Retail
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 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.
Sale-leasebacks Are Back!
The sale-leaseback market is booming. Strong fundamentals including low interest rates, outsized demand for high-quality assets, an active M&A market and significant amounts of capital driven by cheap debt and strong currency make now an opportune time for sellers to execute a sale-leaseback and unlock otherwise illiquid capital tied up in their real estate. According to data from SLB Capital Advisors, sale-leaseback activity increased 17% in Q2 from the previous quarter, reaching $3.6 billion–the second highest in terms of deal volume since before the pandemic in Q4 2019. With interest rates unlikely to rise in the short term and property valuations being pushed higher as new investors enter the sale-leaseback market, we expect this high level of activity to continue into 2022. However, within the broader sale-leaseback market, each core property type–industrial, office and retail–faces unique headwinds and tailwinds, presenting new challenges and opportunities across each. Here’s how we think each will fare in 2022. The Industrial Surge The industrial real estate market continues to be one of the strongest sectors fueled by tailwinds related to the growth of e-commerce, including increased inventory requirements and record-low vacancy rates. These strong fundamentals mean that investor demand for industrial sale-leasebacks will only increase, particularly as new entrants enter the market. We are already seeing the effects of this–but as more entrants enter, the imbalance between the product available and demand for assets will continue to widen, driving prices higher and cap rates lower–even in traditionally non-core industrial markets. In addition, a lag in new development due to increased material and labor costs will keep real estate valuations for existing assets high. As a result, we don’t see the industrial market slowing any time soon–creating immense opportunity for sellers to maximize the value of their real estate through a sale-leaseback. Growing Office Optimism While office has certainly been a dark horse in the real estate market due to lockdowns and work-from-home mandates, there’s some optimism on the horizon going into 2022. Several big tech companies such as Google, Facebook and Amazon, have made investments in NYC office space this year, sparking early signs of recovery in the sector. In addition, Sun Belt markets such as Texas and Florida–where many urbanites migrated during the pandemic–are seeing an increase in demand for offices supported predominantly by the small and mid-size businesses located in those regions. For potential sellers, these are all positive signs and suggest that investor demand for certain office assets will rise in 2022, particularly for high-quality properties in strong markets leased to investment-grade tenants. Retail's Road to Recovery Similar to the office market, retail is seeing a recovery from COVID-19 pandemic lows. Retail foot traffic and sales continue to increase, but the rise of e-commerce has certainly left a lasting impact on the industry as a whole, as most retailers are now implementing hybrid store models which include both brick-and-mortar stores and online distribution. In the next few years, many retailers will likely reevaluate their portfolios in terms of number of stores, location and use–and many may downsize as online orders become a greater proportion of their sales. As a result, the overall level of occupied retail space will likely shrink, meaning the market will favor corporate sellers and tenants. In addition, we expect investor demand for essential retail such as grocery and quick-service-restaurants will remain strong in 2022, as those sectors have demonstrated exceptional resiliency during the pandemic and resulting economic downturn. We’ll likely also see an increase in volume of retail sale-leasebacks in Europe, particularly for those essential assets, as US-based investors expand into new markets to take advantage of different costs of capital. What's Next Overall, the outlook for sale-leasebacks remains positive across all three core property types, with 2021 shaping up to potentially be a record year for deal volume. As long as the market fundamentals remain strong, corporate sellers pursuing a sale-leaseback will be able to secure high valuations for their real estate assets while locking in current low rates for the long term. Working with an experienced sale-leaseback investor such as W. P. Carey ensures sellers unlock 100% fair market value of their assets–which can be reinvested into growth initiatives–and also provides a long-term capital partner that can support future real estate needs.