An outdoor strip retail center in Richmond, Virginia.
Courtesy of Nuveen
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It is no exaggeration to say that the retail real estate industry is in a difficult situation. It started with the birth of e-commerce and expanded with the COVID-19 pandemic. The recovery has been uneven given the different subsectors of retail, from large indoor malls to large shopping centers to outdoor strip centers centered around grocery stores.
This last subsector is today’s big opportunity, says Chad Phillips, global head of Nuveen Real Estate, which is responsible for more than $140 billion in commercial real estate equity and fixed income investments.
“We’ve put a lot of emphasis on this resilient open-air strategy over the past two years,” Phillips says.
It’s probably a grocery-oriented center with a CVS, pizza place, etc. The vacancy rate for these spaces was 7.8% at the beginning of 2016, but by the beginning of this year it had fallen to 4.4%, according to data from CoStar Group.
“It survived the coronavirus. It survived the Amazon effect,” Phillips said. “Our well-located outdoor portfolio, centered around grocery stores, is more than 95% leased.”
Phillips said whenever a tenant closes, Nuveen is able to quickly fill that space because demand is so strong.
He acknowledged that retail real estate has long been overbuilt in the United States. Eventually, developers became more disciplined, especially with the birth of e-commerce. The result was an adjustment that today looks like a shortage of supply.
” [capitalization] The rates you can get are quite attractive,” Mr Phillips said. “So the total return is good. You can buy it for much less than the replacement cost. So, when you put it all together, it’s an essential real estate need that is very resilient and can generate strong risk-adjusted returns.”
While foot traffic is increasing at large indoor malls, especially upscale malls, Phillips said he likes this smaller sector because it’s “bite-sized deals.” You can sell it easily. they are liquid. Malls are not like that.
This is also a simple supply and demand factor. Roughly 15 years ago, real estate investors allocated more than 30% to retail, Nuveen said, but that dropped to 10% because of low returns. Now, returns have improved in just the past 12 months, and investors are paying attention again.
“I can’t say they’re flooding in again, but we’ve raised our year-to-date funding.” [for] “We have $1.4 billion of leveraged equity in convenience-based retail, which gives us more than $2.5 billion of buying power for this type of strategy,” Phillips said. Well, I think investors are starting to look away. ”
This, like any other sector, is not without risks. After several years of strong performance, it has started to slow down.
“After five years of consistent demand and rent growth, the fundamentals are softening,” said Brandon Svec, national director of U.S. retail analysis at CoStar Group, in a recent company newsletter, noting that vacancy rates for outdoor space, primarily grocery stores, have increased for three consecutive quarters. (However, it is still near historic lows.)
But the broader retail leasing environment tells a different story, Subek added.
“With little new retail space expected to be added in the coming years and inventory levels remaining close to historically challenging levels, retailers remain aggressive in opening new stores,” Subek said.
He also said there were concerns about the overall economic situation, consumer confidence and consumer spending.
In the open-air subsector, which focuses on grocery stores, rent growth was strong last year, but has slowed this year, with annual rent growth at its lowest in more than a decade. Svek emphasized that this is clearly different from before.
That’s why the strategy requires investors to be particular about the property, Phillips said.
Ebbs and flows in consumer confidence influence whether consumers go to these centers for a coffee or a manicure. Existing customer bases, those with high savings rates that can withstand rising unemployment rates, are critical in choosing where to invest.
Phillips said one of the requirements is a median household income of more than $100,000, which is primarily a millennial and well-educated population.
He said competition among investors is increasing, but not so much that good deals can’t be made, noting that returns are low in the double digits.
He added that low levels of new construction are helping to keep vacancies down, and the space is attracting a steady audience.
“I think it’s important to go down the path of convenience and that convenience. That’s where we want to invest,” Phillips said.
