You can be a best-in-class operator with the coolest concept on the block, or you can be a well-capitalized landlord who knows all the right people, but if rapid, sustainable growth in the Boston retail market is what you seek, you might be SOL.
According to local brokers, the high-demand, low-supply dynamic that currently exists in most major U.S. retail markets does not fully encapsulate the difficulties that tenants and landlords alike face in growing their footprints in the greater Boston area. As to why growing store counts or portfolios is so challenging in this market, the answer varies depending on who you ask. But a collective recap of all wide-ranging barriers to entry and disruptive forces at play paints a picture of a market that is borderline impenetrable for many tenants and perpetually stagnating for many landlords.
“Boston remains an incredibly high-barrier-to-entry market,” says Zach Nitsche, director of retail capital markets in JLL’s Boston office. “A statistic we like to share with clients and industry people that haven’t historically invested in Boston and New England is that less than 5 percent of our total retail product has been constructed after the Global Financial Crisis. So far this year, the market has delivered less than a tenth of a percent of new supply [of the total inventory], which is below the national average. That’s reflected in our vacancy rate, which is about 2.5 percent across the Boston metro area.”
Data from CoStar Group immediately confirms Nitsche’s anecdotal numbers. As of the second quarter of this year, Boston’s retail vacancy stood at 2.7 percent, per CoStar, up from 2.4 percent in the prior period. Only once in the past three years has the average asking rent, which currently stands at $28.16 per square foot, experienced a negative pace of quarterly growth, according to CoStar’s data. That occurred between the fourth quarter of last year and the first quarter of this year and was really more of a flattening of the curve than a dip. In addition, the marketwide vacancy rate has never eclipsed 3 percent during that stretch.
This dynamic is somewhat ironic given that — at least on the tenant side — Boston checks just about every box: density, walkability, youthfulness, strong levels of disposable income. Further, generally speaking, the one-two punch of strong occupancy and extremely limited inventory growth makes the Boston retail market very attractive to investors with long-term hold strategies. This is a market that features an eclectic blend of soft goods merchandisers, a food-and-beverage sector punctuated with talent and a growing and evolving entertainment scene. It’s all there on paper.
A Brief Window?
In addition, there is presently a little more opportunity in the market for tenants. CoStar reports that there is approximately 850,000 square feet of retail space under construction in the market, which is more or less a three-year high. In addition, one-off vacancies are sprouting up via stores previously occupied by retailers that have filed for bankruptcy in recent months: Big Lots, Party City, JoAnn, etc.
“The bankruptcies freed up some space, but all of those spaces will likely be spoken for in 18 months,” says Rob Robledo, executive vice president of retail advisory and transaction services at CBRE’s Boston office. “Good spaces of 15,000 square feet and above get gobbled up quickly. But what continues to be a really big hurdle for retailers trying to grow and expand is smaller-size spaces; there’s just such a lack of inventory for spaces 5,000 square feet or less, including second-generation restaurant space. The second a unit closes, there’s four or five groups immediately ready to step in.”
Ben Starr, partner at regional brokerage firm Atlantic Retail, has invested considerable time and resources in tracking activity on spaces vacated by bankrupt retailers in recent years. Those efforts found that some bifurcation does actually exist.
“We did some research and tracked those stores, finding that about a third never hit the market because the leases got bought out of bankruptcy,” Starr recalls. “Another third take maybe a year to get filled, and the other third takes longer, which can be problematic. But there’s enough of those bankruptcies such that the extra third puts a dent in occupancy. There’s no question that some owners have high confidence in their real estate that encourages them to wait, but they are a minority among those that own vacant stores.”
Shuttered drugstores from giants like Rite-Aid and CVS represent another form of opportunity for tenants. But Starr says that while junior box stores like those of bankrupt retailers tend to be absorbed quickly, vacated drugstores carry their own sets of challenges because they are often located on prime sites and pay above-market rents. In addition, those space are usually not easily — or cheaply — retrofitted for new uses.
“With drugstore spaces, many owners, especially those that bought newer stores built by merchant developers through 1031 exchanges, believed those investments were as safe as bonds,” says Starr. “But we’re learning that they’re not. A lot of those stores were built in secondary and tertiary markets where land was more available, and it was cheaper to build. They could be problematic, because there are far fewer retailers of drugstore size or near to it that can realistically be expected to pay drugstore rents in secondary or tertiary markets.”
Jack Be Nimble
In order to capitalize on these or other availabilities, tenants have to get flexible, brokers say, especially when it comes to deals in the urban core.
“In Back Bay and similar submarkets, supply has continued to dwindle; we have less than 2 percent vacancy on Newbury Street right now,” says Matt Curtin, executive managing director in Newmark’s Boston office. “Meanwhile demand continues to surge, with multiple tenants showing interest in every available space. So we advise clients in the core submarkets that there’s no such thing as their prototypical store in this market. Buildings are old; layouts are funky, and you have to get creative.”
Curtin adds that his team is currently working on a deal that involves buying existing tenants out of their leases on some upper floors of a four-story building on Newbury Street because the incoming tenant needs the entire building. The deal speaks to the creativity and flexibility that brokers must possess alongside their clients.
“To really create a flagship experience in those core submarkets, tenants may have to take more floors than they would in other markets and really get aggressive on economics to create the opportunity where it may not otherwise exist,” he says. “As brokers, we try to create said opportunity by looking at lease expiration dates that are two or three years out. We talk to landlords about potentially buying an existing tenant out of a lease if they’re not doing well, or if they’ve been there a long time and are paying below-market rent.”
“We get creative in drumming up opportunities because the number of empty storefronts with [for lease] signs on the window is very few and far between, especially for tenants looking for spaces in the 3,000- to 5,000-square-foot range,” Curtin concludes.
Robledo echoes the importance of malleability in this market.
“Tenants have to get flexible on their footprints, dimensions, frontage, loading docks — all the things they say they need, they have to adjust when the right space becomes available,” he says. “And for the most part, they’re willing to do that because we have such great demographics here with medical/life sciences, suburban office, density, disposable income — all the things that retailers look for in growth markets.”
Unique Challenges
As a New England native, Robledo recognizes that even when tenants are willing to adjust their store formats and pony up the dollars, there can still be other factors that keep the deal from getting done — factors that are unique to the region and that nobody can control.
“The topography is part of why we have such a lack of new development in all sectors, and perhaps retail especially,” he explains. “Other limitations include the wetlands and marshlands, plus all the historical buildings and cemeteries. Then you have zoning issues; bylaws in many New England towns are very restrictive on new development. So if you have a site that can be developed and have some decent gross leasable area, there’s the challenge of other uses like multifamily and life sciences — groups that step up and pay to take down that acreage for different uses.”
Nitsche agrees the tendency of vacant sites to become multifamily or life sciences facilities is an obstacle to growth in the Boston retail market, and one that helps assure that the sector’s supply-demand dynamics will not change anytime soon. And while one could argue that construction costs are a deterrent to retail inventory growth in all cities, Nitsche believes they make new development especially challenging in Boston.
“We’re a union city, so a lot of those [construction] costs are higher here than elsewhere,” he explains. “So the return on cost to investors is challenging math to solve for, and in most cases, with where rents and construction costs are, it just doesn’t make sense to build new retail today.”
“Pad sites for corporate tenants like Starbucks or Chipotle are still getting built and command pretty high rents without taking up too much space,” he continues. “Those can be built in parking areas of existing shopping centers, but they’re being constructed with a tenant or signed lease already in hand, so that really doesn’t impact vacancy or the supply-demand imbalance that we have very much.”
Starr, also a New England native, offers a different take on the Boston-specific barriers to entry that is less rooted in economics and more in culture.
“In other markets, people have moved further from the city, creating new residential growth in certain towns, followed by retail growth, but people in New England continue to try to live as close to the major metro of Boston as possible,” he observes. “So you don’t have a westward shift that causes new markets to develop. You have zoning, construction costs and interest rates, but regardless of where those stand, it’s the same story here for the past 30 years — a major challenge [to new retail development] is that people in New England prefer living close to cities.”
— This article originally appeared in the June/July issue of Northeast Real Estate Business magazine.