Jared Feldman is the executive chairman of First National Realty Partners, leading the firm in institutional-quality acquisitions.
The retail real estate landscape is evolving in ways that present opportunities for investors. As retailers face increasing difficulty in securing new spaces to lease, landlords find themselves in a position of strength, with the ability to move quickly to identify new tenants for vacated spaces while having the potential to increase new rents above prior rents. This dynamic is shifting the balance of lease-negotiating power in favor of property owners, signaling a robust environment for retail investors. With demand outpacing supply, particularly in high-performing segments like grocery-anchored shopping centers, investors can capitalize on rising rental rates, stronger lease terms and long-term stability in this resilient asset class.
How We Got Here
Prior to the Great Recession, developers built new retail properties so rapidly that a significant oversupply of space was created. While the financial crisis in 2008 led to a sharp drop in new construction projects, it also led retailers to scale back on expansion plans and close some stores. The oversupply of real estate enabled tenants to demand concessions from landlords. In the ensuing years, the supply has been whittled down. Still, prior to 2019, market analysts continued to believe that the U.S. had too much retail space. That is no longer the case as retail vacancies have declined to a five-year low, outperforming other commercial real estate categories.
With available space consistently below 5% over the past few years, retail real estate is now enjoying record occupancy levels. Net absorption has been positive for 15 consecutive quarters while vacancies have hovered around 4% all year. In practice, there’s even less available space for new and expanding tenants than the data suggests.
Factors Impacting The Market
Several factors are contributing to the supply shortage in retail real estate:
• A dearth of new construction: With inflation hiking the costs of capital, labor and materials, developers remain cautious about spending on retail. Net deliveries of new retail space are about 40% below the 10-year average. The problem has been compounded by the demolition of existing space to the tune of 155 million square feet over the past five years, and most new space is pre-leased by the time construction is complete.
• A desire for convenience: As consumers continue to want to handle transactions with minimal delay, spaces with drive-through facilities are in high demand. Quick-service restaurants are evolving their formats and expanding, banks are seeking more drive-through facilities for conveniences such as cash deposits, and retailers of all types are asking landlords to help them meet curbside pickup demand with locations and parking lot layouts that facilitate this function.
• Retail mergers and acquisitions: Large national bank brands, for instance, have been buying up regional banks. When this happens, they typically want to reposition their real estate, sometimes upgrading to prime locations.
• Consumer habit changes: When the pandemic prompted people to eat at home rather than dine out, it spurred interest in home cooking. This drove grocery sales higher, and the resulting foot traffic attracted people to grocery-anchored shopping centers. Hybrid and remote working models continue to keep people closer to home, spurring foot traffic at necessity-based retail. With inflation prompting consumers to spend judiciously, discount stores are also taking share from department stores, adding to the migration from malls to other retail centers.
Where The Highest Demand Is
Grocery-anchored neighborhood shopping centers in highly populated areas are in especially high demand, including from big-box retailers opening smaller stores. CoStar data shows strip and power centers enjoying high occupancy, while malls decline in popularity. This is due to retailers’ desire to be in open-air centers with high foot traffic—places people frequent close to home.
The brands most eager to inhabit these spaces represent the retail segments performing well in today’s market. CoStar cites food and beverage, discount and off-price, and experiential stores as the top would-be tenants. My firm’s experience bears that out, with heavy demand from big boxes, discounters, gyms, quick-service restaurants and banks. Investors can capitalize on this demand by focusing on properties catering to these sectors.
How Landlords Are Managing Retail Space Challenges
While the shortage of retail space creates opportunities, it also presents challenges for landlords. However, these are manageable and come with potential rewards:
• Capital allocation: Investors need to carefully evaluate tenant mix and the associated costs of tenant improvements. In our experience, we’ve seen retailers requesting just $35 per square foot for improvements compared to $100 in the past, providing more flexibility for landlords.
• Lease negotiations: Exclusive agreements with tenants can limit leasing options. Investors should consider the long-term implications of such restrictions, particularly in multi-tenant properties.
• Waivers for desired tenants: When lease agreements restrict the type of tenants allowed, landlords must negotiate waivers, often offering concessions such as lease extensions or improved terms in other locations.
Why This Matters To Investors
This constrained supply environment is creating opportunities for investors to benefit from:
• Higher rental rates: With limited space available, landlords can command rents significantly above previous lease rates. JLL notes that "backfilling a space under a previous 10-year lease can result in market rents as high as 32% above what the starting rent was for the expired lease."
• Faster lease-up periods: Vacated spaces are being filled quickly, reducing downtime and ensuring steady cash flow.
• Favorable lease terms: Retailers are taking on more of the financial burden for tenant improvements, lowering capital expenditures for landlords and improving overall returns.
With consumers expected to continue to frequent neighborhood shopping centers and little new construction anticipated anytime soon, retail space that can meet the high demand will likely continue to command premium rents. For investors, the tight supply-demand dynamic provides a compelling case for investing in grocery-anchored retail. One of the least affected by the macro environment, this asset class is projected to experience steady performance.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
Forbes Coaches Council is an invitation-only community for leading business and career coaches. Do I qualify?
