which is a segment of the market that Center City really didn’t have for some time.”

Pictured is Anova uCity Square, a 462-unit apartment community in the University City area by GMH Communities. The community opened last summer, adding 10,000 square feet of retail space to the local supply. Retail components of multifamily and life sciences projects like this can add much-needed supply, but more pure-play retail development is also needed.

According to Steinberg, among the upscale dining concepts that will anchor the retail components of new multifamily buildings are steakhouse Loch Bar, tapas restaurant Boqueria and Japanese- Peruvian concept Chotto Matte. All of these users have committed to relatively large spaces — about 9,000 square feet on average.

“Restaurants are having some of their best years ever in terms of revenue and volume — even when adjusted for inflation— driven by people that dwell in the city and are returning to visit from the suburbs of outside the region,” says Gartner. “Retail space is sought-after on Center City’s prime shopping corridors of Walnut and Chestnut, and we see more entrants in what we call ‘competitive socializing’ — restaurants with a stated activity to accompany the food and drink. These concepts are taking up some of the larger vacancies.”

Coradino of PREIT also highlights the importance of this emerging subcategory of F&B real estate — and of this segment of the market in general.

“As a result of the shifting dynamic of work schedules and locations, the suburbanization of the region has greatly benefitted the dining and entertainment venues at our properties,” he says. “Specifically, sales at food venues are outpacing the balance of the portfolio, and our entertainment destinations are exceeding their sales expectations.”

“In addition to traditional dining and entertainment, we are seeing a rise of new uses including ‘competitive socializing’ — think golf simulators, pickleball, axe throwing, electric go-karts and more,” Coradino continues. “These venues typically look for larger-than-average spaces, so they can be difficult to accommodate, but they round out a tenant mix nicely for the community hubs we’re creating.”

Among the marquee deals for this emerging subcategory of retail real estate is Puttshack’s 26,000-square-foot lease at The Shops at Liberty Place. Scheduled to open before the end of the year, the space will feature four tech-driven courses as well as a full bar and restaurant.

Fischer of Federal Realty says that Philly landlords are also fielding healthy demand from fast-casual/quick-service restaurants, as well as grocers that are aggressively expanding their regional and/or national footprints. This activity appears to be moving forward despite diminished daytime populations in certain submarkets that are heavy on office buildings.

“There’s still a good portion of the population that hasn’t returned to the office on any frequent level. This impacts retailers and restaurants that rely heavily on the daytime population, but many have found other revenue streams and are still performing well, so demand is coming from elsewhere,” he says.

This article originally appeared in the August/September 2023 issue of Northeast Real Estate Business magazine.

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