Retail Now—Booming Business or Looming Stagnation?
From the vantage point of New York’s most coveted retail storefronts, the recovery in property fundamentals and values is a fait accompli. Rents and price tags for buildings with flashy retail continue rising, surpassing their pre-crisis peaks with increasing regularity. Buyers on the prowl for urban street retail with trophy status—or even a loose resemblance to fixed income—are not alone, but rather are backed up by lenders vying for opportunities to line up their capital behind stable, albeit aggressively valued, properties.
The enviable trends are not confined to the gilded blocks of Fifth Avenue, Times Square, or Soho, where record numbers of tourists have buoyed the count of pedestrians. Rumor has it the World Trade Center’s transit hub will arrive fully leased. Removed from the traditional tourist circuit, Brooklyn’s population surge and the reinvention of its downtown as a broadly appealing entertainment hub bear out the retail opportunity in the boroughs.
New York City’s notable retail properties have distinct advantages over the highly heterogeneous sector writ large. The headline urban tenant mix offers a sense of place and experience and it is a group more seamlessly able to transition to complementary online commerce than the full range of American retailers. In bolstering brand perception, there is a marketing benefit to a prominent New York flagship that transcends the standard occupancy cost calculus for any one store. And, assuming their numbers hold, visitors to the city are relatively flush with discretionary dollars.
The special circumstances of New York City’s retail landscape are important qualifiers in assessing the broader outlook for the retail sector and its many subtypes. Vibrant urban centers command a premium, as retailers follow residents and businesses back towards downtowns. With few exceptions, demand growth everywhere else is weak and the reality of changing consumer behaviors and channel preferences are more challenging and difficult to augur. Recent history suggests we struggle to foresee these changes. Fairly late into the game, ratings reports were extolling bookshops as stabilizing anchors.
Construction and Closings
Outside New York and its gateway peers, the retail sector is on the mend, albeit slowly. As compared to more stable regional malls, suburban neighborhood and community shopping centers that saw occupancy rates fall further during the recession have been on a gradual but reasonably consistent path of improvement. Absorption of retail space has been unspectacular, but binding constraints on development—including hesitant lenders—have kept supply in check until recently.
The absence of significant construction has been a saving grace to the sector. The development pipeline was measured heading into the recession and has been slow to expand. In the shopping center segment, the combination of the last year’s deliveries and space under construction barely amounts to half a percent on in-place inventory. The pipeline has been even thinner for neighborhood and community shopping centers, where the national vacancy rate still hovers above 10 percent. The vacancy rate is less than half that for malls, but even here development has remained subdued.
Spending on shopping center and mall construction increased to $12.2 billion in 2013, up 20 percent from a year earlier but less than half its 2008 tally. The numbers are rising faster in 2014, particularly as competition-weary banks reenter the development lending space, as they look past the multifamily sector that had been their bread and butter.
If the anecdotes are any guide, development has embraced the idea that retail space must appeal to our desire for an experience and should be lifestyle-oriented. The mix of tenants in a desirable development is more inclined to provide a service, or feed you, than fill your shopping bag. Even grocery stores may come under pressure if the AmazonFresh experiment in same-day grocery delivery proves out and attracts other entrants to the space.
As the drought in the development pipeline reaches a conclusion, the changing relationship between retailers and their customers becomes a more acute issue for investors. More stores will open, even though net new demand for space will remain subdued across a range of product categories. And we can disabuse ourselves of the idea that store closings are a historical feature of the Great Recession. Disruptions to the sector, principally from shifts in consumer preferences and from substitution into online sales, have supported a parallel pipeline of announced and prospective closures that easily rivals development in its robustness.
Consumer Wild Card
Some stores close because the times have changed. On the margin, others might remain open if shoppers find their wallets replenished. The consumer has been an uneven contributor to the retail recovery and will likely remain so, barring stronger outcomes in wages and income which have yet to materialize. Notwithstanding a sideways housing rebound, higher home prices have converged on the slowly improving labor market to lift consumer confidence. Simple population math has also meant that aggregate consumer spending has risen since before the recession even ended, blunting the drag on individual consumer spending from flat or declining U.S. household incomes.
But looking forward, and without a strong supply constraint, property income gains will depend increasingly on improved labor market outcomes and consumers that are deeply engaged in the experiences bricks and mortar can offer—and the Internet cannot.