As I have said for years, there are three certainties of life; death, taxes AND that retail real estate keeps changing.
Many who read this blog are not in the retail leasing market trenches day in and day out. For those of you who are, items in this blog may confirm what you already know, but I am sure there are a few good takeaways for you.
For those not in the trenches, hopefully you gain some insights that helps you navigate this frequently complex marketplace.
The following are 7 observations that I am seeing in today’s retail leasing market:
1. Strong Demand from Certain Tenant Categories: There is still an extensive list of tenants seeking certain types of spaces. Grocery operators, fitness chains, indoor entertainment uses, coffee operators, and a myriad of restaurant concepts are most aggressive in today’s market. Demand for inline shop space is still relatively high but such users are mostly independent tenants in an assortment of use categories. Those strongest include pet related tenants, health & beauty, and the opposite of health & beauty like ice cream, donuts, and boba.
2. Triple Net Charges Are Rising: For the longest time, NNN charges for most centers would be between $.50 to $.75/SF per month. This year, 56% of our lease transactions had NNN charges more than $.75/SF which included 40% between $.75 to $.99/SF and therefore 16% above $1.00/SF. Rising insurance costs, refuse costs, and utility costs are the most cited reasons for these rising NNN charges.
3. Second Generation Restaurants Are Very Valuable: The hottest spaces in the market are second generation restaurant spaces between 1,500 and 2,500 SF that include a grease intercept, hood system, walk in refrigeration, and a minimum of 400 amps of electricity. The cost and time savings related to having all these features available frequently results in multiple offers, top of market rents, and the space leasing within 90 days.
4. Hesitation in the Market: I use the word “hesitation” very carefully. Hesitation means the lease gets signed, but with a little more caution and apprehension. For example, the letter of intent and lease negotiation process is taking longer. Real estate committee approval for national retailers seems to involve more questions being asked of everyone. A part of this hesitation is that retailers are evaluating their deal risk and trying to mitigate it. On the landlord side, landlords are scrutinizing the deal terms they are willing to accept. In a market where landlords have more leverage, the concept of tenant mix is coming more into play as landlords want to make sure they are leasing to tenants that both enhance their property and have a higher probability of success.
5. Construction Costs Frequently Cited When a Deal Goes South: When a deal does not get completed, it is frequently construction costs coming in above expectations. This may be true for the tenant’s work, but it is also true for landlord’s work. When a landlord gets their costs and then looks at the rent and the tenant improvement allowance, some owners are taking a step back and re-evaluating the deal. In certain cases, the owner goes back and asks for additional rent which frequently the tenant will not pay. This results in an impasse. Under these circumstances, we have seen select landlords make a very logical decision to terminate the lease, but in some cases the deal is one they should still do but ego gets in the way. One factor that we often see landlords omit from their analysis is the lost rent from starting over and seeking a new tenant for the space.
6. Inbound Activity Has Slowed: One of the questions I am always asking our brokers is whether inbound activity is up or down relative to sign calls, Crexi/Loopnet/Costar activity, and direct phone calls and emails. Their answers give me a quick snapshot from a subjective perspective. I also look at Crexi leasing leads as one of my key indicators which is off by about 20%. Keep in mind that the quality and number of available spaces as well as the time of year certainly affects these figures, but as I look at year-to-year comparisons as well as monthly trends, activity does seem to have softened.
7. Dynamic Changes in Mid Box Retail: 99 Cent Only’s implosion, Big Lots and Rite Aid’s substantial store closures, and Walgreens announcement to close about 25% of their locations is resulting in a substantial number of changes for these types of spaces. On the positive side it is creating opportunities for retailers that are seeking these types of spaces, but there is no doubt that there is going to be pain that will come from these closures. In many cases, especially in the case of Rite Aid and Walgreens, these stores are owned by single tenant investors who are ill equipped to deal with the re-tenanting process. Furthermore, the rents paid by the vacating tenant are not replaceable.
Overall, the retail leasing market remains healthy, and the insights shared here are broad observations. The Progressive Real Estate Partners team is looking forward to the Palm Springs ICSC Western Conference at the end of September where we will be making deals, building relationships, and expanding our knowledge. If you are attending, we are members of Retail Brokers Network and will be at their booth this year. Hope you can stop by and say hello!