How Shifts in Consumer Habits Impact Retail Investment

In today’s economy, the consumer drives change. As consumer habits, behaviors, and preferences shift at a faster rate than ever, so must the strategies of property owners, investors, and retailers. Recent economic indicators paint a nuanced picture. Consumer spending, long a pillar of economic growth, shows signs of strain. The U.S. Bureau of Economic Analysis reported a modest 0.2% increase in personal consumption expenditures for March 2024, a deceleration from previous months.

This slowdown, coupled with persistent inflation concerns, signals a potential decline in consumer pricing power. For commercial real estate professionals, these economic changes call for a more tailored approach to investment and property management. Inseparable from the consumer, the retail sector particularly finds itself at a crossroads.

The Digital Shift in Pharmacy Retail

One sector experiencing significant transformation is pharmacy retail. The global online pharmacy market is projected to grow by 79.4% between 2023 and 2028, according to recent industry reports. While e-commerce isn’t new, the surge in its adoption has profound implications for brick-and-mortar pharmacies and their landlords. James Dumont of White Cross Dispensary in Ottawa, Ontario, encapsulates this shift. “Embracing e-commerce has expanded our reach into the global market,” he notes. “It’s directly integrated with our brick-and-mortar business, seamlessly connecting us to a world of new customers.”

This digital pivot isn’t just about convenience; it’s a response to changing consumer expectations and economic realities. With widespread reduced pharmacy store hours due to staffing issues, an online presence opens new sales avenues. However, the transition to digital comes with challenges for commercial real estate. Walgreens’ recent announcement of plans to close 25% of its physical locations signals the potential impact on property owners. As major pharmacy chains reassess their brick-and-mortar footprints, landlords must adapt to maintain property values and attract tenants.

The Grocery Sector’s Resilience

In contrast to the upheaval in pharmacy retail, the grocery sector shows remarkable resilience. Despite a challenging transaction environment in 2023, when total investment volume dropped to $7.5 billion (the lowest in 12 years, excluding 2020), analysts are optimistic for 2024 and beyond. This optimism stems from consistently higher occupancy rates compared to other commercial real estate asset classes. Grocery-anchored centers, with their strategic market positioning and synergistic tenant mixes, create ecosystems that promote tenant success and customer satisfaction.

Consumer behavior plays a crucial role in this resilience. Foot traffic data from Placer.ai reveals interesting trends. While established giants like Kroger and Publix continue to lead in total visits, discount chains such as Aldi and Lidl are experiencing significant year-over-year growth. This shift reflects consumers’ increasing price sensitivity in the face of economic uncertainties. For investors, this shift only reinforces the importance of tenant mix. Properties anchored by adaptable, consumer-focused grocery chains will prove more resilient to economic changes.

The Omnichannel Imperative

As consumers increasingly toggle between digital and physical shopping experiences, retailers and property owners must embrace an omnichannel approach. This strategy isn’t about choosing between online and offline; it’s about creating a seamless integration of both. In the pharmacy sector, this might mean using physical locations as fulfillment centers for online orders or offering in-store health services that can’t be replicated digitally. For grocers, it could involve expanding curbside pickup options or integrating mobile apps with in-store experiences.

From a real estate perspective, this shift demands flexibility. Properties that can accommodate both traditional retail and e-commerce fulfillment may command premium values. Likewise, locations that offer easy access for both foot traffic and delivery vehicles will likely see increased demand.

Impact on Commercial Property Values

The relationship between changing consumer habits and commercial property values is complicated. On one hand, the rise of e-commerce and changing shopping patterns could potentially depress demand for certain retail spaces. On the other, properties that successfully adapt to these new realities may see their values rise.

Cap rates for retail properties have remained relatively stable, with yields hovering between 6.7% and 6.9% in Q3 2024. However, as interest rates potentially decline in 2024, investors should anticipate some compression in these rates. Transaction volumes tell a more nuanced story. While the average deal size for grocery retail fell by 16.6% year-over-year in 2023 due to investor caution amid economic uncertainty, this trend reversed in 2024 with an 8% increase.

Real Estate Investment Trusts (REITs) are adjusting their strategies to match changing consumer behaviors. With consumer spending slowing, REITs are focusing on tenants with strong online and offline shopping strategies. Grocery-anchored centers are particularly attractive due to their high occupancy rates and effective tenant mixes. REITs are also paying close attention to the financial health and plans of their tenants. Properties with flexible, omnichannel tenants are more likely to maintain value.

Regional Variations and Net Lease Retail Perspective

Consumer behavior and its impact on commercial real estate vary across the country. For example, in Southern California, demand for grocery-anchored spaces is high, with vacancy rates for big-box spaces below 3%, often leading to higher rents when grocery stores replace previous tenants. Local market knowledge is crucial as properties that align with regional consumer preferences are likely to outperform their peers.

Understanding consumer behavior is essential for investors in net lease retail properties. Properties occupied by national chains like pharmacies or grocery stores are sensitive to shifts in retail strategies. The announced closures of Walgreens locations highlight the need for investors to scrutinize tenant financial health and long-term strategies. Properties with tenants that have strong omnichannel strategies and adaptable business models may command premium prices and lower cap rates.

Consumer Habits: Looking Ahead

As investors, owners, and retailers encounter more nuanced shifts in consumer habits, several key considerations emerge:

1. Flexibility is key. Properties that can adapt to changing retail strategies will likely see sustained demand.
2. Location remains crucial, but its definition is evolving. Proximity to population centers matters, but so does accessibility for both customers and delivery services.
3. Tenant mix is more important than ever. A diverse array of tenants that complement each other and serve various consumer needs can create resilient retail ecosystems.
4. Technology integration is no longer optional. Properties that support retailers’ omnichannel strategies will have a competitive edge.
5. Economic indicators, particularly those related to consumer spending and inflation, will continue to play a crucial role in shaping retail real estate trends.

The connection between consumer behavior and commercial real estate is complex and constantly changing. As the industry moves forward, success will hinge on the ability to anticipate and adapt to changing consumer preferences. Those who can navigate these shifts skillfully will find opportunities amidst the challenges, shaping the future of retail real estate in the process.