Retail
What’s Next for Commercial Real Estate?
After several challenging years contending with the impacts of a global pandemic, the commercial real estate market finally seems to be healing. As noted in the latest Emerging Trends in Real Estate report from PwC and the Urban Land Institute, the Fed's 50-basis-point cut in September and subsequent 25-basis-point cut in November have generated some optimism in the CRE community that we are entering a new expansionary phase in the real estate cycle. Here are four of the top emerging trends taking shape as a result. 1. Interest Rates and Capital Cost Concerns Have Eased, but Still Remain In the aftermath of the global financial crisis of 2007-2008, the Fed attempted to revive the economy by lowering the federal funds rate to near zero. What followed was nearly a decade in which cheap debt became a way of life. However, starting in the spring of 2022, with inflation surging, the federal funds rate was increased 11 times, pushing the rate from zero to over 5 percent, bringing real estate investment activity to a near standstill. Reflecting on the market today, interest rates and cost of capital remain among the top concerns of respondents to the PwC Emerging Trends in Real Estate survey, but those concerns have eased since last year. While respondents largely agree that the rate cuts so far are not enough to alter deal economics fundamentally, the monetary policy movements have still injected optimism into the market. In addition, more than 80% believe that commercial mortgage rates will decrease in 2025, with 75% believing those rates will continue to decrease over the next five years. As an industry that relies heavily on leverage to get deals done, signs of lower-costing debt bode well for the future and will support more robust deal volume. That said, the Fed’s future decisions on rate cuts will depend on how inflation and the overall economic outlook evolve. 2. Acquisitions, Refinancing and Development Markets Improving The acquisitions, refinancing and development markets are slowly starting to heal, the Emerging Trends report noted, pointing to steady improvement in liquidity and more bids in the market, as well as tighter prices and debt spreads. Industry participants are also optimistic about debt conditions ahead, with lending expected to grow by 24% in 2025, indicating a full recovery to pre-pandemic levels and further signaling that normalization and stability are on the horizon. Another key factor market participants are looking at is the stabilization of recent real estate price declines. Cap rates began rising when prices peaked in mid-2022 and continued increasing until plateauing in early 2024. The most recent figures suggest prices might be turning positive again, although this may simply reflect that higher-quality real estate is accounting for a larger share of transactions. 3. Occupied Space Now Exceeds Pre-Pandemic Levels in Most Sectors The pandemic created significant changes in how tenants use space, and where. There are fewer office workers commuting to the workplace, more consumers shopping online and more goods being stored in warehouses. However, despite these changes, overall demand for space has more than recovered from the pandemic and remains robust across most property types, with the exception of office. When looking at the future of the retail market, survey respondents indicated that location is key. While newness is a significant priority for some property types like office, retail spaces tend to derive much of their value and demand based on their location. Frequently, older retail centers command the best locations, preventing newer entrants from gaining a foothold and making them more attractive to investors. In the industrial sector, net absorption has been positive, meaning more space is occupied than ever before. Yet demand has not kept pace with new supply, leading to an increase in vacant space. This has given more negotiating power to tenants, who are increasingly seeking spaces with more modern features such as high energy efficiency, LED lighting and higher clear heights. However, this “flight to quality” trend should abate slightly as the pipeline for new product slows and the supply/demand dynamics balance out. 4. There Is Less Movement Due to the High Costs of Relocation The pandemic not only created a shift in the demand for commercial property, but also shifted where people want to live and work. After years of increasing interstate migration, many areas are experiencing slower population growth or even outright population losses due to soaring home prices, fewer renters having the ability to transition to home ownership, and fewer households relocating for new jobs. The report notes that climate change is also becoming a greater factor in location decisions. The report points to a Freddie Mac analysis that shows natural disaster concerns have prompted one in seven households to consider other places to live. Many commercial properties are also at risk of damage from natural disasters and commercial property owners are facing increasing insurance premiums as a result. Conclusion As the real estate market transitions into a new cycle in 2025, we remain cautiously optimistic for the future. With change comes opportunity, and we’re excited to see how the landscape evolves as we enter a phase of recovery and renewal. With more than 50 years of experience operating in all market cycles, we’re well positioned to continue helping companies unlock otherwise illiquid capital from their real estate assets. If you're interested in learning more, contact us today.
‘We’re Bullish On Net Lease Retail’
Investors are flocking to the net lease sector anew as the Fed pauses its rate actions and cap rates stabilize, W. P. Carey’s Michael Fitzgerald told GlobeSt. GlobeSt's Holly Amaya spoke with Fitzgerald at ICSC Las Vegas about the state of retail net lease and what has changed in the sector from last year. In this video, you’ll learn: Why he continues to be bullish on net lease retail, What an increase in cap rates has meant for investment, and How the sector will fare in 2024 and beyond. Watch now An interview with Michael Fitzgerald, W. P. Carey, and Holly Amaya, GlobeSt.com.
Countdown to ICSC Las Vegas
ICSC Las Vegas, one of the largest tradeshows for the retail industry, is on the horizon with an expected 30,000 attendees eager to network and reconnect face-to-face with industry leaders and peers. After a somewhat sluggish 2023, attendees will be looking to the conference to shed some light on the retail landscape and offer insights on new trends and opportunities within the sector. Consumer spending, retail vacancies and sale-leaseback activity will be among the most pressing topics discussed at the show. Here's an overview of each: Consumer spending remains steady Despite inflationary concerns, consumer spending has remained steady over the past year, as core retail sales, excluding gasoline, food service and auto vehicle purchases, increased by 3.3% at the end of 2023. As a result, demand for retail space has remained strong and the market is starting to see in uptick in new developer-built retail locations coming online. W. P. Carey has completed several deals that align with this trend – for example, the acquisition of 22 recently built and to-be-completed car wash facilities across the U.S., leased to Tidal Wave Auto Spa, a prominent car wash operator. With interest rates projected to decrease in late 2024, the market will likely continue to see a ramp up in new development over the coming months. Retail vacancies at record lows Strong demand for retail space has resulted in record-low vacancy rates, with total retail vacancy reaching 4.2% at the end of 2023. Low vacancy rates are a positive sign for investors like W. P. Carey as it provides greater confidence in long-term leases and the ability to re-lease vacant buildings if the need arises. However, it also means more competition for less space which is pushing retail rents significantly higher. This makes it more expensive for retailers looking to expand and acquire new space, which in turn increases operational costs. Sale-leaseback activity picks up With rents rising significantly, retailers – particularly those looking to grow their real estate footprints – will be seeking new ways to access capital. This will likely contribute to greater demand for sale-leasebacks, where a retailer sells its real estate to an investor (like W. P. Carey) for cash and simultaneously enters into a long-term lease. This is a valuable business decision for most retail companies because owning real estate can serve as a drag on their balance sheet. By unlocking the value of their real estate through a sale-leaseback, retailers can reinvest proceeds into their core competencies, leading to better overall returns and long-term growth.
Navigating Net Lease Retail
Rising interest rates, increased cap rates, and sluggish deal activity created changes in the retail market over the past couple of years. Indeed, the bid-ask spread left many retail net lease deals stuck in negotiations. “There was a time when buyers and sellers found themselves pretty far apart, trying to find a way to meet in the middle,” says Michael Fitzgerald, executive director and head of US retail at W. P. Carey. “During 2023, we saw volume slowdowns of traditionally marketed sale-leaseback deals, as some sectors experienced 50, 75, or even 80 basis point increases in cap rates.” However, at the start of 2024, Fitzgerald notes that he’s seen a stable flow of developer-fueled deals and a higher demand for liquidity. As the market progresses into 2024 and beyond, understanding its direction can help investors make more strategic decisions. Low vacancy rates, creating new opportunities A recent report found that retail vacancy rates are at their lowest level in two decades, as rents continue to rise. The report compared 390 retail marketers across the United States and found that the national retail vacancy rate sat at just 4%. According to Fitzgerald, low vacancy rates are a positive sign that provides confidence in long-term leases and the ability to quickly replace tenants. “Let’s say a fitness operator signs a 20-year lease,” says Fitzgerald. “If retail vacancies are low, that’s a positive for us if we need to re-tenant, as we can likely replace them with a new tenant at or above the original price without compromising our income stream.” He explains that W. P. Carey typically focuses on finding deals in markets with growing rents, such as Phoenix, versus smaller and less vibrant markets. “When you get into underwriting situations where vacancy rates are low, it often allows us to get more aggressive with the cap rate and other deal terms,” says Fitzgerald. Looking into 2025 and beyond Another factor that could contribute to an uptick in activity is merger and acquisition deals. An increase in M&A typically corresponds to an uptick in sale-leaseback activity, as firms leverage proceeds as part of the capital stack for new acquisitions. Overall, Fitzgerald remains optimistic about the coming months. “I think the retail market will continue to be strong because there’s always compelling fundamental reasons why retailers want to sell their real estate rather than hold it,” says Fitzgerald. He explains that it comes down to retailers not being real estate companies. Businesses can generate better returns for investors by investing in their core competencies, ie. running retail operations, and often find holding onto real estate is a drag on their cash and liquidity. As a result, he predicts continued demand from retailers for creative ways to access that liquidity – such as sale-leasebacks.
Why Net Lease Continues to Draw Investors
The net lease retail sector continues to outperform despite changing interest rates, with a growing number of retailers expanding their footprints or developing new properties against a “compelling” cap rate environment. That’s according to Michael Fitzgerald, executive director, head of US Retail, W. P. Carey, who told GlobeSt at ICSC Las Vegas that many retailers are “aggressively expanding” in their markets. “We’ve seen a lot of activity in sale-leaseback and we are bullish on net lease retail,” Fitzgerald says. “The retail sector is enormous – and we’re chasing deals.” Fitzgerald also discusses: The state of retail fundamentals How investors are responding to changing interest rates and economic uncertainty What makes W. P. Carey stand out from its competitors in terms of investment opportunities Watch now An interview with Michael Fitzgerald, W. P. Carey, and Holly Amaya, GlobeSt.com.
Navigating a Rapidly Changing Retail Industry
Over 20,000 real estate investors, developers, property managers, retailers and brokers convened in Las Vegas last month for the annual ICSC convention. In the midst of a volatile market, attendees sought answers on how to navigate current challenges impacting the retail industry. Below were three of the biggest themes to emerge. Retail resiliency amid market headwinds Just a few years ago, the outlook for the retail industry was grim. Consumers weren’t shopping due to the pandemic, brick-and-mortar stores were closing and many large retailers were filing for bankruptcy. However, the market surprisingly bounced back post-covid as consumers returned to stores with a desire to spend. As the real estate industry as a whole now contends with new challenges including higher interest rates and economic uncertainty, the silver lining is that retail has been somewhat less impacted than other asset classes. Office continues to face return-to-work challenges and industrial is contending with supply chain bottlenecks and overall supply shortages. While retail has not been entirely insulated, the fundamentals have remained quite sound – leasing remains strong, occupancy is high and companies are continuing to announce new store openings. The consensus at ICSC was that there are certainly challenges ahead, but that the retail industry is well positioned to weather the storm and come out in a position of strength. Trend toward mixed-use retail One of the biggest challenges in today’s retail environment is adapting to the growing and changing needs of the everyday consumer. As a result, landlords, retail owners and developers are increasingly exploring mixed-use developments – which blend multiple uses such as retail, residential and entertainment. For instance, a landlord may decide to redevelop an existing retail center by incorporating entertainment facilities, residential apartments and hotel amenities that attract consumers while also helping drive sales and boost profits. Landlords are also embracing a more experiential approach to retail centers by incorporating movie theaters, fitness centers, spas and other lifestyle attractions. Particularly now when ground-up retail development is not the most attractive given the current market, converting existing retail centers into mixed-use sites is a unique way for landlords to maximize value and grab consumer attention. Sale-leasebacks as a solution for rising development costs Rising interest rates continue to impact retail development. Developers’ capital costs have increased drastically, and as a result they are demanding higher asking rents from retailers. This is forcing more retailers to turn toward in-house development, which means the development costs are held on the balance sheet of the company. To offset these costs, retailers are exploring sale-leasebacks – where a company sells its real estate to an investor for cash and simultaneously enters into a long-term lease. This enables the retailer to receive a significant cash infusion while maintaining full operational control of the property. Developers can also take advantage of the sale-leaseback model. If they’re developing a building in which a tenant has already been secured, developers can work with an investor on a forward commitment in which the investor funds construction costs and acquires the building upon completion, or the investor purchases the building once complete. This enables the developer to recoup costs while still collecting a development fee. With an interest rate decrease not likely for 2023, sale-leasebacks are expected to continue growing in popularity for retailers looking to expand their footprints and developers, providing opportunity for investors that specialize in these types of transactions (like W. P. Carey!).
Retail's Latest Transformation Has Investors Watching
Retail has been the commercial real estate chameleon, changing and adapting with the times, including the rise of e-commerce and COVID-19. The post-pandemic rebirth of the sector has made major headlines and many retail operators and owners see flying colors. Michael Fitzgerald, executive director and head of US retail investments at W. P. Carey, sees three major trends that sector stakeholders should be watching: the strength of needs-based retail, a development switch favoring sale-leaseback investors and the continued recalibration of buyer-seller expectations. Targets & Tactics “An interesting thing about COVID was how resilient certain areas of retail actually were,” said Fitzgerald. “We saw immediate and sustained growth after that short period of shutdowns.” Non-discretionary, core-good retail including grocery stores and services-based tenants, such as auto services, have been “very strong,” according to Fitzgerald. Low-cost discount stores are a good place to do deals given the economic worries. And family entertainment centers, such as arcades and bowling alleys with full-service restaurants, have seen sustained periods of same-store sales growth and high profitability, benefitting from the post-COVID pent-up consumer demand. “When you’re very flexible, have tons of ability to evaluate business models, take a partnership approach and meet with management teams to understand how they position themselves in the market, you’ll have a lot of good investment options,” said Fitzgerald, who prefers master leases of 15- to 25-year term with escalations every five years. “We can do anything from convenience stores to an automotive service business to grocery and sporting goods. We’re pretty agnostic as to the types of retail we pursue.” Rate Responses As the impact of rising interest rates continues to unfold, Fitzgerald has found that most tenants and retailers are somewhat hesitant to raise their prices so as not to alienate or even “destroy” their customer base. There’s an opportunity to boost profitability, but also a concern about the outcome if companies go down that path and then the economic “switch flips” and customers stop spending. Increased interest rates affect retail development negatively, but Fitzgerald believes a specific shift in that regard that could yield investment opportunity. Retailers planning to grow their footprint have traditionally partnered with merchant developers, but with higher capital costs the latter’s return requirements “have increased significantly” and, in turn, their hiked asking rents have forced retailers to look for alternatives. As a result, retailers are doing more of their own development, whether in-house or through fee developers. “So a lot of these developments will be held on the balance sheet of retail companies, which is good because a lot of companies will likely decide to do sale-leasebacks,” he said. “Given that’s our company’s prime target, we think that’s a good trend to come from the higher rates.” Outlook Fitzgerald maintains that it’s still too early to make a prediction for overall transaction volume in the retail sector in 2023, adding that since last fall cap rate expectations have gone up 45 to 50 basis points in many cases. “What we’re seeing is that retailers that need to grow their footprint and monetize new developments are going to meet the market and are going to do deals,” he said. “If retailers continue to meet the market I think it’ll be a good, active year. If there’s a standoff I think it’s going to be more difficult.”
It's Sale-Leaseback's Time to Shine
The current capital environment has tested the adaptability of many companies, as increasing interest rates have made the cost of capital rise uncomfortably. And while it’s unknown if recent events will calm the Federal Reserve’s zeal for future hikes, some companies are already availing themselves of an alternative capital source: the sale-leaseback. In fact, the transaction type matched its 2019 peak in Q4 of 2021, and there are signs it may not be slowing. Zachary Pasanen, managing director, investments at W. P. Carey, sees two big factors playing into the current interest in sale-leaseback: cheaper cost of capital and extra liquidity during tough times. A Corporate Alternative to Expensive Capital A major concern for corporate real estate holders is reducing the cost of capital for the next several years. As Pasanen notes, while they are “not quite desperate yet, the lag between interest rates and cap rates hadn’t caught up six months ago, but it’s starting to now. Prudent CFOs are looking to maximize capital and a long-term sale-leaseback is a great way to do that.” A sale-leaseback offers a “naturally accretive” alternative funding source. Holders of good, fungible, mission-critical real estate that are willing to sign a long-term lease with market or better rental increases built in will likely find that the underlying rate with which they can monetize those assets is inside the going long-term borrowing rate, according to Pasanen. The 50-year-old REIT’s predominant focus has been on warehousing, specialty manufacturing and food production, but it also delves into the education and retail sectors, the latter ranging from experiential sites to fitness-related products to auto repair locations. “By and large, we’ll look at anything as long as there’s criticality to it, meaning the stuff is made at our subject facilities or there’s a really strong location story to it or rent coverage or just a good real estate fundamental story,” Pasanen says. A Liquidity Solution for Tough Times Another consideration facing corporate real estate owners is having the capital on hand to weather the current economic instability. Rates again become a major problem, especially for companies or properties that might be lower on the credit spectrum. “For companies facing challenges that don’t have the ability to finance at attractive rates it’s a very simple calculus: if your borrowing costs go up that’s going to eat into your profit margins and there are only so many levers you can play with when operating a business,” Pasanen said. “They have to be laser-focused on how to get through this period of instability and unknowns.” Sale-leasebacks appeal here as well, allowing companies to put money back into their core competencies or pay down shorter-term debt that’s gotten more expensive, or perhaps even expand given that acquisition targets may have become cheaper. But Pasanen also notes that W. P. Carey’s sale-leaseback business is not just a capital product for troubled times, whether or not it’s on top of mind for companies and owners. “A sale-leaseback is a good tool in good times and a great tool in really uncertain times,” says Pasanen.
Retail Revitalization: Key Takeaways from ICSC Las Vegas
After a two-year hiatus, ICSC Las Vegas – one of the largest conventions for the retail industry – made its big comeback with over 22,000 attendees getting together to discuss the opportunities and trends in the sector. Retailers, brokers and real estate investors were among the exhibitors on the conference floor, where a number of topics dominated the discussion. Rising rates and inflation, the retail recovery and resurgence of brick-and-mortar were among the biggest themes at the conference. Here’s an overview of each: Financing amid rising interest rates and inflation Inflation continues to rise at its fastest pace in 40 years, with the consumer price index reaching 8.6% for the 12 months ending in May. Interest rates have also been surging, with the Fed raising benchmark rates in its most aggressive hike since 1994. This challenging and volatile economic environment has made it difficult for retailers to secure traditional debt financing at attractive rates. However, one method of financing that has been gaining traction in the retail sector is the sale-leaseback – where a company sells its real estate to an investor for cash and simultaneously enters into a long-term lease. Big names such as 7-Eleven, Sherwin Williams and Mister Car Wash have made sale-leasebacks a core part of their growth strategies due to the ability to quickly unlock otherwise illiquid capital and reinvest those proceeds into their business. Retailers can also lock in a long-term rental rate which is especially advantageous in the current economic landscape while not having to worry about short-term refinancing or restrictive debt covenants. Retail revival Despite the challenging market environment, there was a lot of optimism for the retail sector at ICSC Las Vegas. Virtually all retail property types from grocery to c-stores experienced an increase in leasing activity over the past year – with retail tenants absorbing 91 million square feet of space nationally over the past 12 months. Furthermore, the retail sector is now seeing the lowest levels of bankruptcy filings in the past five years in addition to a steady uptick in foot traffic in physical stores. This is indicative of a larger retail recovery, leaving the sector in its best position since the pandemic began. Resurgence of brick-and-mortar Perhaps the biggest topic of discussion at the conference was the resurgence of brick-and-mortar retail. While many had predicted that e-commerce would be the way of the future, consumers have proved them wrong by returning to physical stores en masse. In 2021, retail sales totaled $5 trillion – with only about 13% of that stemming from e-commerce. Online shopping actually decreased year-over-year, demonstrating that consumers were eager to return to physical stores as the pandemic subsided. This increased demand also spurred many existing retailers to expand their store footprints and some online-only retailers to open physical stores. However, not all segments within retail are created equal, with some property types like movie theaters continuing to struggle while others like restaurants have thrived. Regardless, retailers have continued to adapt to meet the evolving demands of consumers, with omnichannel – a combination of e-commerce and brick-and-mortar – emerging as the prevailing strategy for success. Conclusion Despite a challenging few years for the retail sector, fundamentals continue to improve in 2022 as demand for high-quality retail assets returns and retailers look to cash in on owned real estate to improve balance sheet health and fund future growth. Interest rates, inflation and a rumored recession lingered in the air at this year's ICSC Las Vegas, but attendees were confident that the retail revival is underway.