How High Rates and Low Supply Are Shaping the Retail CRE Market

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Supply Drought and Soaring Rates Propel Retail to

Despite e-commerce challenges amidst the pandemic, the retail sector is thriving with six months of continuous sales growth. However, rent growth is slowing down. JLL's U.S. Retail Outlook Q3 2023 report emphasizes that the main challenge is limited prime space, not a lack of demand.

What’s hampering the growth? The shortage in retail real estate is mainly due to a scarcity of new constructions and the demolition of 145 million square feet in the past half-decade. Availability rates are 200 basis points below the long-term average, with a particular deficit of medium-sized units and additional parcels in prime Sun Belt locations.

Between the lines: Despite this, the percentage of leased space is still higher than average, at 8% of total space. Construction has dropped by 30.4% from the previous quarter, contributing to a steady vacancy rate of 4.2%. Rent is increasing across all major markets, with the Sun Belt experiencing the highest growth, though the overall pace of rent hikes is decelerating.

Demand is shifting to freestanding retail spaces: Retail space is shifting to standalone stores with a 10.2% dip in space occupation from last quarter to 10.4 million square feet. Independent retail spaces are on the rise, with less space taken up by larger malls. Quick Service Restaurants, discounters, and food and beverage shops are leading in leasing activity. Fitness and experiential stores like Planet Fitness and Urban Air are also claiming more large retail spaces.

M&A activity: Recent major transactions in the retail space, such as Kimco Realty's acquisition of RPT Realty and the merger of Realty Income Corporation with Spirit Realty Capital, underscore the sector's attractiveness. The CMBS market reflects this trend, with a notable pivot towards retail investment over office spaces, demonstrating retail's renewed investment appeal.

➥ THE TAKEAWAY

Big picture: Retail real estate has made a remarkable comeback, transitioning from the CRE underdog t to an investor favorite, fueled by limited supply and increasing rents. This resurgence is characterized by a continuous rise in property sales, thanks to a scarcity of space and the removal of outdated malls. The lack of new developments post-Global Financial Crisis has further constricted supply, leading to significant rent growth and a strong performance of retail spaces.

• District Development: A coalition of South Austin bar and property owners is investing in transforming the area into a bustling $270 million entertainment district, complete with residential, retail, and nightlife spaces, modeled after the success of Rainey Street.

• Loan Trigger: The request to terminate a lease at 410 Tenth Avenue has activated a cash management provision in its $565 million CMBS loan, affecting the Manhattan Hudson Yards office property.

• Urban Equity: Over three decades since New York mandated equitable facility distribution, a City Comptroller report reveals persistent siting of less-wanted amenities like shelters and waste stations in already strained neighborhoods, contrary to the intent for citywide parity.

• Antitrust Case: A class-action lawsuit accuses the Real Estate Board of New York and 26 brokerage firms of inflating commissions by enforcing rules that compel sellers to pay buyer's broker fees, spotlighting broader legal challenges to National Realtors' policies.

How Mixed-Use Spaces Are Transforming for Flexible Work

Urban spaces are witnessing a shift as high vacancies turn traditional offices into flexible, mixed-use buildings that cater to the changing preferences of today's workers.

Redefining mixed-use developments: The changing needs of the workforce have architects and designers rethinking the function and layout of mixed-use developments. Where once retail shops stood, now innovative co-working spaces emerge, equipped with the latest technology, ergonomic design, and amenities that support both work efficiency and lifestyle quality.

• These new spaces are responding to a workforce that values the accessibility of workspaces within their living environment, exemplified by projects like The Q Variel in Los Angeles' Warner Center.

Boosting community engagement: Creative office spaces within these mixed-use environments offer more than just a place to work; they serve as catalysts for community and economic development. By situating workspaces in densely populated areas, there's a direct infusion of economic activity as local businesses receive increased patronage from remote workers.

• This strategy enhances the economic vibrancy of neighborhoods and fosters a sense of community, where residents and workers can enjoy a synergistic mix of amenities that promote social interaction and professional networking.

➥ THE TAKEAWAY

The future of work: The shifting landscape of office and residential spaces signifies more than a trend; it's a cultural pivot towards a future where work-life balance is physically embedded in our architecture. These changes are not just reshaping buildings but are redefining the essence of community and the economy, promising a more integrated and fulfilling urban life.

The Sun Belt has seen a surge in new multifamily units in the past two years, and while the West Coast also reported high numbers this year, forecasts predict a decline in new units for the region in the coming year.