2 trends that will shape retail estate in 2017

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2 trends that will shape retail estate in 2017

01/26/2017

Lost amid the post-holiday season noise in the retail industry are major cost issues that will affect the profitability of physical and digital retailers’ growth plans in 2017 and beyond.

There are two major issues impacting virtually every retailer, from the corner drug store to the neighborhood supermarket and mall-based specialty chains: 

 

  1. Available retail space, especially high quality location, is in reduced supply, causing retailers to pay higher rents for space even as that space becomes less productive due to e-commerce competitors siphoning off trips.
  2. Retailers looking to grow their e-commerce business are faced with expense pressures caused by increased demand for supply chain capacity in the best locations.

Both of these factors tend to be overlooked in the February/March timeframe as the holiday season shakes out to reveal winners and losers. That’s the case again this year as financial markets focus on retailers who have pre-announced weak results or store closings. The tendency is to attribute the entirety of the weakness to the growth of e-commerce, which undoubtedly plays a role, but also overlooks the fact that plenty of retailers failed or began their current downward spiral before the advent of e-commerce and smartphones.

That said, retailers whose business models are dependent on customers regularly visiting physical locations are coping with challenges beyond increased e-commerce penetration. For starters, the percentage of available space in U.S. neighborhood, community and strip centers remains near a decade low and could be headed lower, according to CBRE Group, the world’s largest commercial real estate services and investment firm. Availability in such centers across major U.S. markets stood at 10.2 percent in the fourth quarter, unchanged from the third quarter, but half a percent lower than the prior year and well below the post-recession peak of 13.1 percent in 2011. Simple laws of supply and demand are behind the shift: new construction slowed even as demand for space held steady. That’s a favorable scenario for landlords, but not retailers, for whom rental rates are the largest component of occupancy costs.

“We anticipate that 2017 will be a solid year in retail real estate because wages are growing at their fastest pace in nearly a decade, and that will drive spending,” according to Jeffrey Havsy, CBRE’s Chief Economist in the Americas. “Retail availability rates should continue to decline, which should fuel rent growth. New construction remains tepid, which counters any drain on demand from the growth of e-commerce.”

Just how tepid is evident when comparing new space that has come online in recent years to the peak of activity in 2005. CBRE forecasts that developers will have delivered roughly 16.4 million square feet of new neighborhood, community and strip retail centers in the U.S. in 2016, roughly equivalent to 2015 and 2014. That is a paltry amount compared to the boom year of 2005 when developers delivered a record 73 million square feet, according to CBRE data.

While all manner of store related cost pressures have increased, those looking to grow their e-commerce business face a different type of expense issue. The rapid rise of e-commerce has increased demand for supply chain capacity which means prices for prime logistics locations have surged. CBRE identifies this trend by looking at investment yields on logistics properties around the globe. Those yields are close to record lows, which might sound like a good thing on the surface, however yield measures the rate of income a property produces for an acquirer relative to the price paid for it, according to CBRE, and is arrived at by dividing the property’s net operating income by the purchase price. A lower yield indicates a higher purchase price. Additionally, a market’s prime yield is that for the highest quality property in the best location in that market. North American markets accounting for seven of the 10 lowest prime logistics yields globally, according to CBRE.

“Prime logistics yields across the world have greatly compressed in recent years as investors worldwide have sought to buy into the burgeoning U.S. industrial-property market,” said Jack Fraker, Vice Chairman and Managing Director of CBRE’s Capital Markets Industrial Practice. “As they do so, many are gravitating to the stability of prime assets in the world’s leading logistics hubs, which has put prime yields in those markets at nearly unprecedented levels for industrial-and-logistics assets.”

The seven U.S. markets among the 10 globally with the lowest yields include: New Jersey, California’s Inland Empire, Los Angeles/Orange County and Oakland at 4.25 percent; Seattle at 4.5 percent; and Vancouver, B.C., at 4.75 percent.

“Given the very strong fundamentals with record leasing activity and net absorption considerably in excess of new construction, investors can easily forecast near-term rental rate growth to counter the relatively low going-in yields,” Fraker said.

Occupancy costs and investment yields on logistics properties may not be issues that receive a lot of attention in the aftermath of the holiday season, but both promise to have an impact on retailers’ financial performance this year.