Exploring Undefined Territory: Strip Retail Centers

Strip retail centers have flown under the radar in recent years as investors have gobbled up shopping centers anchored by grocery stores. Over the past 24 months, institutional capital has turned its eyes to properties without a high-profile anchor to strip retail centers. Let’s explore why.

 

What Is a Strip Center?

Generally speaking, strip or convenience centers are smaller shopping centers between 10,000 and 50,000 square feet with four tenants or more, none of which are considered an anchor. Tenants include a mix of local mom-and-pop businesses and credit tenants who lease space 1,000 to 5,000 square feet, each. These centers are among the smallest of centers that provide services to a limited trade area.

 

 

 

Strip centers are in a different category from new outparcels or pad sites that accompany neighborhood, power, or community centers that typically host two or three tenants with above-market rents, boosted by tenant build-out and backed by credit.

 

Shopping Center Fundamentals

 

 

Rents

Retail rents are rising as there’s not enough quality retail space to go around. This can be good or bad news, depending on whether you are a tenant or a landlord. Unanchored strip centers reached a record high of $20.37 per square foot in Q3 2023, a 17.3% increase compared with the same period in 2019. By Q1 2024, these strip centers’ market asking rent reached $22.86 per square foot.

 

Rent increases were felt, especially in primary Sunbelt markets like South Florida, Las Vegas, and Austin, which saw increases between 7% and 8%. But they were even more notable in secondary and tertiary markets like Jacksonville (up 12.6% YOY), Phoenix (up 9.8%), and Omaha (up 9%).

 

 

Openings vs. Closures

In 2023, store openings outpaced store closures for the second straight year. Retailers closed 4,913 stores (totaling 88+ million square feet) but opened 5,645 stores, up 4.7% annually. Discount stores, typically found in strip centers, recorded 34.4% of all openings or approximately 1,941 stores.

 

According to CoStar, over two-thirds of retail leasing activity in 2023 came from small tenants occupying, on average, less than 5,000 square feet. Food and beverage tenants, in particular, snapped up small strip spaces under 3,000 square feet, accounting for 20% of all leasing activity. The top two tenants include Wingstop (leased 205,100 square feet in 2023, average square feet under 2,500) and Raising Canes (leased 318,500 square feet in 2023, average square feet between 2,500 to 5,000).

 

This year, 4,000 retail store closures and 5,500 openings are projected. (Source: Coresight)

 

Traditional shopping malls remain at higher risk for closures compared to strip centers. This is in large part because shopper traffic to malls, often anchored by department store chains, has been pressured in recent years as consumers prefer quick trips to stores closer to where they live.

 

Annual visits to strip malls increased by 18% in 2022 compared to before the pandemic. (Source: RetailStat)

 

Occupancy

As more retailers move to strip centers, the rate of available space fell to 5.3% in 2023, representing the tightest supply level on record. In 2024, the availability rate has increased slightly to 5.7%, a direct result of new construction coming online. Strip center occupancy remains strong, with spaces less than 5,000 square feet having the highest demand, largely thanks to QSR openings. Occupancy is 95% or higher in most markets, with tenants such as Chipotle, Starbucks, and Chase drawing attention to the space.

 

In Q1 2023, the occupancy rate for strip center REITs was 95.2%—a rate that hasn’t been seen since 2015. (Source: LP Legal)

 

 

Developers Shift Focus

There used to be space for all retailers looking for frontage, but times have changed. Shopping center development isn’t happening at the same magnitude it was in the early 2000s. Construction costs, the cost of capital, and competing uses for land hinder justification for new development. Given this information and the already low rate of available space in strip malls, supply is tight in relation to demand.

 

Unanchored strip centers account for 60% of total shopping centers by count and almost 13% by GLA (Source: Curbline)

 

The only centers being built in abundance are outparcel centers with rents within the range of $40 to $60 per square foot and anchored shopping centers. These centers are composed of national credit tenants that have pre-leased the space and can pay these rents as high TI dollars bolster them.

 

Unanchored strip centers cost between $300 and $500 per square foot to construct, depending on location and land costs.

 

Strip center tenants typically pay within the range of $20 and $30 per square foot, with landlords unwilling to front hundreds of thousands of TI dollars. The few new strip centers that are being developed contain small spaces on spec for tenants needing between 1,000 and 5,000 square feet.

 

Less than 25% of under construction stock was available for lease at the end of 2023. (Source: CoStar Group)

 

 

Investor Interest Increases

Investors were especially interested in grocery-anchored open-air product types in 2023, with unanchored strip centers, neighborhood centers, and power centers as runners-up. Unanchored strip centers comprise a large portion of U.S. retail real estate but are primarily owned by small, private owners. In 2023, according to data from RCA, 88% of unanchored retail center transactions involved purchases by private investors. Publicly traded and institutional investors purchased 9%.

 

 

 

 

As of recent, institutional investors and other large funds with significantly raised capital have taken notice of the space. Since close to 90% of unanchored retail assets were acquired by private buyers in 2023, this provides a unique opportunity for a public vehicle to scale and differentiate itself in the marketplace. As of Q1 2024, the buyer composition for unanchored strip retail centers has shifted in favor of institutional REITs, recording a 6.7% increase in interest. Despite this new attention, institutional money and private discretionary funds still need to be selective in acquiring strip centers; they must have very sound fundamentals for the deal to pencil.

 

SITE Centers announced in October 2023 its plan to spin off its convenience properties (strip centers) into a separate publicly traded REIT called Curbline, capitalizing on the growing interest in unanchored retail strip centers. The REIT expects 2024 SITE Centers’ NOI of $260.7M to $269.8M, while Curbline properties will generate NOI of $73.9M to $77.9M.

 

 

Pros of Unanchored Retail Strip Centers

Attractive Economics

Strip centers are laid out as a ubiquitous line-up of shop units attractive to a wide variety of high-credit national tenants (typically with annual bumps), limiting long-term capital needs and obsolescence risk.

 

Unanchored strip centers have higher returns than retail properties leased to a single tenant. They also have low risk as space is easy to backfill, meaning less reliance on credit tenants.

 

Small businesses turned to retail strip centers in urban and suburban areas during COVID-19 to avoid being dragged down by the closure of anchor stores. These centers also provide an opportunity for smaller tenants, or businesses needing to get off the ground to lease space despite not being credit tenants but having an established credit history.

 

Scalable

Convenience assets are among the most liquid retail real estate, with $8.7B in transaction volume trading annually on a total inventory of 68,000 unanchored centers nationwide, providing an opportunity to scale a portfolio in the top sub-markets of the U.S. There is a lot of untapped “mark to market” opportunity.

 

Fewer Competitors

While this can be a pro or con depending on which side of the transaction an investor is on, fewer strip centers have been coming to market, meaning assets are entering a market with little product available at higher interest rates. However, those owners that have favorable debt on current holdings are within the 3% – 4% interest rate change.

 

Convenience

Data analytics confirm that real estate on the curbline overwhelmingly caters to convenience trips from the growing suburban population, boosted by work-from-home and limited supply. Annual visits to strip centers increased 18% last year compared with before the pandemic, according to retail and commercial real estate data analytics firm RetailStat, which analyzed foot-traffic data from 2,500 centers.

 

The assets draw customers from larger trade areas and experience more frequent, short-duration visits than previously believed. The dedicated parking and excellent visibility have also led to historically elevated retention and occupancy.

 

Cons of Unanchored Retail Strip Centers

While retail strip centers can be excellent investments and be included as part of a diversified portfolio, convenience is critical as these centers, by definition, have no major anchor draw. Real estate fundamentals aside, some common pitfalls for retail strip centers exist.

 

The Inconvenient Center

Spanning between 40,000-50,000 square feet, these centers are situated away from intersections and feature inconvenient curb cuts. They fall into a size limbo, too small to accommodate a grocer yet too large to be filled with convenience tenants. Visibility is hindered by the troublesome curb cuts, making it impossible for consumers to navigate in/out of the center, often resulting in them passing by or restoring to U-turns on busy roads for entry and exit.

 

The Center Without Focus

Unlike strip centers with a harmonious blend of tenants, which attract consumers from a broader area, these centers lack a cohesive tenant mix. The leasing strategy of these centers prioritizes filling vacancies over addressing the fundamental issues within the center. In today’s consumer landscape, convenience reigns supreme. A strip center with a complementing tenant mix, one with a mixture of convenience and specialty shops allows individuals juggling work and household responsibilities the convenience of one-stop shopping.

 

The Not So Visible Center

These centers suffer from poor overall visibility, with notable dead zones such as cramped “elbow space” found in the corners of L-shaped layouts. Approximately 80% of the stores in these centers have less than 20% visibility. The fundamental issue lies in the imbalance between the number of stores and available frontage, rendering it impossible to accommodate stores smaller than 2,000 square feet when depths exceed 100 feet. When center signage fails to face traffic or if neighboring buildings obstruct store views, drivers approaching will be unable to pull in easily, resulting in hardships for small chains and mom-and-pop retailers that already do very little advertising. In contrast, perpendicular centers typically offer 20% – 30% visibility.

 

The Two-Story Center

This type of center features two stories but struggles with vacant tenancy and inadequate parking, making it impractical except in urban or densely populated areas. The high vacancy stems from retailers’ reluctance to lease on the second floor, as it requires consumers to climb stairs. This prompts landlords to repurpose the upper level for office use.

 

Office space on the second level and retail on the first introduces concerns for both. Retailers fear office employees occupying the second story will congest the parking lot, inconveniencing shoppers. Conversely, office workers hesitate to park in crowded lots, fearing hurried consumers will damage their vehicles.

 

The Unnecessary Center

This center is located in an area where there is either (1) not enough population or (2) too much competition. As such, this otherwise well-planned center may be rendered unleasable.

 

A Rising Tide Lifts All Ships

In a strong retail market like the one we are currently in, as defined by increasing rents and historically low vacancies, many of the “cons” of strip centers are not as visible. Even centers with poor fundamentals are well leased even now. As they say, a rising tide lifts all ships, but when the tide eventually goes back out, the fundamentals of the center will prove themselves. The poorly designed or located centers will have a disproportionate amount of vacancies compared to fundamentally sound counterparts. This is a large reason why institutional funds are very selective in their investments and still only account for a small percentage of overall ownership.