Landlords, tenants adapt as we await a vaccine

Ryan Bowlby
First vice president investments,
National Retail Group, Marcus & Millichap,

Prior to the pandemic, retail as an asset class was in the midst of significant change and a sustained period of transformation. Shopping centers were becoming gathering places for neighborhoods and featured tenant mixes that were service oriented, with traditional retailers decreasing to less than half of total shopping center tenancy. For the first time ever, consumers were spending more money eating out than at the grocery store. Fitness and entertainment users were rapidly backfilling vacant boxes previously occupied by retailers that were not equipped to compete in the age of e-commerce. Shopping center owners adapted and adjusted their tenant mixes accordingly; they were thriving in the prepandemic era.

Drew Isaac
Senior vice president investments,
National Retail Group, Marcus & Millichap,

These types of businesses, which require significant social interaction, are among the most hurt by the government’s efforts to combat COVID-19 via shutdowns and social distancing measures. However, it is important to note that in spite of the unprecedented headwinds shopping centers have faced due to the pandemic, the vacancy rate in the Denver metro area currently is at 5.2%, per CoStar. To put that in perspective, during the previous downturn, the retail vacancy rate rose as high as 9%. While we are likely to see an increase in vacancies over the next six months, in particular if there is another shutdown, many tenants are reporting monthly sales volumes at or above levels they produced in the summer and fall of 2019. Landlords and tenants have adapted and the recent strong gross domestic product numbers indicate an economy that is a vaccine away from roaring back.

Retail employment gains. Many retail trade workers have been added back to payrolls since February. Of the 2.4 million workers who lost their jobs in March and April, only 480,000 still are not on payrolls. Per the Bureau of Labor Statistics, Denver has recovered approximately two-thirds of the jobs lost during April shutdowns. Nonetheless, recouping additional positions may prove to be challenging until occupancy constraints are lifted; however, the recent “safer-at-home” order issued in several counties indicates we likely still are several months out from seeing relief in that regard. This trend is particularly challenging for restaurants, which are not included in the retail trade sector. While restaurants on a national basis have rehired almost 80% of their employees, significant revenue was generated by the ability to add outdoor patio seating on sidewalks and in parking lots. With winter coming, it will be increasingly difficult to generate comparable revenues from outdoor seating in states with colder climates like Colorado.

Investor activity. Shopping center transactions ground to a halt in the months immediately following the shutdown, and while we have seen a significant increase in demand in the months that followed, the number of transactions still is down considerably from 2019. Between March 15 and Nov. 1, there were 11 multitenant retail properties that traded over $3 million in Colorado. During that same time period in 2019, there were 33 such transactions. While transaction volume is down, pricing has remained very aggressive. For the most part, the properties that are trading are those that are performing well in spite of the challenging conditions and can provide investors a safe haven in turbulent times. Suburban properties, and those located in tertiary markets with less density, also are in high demand. Investors generally are avoiding urban infill areas that have been disproportionately impacted due to the significant reduction in daytime traffic.

While shopping center transactions have slowed, the market for single-tenant net-leased assets operated by an essential business or with a drive-thru has never been stronger. While demand overall is similar to pre-COVID-19 levels, the supply side of the net-leased market has changed drastically. With tenants halting their growth strategy and an increase in construction delay, there is a limited amount of new build-to-suit developments coming to market.       Furthermore, investors have revised their acquisition criteria to account for COVID-19’s impact on consumer behavior and retail businesses. Several retail segments that previously were highly desired, including sit-down restaurants and day care operators, are not being targeted, limiting the pool of sellable inventory.

Distressed assets. Almost as soon as the pandemic-induced shutdowns began, investors started lining up capital to chase distressed retail assets that many felt was on the horizon. Thus far, at least, a wave of these distressed assets has not materialized. During the previous downturn, there was not enough liquidity in the market to allow for the deferments and offers of forbearance that were commonplace in the early days of the pandemic. In the previous downturn, owners were forced to sell performing assets because of a lack of refinancing debt available in the marketplace. Today, financing is readily available for most performing assets at historically low rates. In addition, the Paycheck Protection Program and other government stimulus programs have kept a significant number of small businesses afloat. However, while these government and lender programs have given owners and tenants much-needed lifelines, there are a number of indicators that suggest there will be distressed opportunities in 2021, particularly if we are forced into another shutdown. In October, TREPP reported that 18% of retail loans were in special servicing and 14.33% were delinquent. While delinquency rates are down from a peak of 18.1% in June, they still are much higher than their previous peak of approximately 8% in 2012.

Holiday sales. A potential silver lining we are optimistic about as we close out 2020 is there are a combination of factors that could result in an exceptionally strong holiday season, providing retailers with a boost at a much-needed time. Those factors include a deal to inject a new round of stimulus in the economy after the election; the potential for a new round of stimulus checks; bipartisan support for a resumption of unemployment benefits; and a lack of travel and entertainment options will result in many consumers having significantly more disposable income and increased purchasing power with more time on their hands to shop for friends and family.

Featured in CREJ’s November 2020 issue of Retail Properties Quarterly

Edited by the Colorado Real Estate Journal staff.