Investor sentiments and trends in retail real estate

Chad Murray
Director, HFF

Posting a year-over-year increase in transaction volumes, it appears the consecutive decline in retail real estate trades has turned the corner. After surviving a few years of negative headlines and threats of the much-hyped “retail apocalypse,” the story has largely shifted, as accumulated capital to acquire assets is actively deploying.

An abundance of capital continues to target retail assets in Denver, and, with limited opportunities, we are seeing that capital become more flexible and aggressive for the right deal. For example, Colorado Springs has become a viable market for some investors who may not have considered it five years ago. In our discussions with capital sources locally and nationally, we hear consistent sentiments and trends across the sector that are worth noting.

Jason Schmidt
Managing director, HFF

•Retail fundamentals remain healthy. Retail occupancy levels in metro Denver are healthy, with an average of 95.8 percent, compared to 93.8 percent in the top markets nationally. While big-box stores do become available when tenants vacate, the overall health of the market remains strong. Retailers such as Hobby Lobby, Burlington, Old Navy and Planet Fitness continue to backfill large vacancies in the market.

Rents continue to show growth, and Denver is no exception. Denver saw rates grow roughly 5 percent in 2018. Large-format retailers and grocery stores can negotiate some reductions in exchange for more favorable terms, but smaller-shop tenants who renew their terms generally are accepting options as stated in their leases. Investors acquiring large format centers are writing down rents in these scenarios, which is in response to the reality of these negotiations.

• Headline risk has overshadowed retailer performance. Many retailers have posted strong earnings reports and improved profit margins over the course of 2018. Leading the way is Amazon with third-quarter 2018 sales amounting to $56.6 billion. Equally important categories include discount retailers, home improvement and the continued expansion of the fitness space. While 90 percent of retail sales still occur in physical stores, it is hard to deny the effect of e-commence with sales growing 15.2 percent in 2018. Both traditional and online retailers are working to capitalize on omnichannel approaches to reach the entire customer base. Landlords are finding newer, smarter and more creative retailers to create energy in their retail centers.

• Record-low new inventory. The most notable part of the transformation of the retail industry is the slowdown of new construction and the corresponding reduction of retail space. The number of retail buildings nationally decreased 1.04 percent in the third quarter and 7.88 percent year over year from 2017. This reflects the way many retailers are adjusting their total footprint to fit the new market.

Lately, Denver ranked as having the largest decrease in retail square footage per capita among 20 of the largest U.S. metros with a decrease of roughly 2.7 million square feet. This helps explain why only 1.1 percent of Denver’s total retail square footage is new inventory. Between 2017 and 2018, Denver saw an average of 2.5 million sf of new retail inventory (the 35-year average is 3.6 million sf). This compares to 225 million sf of existing retail sf across Denver, Fort Collins and Colorado Springs.

•Transaction volume no longer in decline. The reduction in sales volume experienced over the past few years may be turning around as year-over-year transaction volume was up 31 percent from the third quarter 2017. This demonstrates an implied optimism in ownership arising from the “wait and see” strategy that settled into the market in 2017. Last year also saw an increase in activity from private investors with smaller transactions. Core assets continue to be most desirable, pricing aggressively as investors target well-positioned, credit real estate in top-tier locations. Among these, grocery anchored product still is the most desirable, particularly with best-in-class brand named grocers. Investors are underwriting opportunities to either core or value-add returns, with little appetite for core-plus returns on retail assets.

• Meaningful capital formation. Although cycle timing is making it increasingly more difficult, the desire for value-add assets is likely to persist. Investors recognize the opportunities that exist with valueadd real estate and continue to chase markets with strong tenant history. An abundance of equity has been raised in the pursuit of retail assets in desirable markets. Capital is not the issue but rather finding those opportunities to deploy capital into retail assets is the challenge.

Lender underwriting for retail real estate has become more conservative with a keen look at tenancy. Money moving into the system has a higher cost of capital due to cautious lending on retail assets. However, the debt reserves are extremely high and, on a historical basis, debt remains decidedly favorable. Debt will continue to create value in retail assets with a history of performance and a strong tenant outlook.

With national sales transaction volume increasing for retail assets, coupled with Denver’s continued growth and strong fundamentals, we are poised for another active year in the retail sector.

Featured in CREJ’s February 2019 Retail Properties Quarterly

Edited by the Colorado Real Estate Journal staff.