Looking back to the beginning of 2018, the commercial real estate industry narrative revolved around the so called “retail apocalypse”.
Professionals throughout the country expressed a shared concern about the impact of ecommerce and most importantly Amazon’s effect on brick and mortar retail. Recent bankruptcy filings by Sears, Mattress Firm, and Toys R Us undoubtedly instilled a sense of urgency for retail owners and tenants to rethink their position in the industry. As retailers continue to adapt to the evolving retail market, it’s important to consider some key factors influencing the retail industry.
With the accessibility of information today, consumers have an increasing desire for a convenient personalized shopping experience. Social media platforms such as Facebook and Instagram continue to play an important role in the way retailers market their products to consumers. These platforms utilize artificial intelligence allowing retailers to leverage what consumers search for, personalizing the products being advertised. To combat the convenience of the online experience, retailers will have to make concerted efforts to maintain and increase brand loyalty. Retailers have begun to shift their business models to incorporate both consumer experience and lifestyle branding to buyers who are spending money with companies that align with their values and purchase behavior. Although brick and mortar retail has struggled with the emergence of ecommerce, the majority of consumers still choose to shop in-store. Retailers that can create an emotional tie to the consumer experience while maintaining convenience should flourish as retail continues to evolve.
“With the accessibility of information today, consumers have an increasing desire for a convenient personalized shopping experience.”
The evolution of retail in 2018 was also impacted by a maturing market cycle and a rising interest rate environment. After seven consecutive years of cap rate compression across all major retail property types, 2018 marked the first year of cap rate decompression since 2011. Not only did we see cap rate decompression, but single tenant retail transaction volume decreased more than $150M, a 21% decrease YOY. A decrease of this size suggests buyer and seller pricing expectations are not aligned as indications of a maturing market cycle become more evident. On a brighter note, transaction volume for institutional investments in power and grocery anchored centers set record numbers totaling over $745M in 2018, a 36% increase YOY. Institutional capital continues to not only transact but pay a premium on core urban assets, while secondary and tertiary markets are struggling to close the gap on similar real estate. 2018 began as the year of the retail apocalypse but was truly a year of transition and the evolution of understanding consumer needs.
Single-tenant transaction volume saw a sharp decrease in 2018 even though the number of transactions was nearly identical. The average single-tenant cap rate in the Pacific Northwest increased 16bps in 2018. Big box retailers such as Sears, Mattress Firm, and Toys R Us filing for bankruptcy has created a noticeable inventory of dark single-tenant big box assets. Such assets are problematic for investors as they continue to find ways to create value in back-filling these vacant spaces. Additionally, lower transaction volume can also be attributed to the lack of inventory for single-tenant absolute net lease properties. Single-tenant fast food properties continue to be a highly sought-after investment accounting for nearly 30% of all single-tenant transactions in 2018, trading at an average cap rate of 5.22%. Lease structures also have significant impact on cap rates, as single-tenant properties with rent increases traded at a 67bps premium compared to flat lease properties. The premium placed on rent increases allow investors to hedge against inflation – another valuable consideration in a rising interest rate environment.
Multi-tenant retail transaction volume in 2018 was the lowest it has been since 2015, down nearly $50M compared to 2017. Cap rates across multi-tenant retail increased 20bps YOY. Investors are placing a premium on new construction with such centers trading at an average cap rate of 5.88% in 2018- a 101bps premium compared to their older vintage counterparts. This premium can be partially attributed to the rising cost of construction. For multi-tenant centers to stay relevant, retailers must provide consumers with services that appeal to the consumer experience. Creative mixed-use spaces and experimental tenant lineups can aid in creating value. 2019 should be a year of creativity, innovation, and evolution for multi-tenant retail.
Grocery & Power Centers
As mentioned previously, institutional investment in power and grocery anchored centers set record numbers in terms of transaction volume in 2018. Transaction volume topped $745M in 2018, more than $20M more than the previous record set in 2014. Power centers traded at an average cap rate of 8.51% while grocery anchored centers traded at an average cap rate of 5.39%. The 312bps premium placed on grocery anchored centers indicates two significantly different stories; one, continued investor concern regarding big box risk associated with power centers and the growing impact of the Amazon Effect and two, grocery anchored assets continuing to thrive due in part to the slow integration of the online grocery shopping market. Continued bifurcation between these two asset types will be a trend to keep an eye on in 2019 as retailers reinvent themselves in light of the challenges presented by ecommerce and aligning with consumer demand.