Strong Retail Fundamentals Limiting Value-Add Opportunities, Boosting Outlook and Sales Trends for Most Retail Sub-Types

Lack Of Available Space Discouraging Listings for Lower-Tier Centers

Retail has successfully overcome the “Retail Apocalypse” narrative that dominated the 2010s, and has even improved its performance since the onset of COVID-19. While e-commerce is fully integrated into consumer habits, store-based retail sales continue to grow. This sustained consumer spending has driven retail vacancy to a record low for the asset class. Meanwhile, annual rent growth has been positive for more than a decade. Though this benefits existing owners, it has created a sales market where value-add opportunities are increasingly scarce.

Retail fundamentals have also been bolstered by a sharp decline in new development. In 2008, 231 million square feet of new retail space entered the market, compared to just under 100 million square feet completed from early 2023 through the end of Q3 2024. Over the past 12 months, construction has started on only 32 million square feet. This drop in development has further inflated Class A rent premiums due to the shortage of high-quality options. As a result, tenants are less likely to vacate older centers, tightening vacancy rates and boosting rent growth even in older, less amenity-rich properties.

From the tenant’s perspective, only 6% of available retail space for lease is in Class A buildings, making it difficult for many retailers to upgrade to newer spaces. This scarcity has driven up rent growth and demand for older centers, many of which would have previously been candidates for renovation. Pre-1980s buildings have seen rent growth at or above the long-term average for nearly a decade. Existing owners are seeing better-than-expected performance, reducing the incentive to list assets or cut prices to offset the higher borrowing costs that buyers face. Forced sales remain well below recessionary levels, despite increased refinancing costs. Retail CMBS delinquency was just 6.1% in August, down significantly from the 18.1% peak recorded in June 2020.

Institutional Investors Expanded Property Search

The scarcity of listings is affecting more than just value-add opportunities. Investors looking to enter the retail space or expand their portfolios are broadening their criteria to find deals that make financial sense. Strong rent growth in the lifestyle and power center subtypes has made holding onto centers more profitable for owners, while institutional investors are struggling to find opportunities to deploy their built-up capital. Dry powder reached record levels at the start of the year, but firms like Blackstone and Kimco have begun to put that capital to work.

At the same time, shifting consumer preferences have redirected tenant demand away from big-box stores, favoring the smaller spaces typical of strip and unanchored centers. Demand for these spaces is significantly outpacing new supply, as many of the tenants occupying them offer services or experiences that are difficult to replicate online. Nail salons, barbershops, restaurants, and bars are among the primary tenants of unanchored retail centers, each recording an increase in demand growth from 2021 to today. As a result, vacancy rates at unanchored centers have fallen from nearly 12% a decade ago to just over 4.5% today.

Investors have taken notice, and institutions that once targeted only larger or grocery-anchored centers are now showing interest in the returns offered by strip and unanchored centers. For example, the Woodfield Village Green shopping center, an unanchored property, recently sold for over $93 million, marking the largest retail deal in Chicago since 2022. Additionally, Brookhaven Station – a well-located neighborhood strip asset, near Buckhead, set the price per square foot record in the Atlanta MSA in 2024, trading for $30.2M or $670 PSF. More deals like this are expected as firms work to reintegrate their accumulated capital into the market.

Fundamental Strength Persists Across Shopping Center Type, Excluding Malls

Retail’s recent success spans across various types of centers. Vacancy rates have hit record lows for neighborhood, grocery-anchored, and strip centers, and are near record levels for larger power centers, despite notable store closures. Tenants are becoming less selective with site selection, often favoring smaller spaces, which has particularly boosted demand for strip centers. Mall vacancy has stabilized between 8.5% and 9.5%, and the ongoing redevelopment of older malls is expected to enhance demand and foot traffic at the remaining properties.

Grocery-anchored centers have outperformed expectations in both operations and sales. Rent growth in this subcategory reached 3.4% for the 12 months ending in July 2024, outpacing the U.S. retail average. The strong performance is largely driven by high foot traffic, as online ordering and store pickup options have not significantly reduced grocery store visits. While grocery sales spiked in 2020 due to restaurant closures, spending on groceries has returned to record levels, even with restaurants back in competition.

Investors have taken notice of this strong performance, driving record sales trends in grocery-anchored centers that contrast with broader CRE and retail trends. Although cap rates have risen slightly since 2022, this is primarily due to capital market volatility rather than discounted trades. Investors are particularly drawn to grocery-anchored properties in fast-growing Sun Belt cities. Further relief on debt costs, fueled by anticipated Federal Reserve rate cuts, is expected to boost retail CRE sales going into 1Q 2025, especially as chains like Publix, Aldi, and Whole Foods continue their expansion plans.

Retail leasing’s strength has had a curious (negative) effect, in some ways, regarding retail investment sales over the last two years. Given the overall strength of retail fundamentals post-COVID, the stability of shopping centers has created a significant dearth of value-add product in the market; specifically in regions like the Sun Belt, which have seen tremendous population growth, along with a flood of new investors clamoring for opportunities. Over the last 24 months, there has been a significant dumbbell effect at work, with many traded assets falling into the category of lower cap rate, grocery-anchored centers or higher cap rate, stabilized community centers. In between these two asset types, there has been next to no value-add product, even as the amount of sidelined capital awaiting these opportunities has exploded. The result has been a feeding frenzy for the few, well-located retail centers with notable upside (i.e. a vacant box), with competitive interest driving value well above anticipated pricing.