The Progressive Real Estate Partners team just returned from the ICSC Western Conference held in Palm Springs, CA. The energy level was high and it’s always refreshing to meet face-to-face and have those impromptu chats you just can’t replicate online. As we debriefed from this conference, it’s clear that each individual’s perspective is very much affected by their role within the retail real estate industry.
Some traditional ground up developers indicated that they are focused on buying existing product because they are having a really hard time making ground up pencil. Although there is a fair share of single tenant buildings under construction, you can count the number of 50,000 SF+ retail projects within Southern California’s Inland Empire on one hand.
Tenants and Tenant Rep Brokers were commenting on how difficult it is to find quality real estate. The demand for locations amongst many retailers remains strong but getting real estate committee approval seems to be getting harder. With rents, labor costs, and tenant improvement costs all trending higher there seems to be hesitation from many on the retailer side to believe they can do the revenue required to get their desired return on investment.
The other recurring comment from the tenant side was how difficult it is to get permits in a timely manner. It has become apparent that one of the factors affecting site selection is a municipalities’ reputation of issuing planning approvals and building permits under reasonable timing and conditions. The predictability for retailers of being able to meet their store forecasts is crucial.
Landlord Leasing Brokers recognize that their inventory of vacant space is quite low and that when they get quality space that becomes available, it is leasing quickly BUT the more challenging space is just that, more challenging. Some were commenting about how they recently had deals fall apart because of the challenges facing the retailers.
Investment Sales Brokers were out in full force, but there likely were not enough potential clients for them to speak with as the number of principals attending ICSC appeared to be much lower than previous years. This is likely because their retail centers are full so there is not much reason to attend.
Vendors were also walking the floor seeking more projects as those who do title, signage, environmental, construction, and similar have mostly seen a decrease in volume and are trying to secure a bigger piece of a shrinking pie.
Carrying the “mixed signals” theme forward, the retail marketplace in the Inland Empire is conveying potentially conflicting data, especially if you don’t know how to interpret it.
Here is my current interpretation of the data:
Net Absorption: Net absorption which is the total amount leased, less the amount that has become vacant is negative 541,000 SF during the past 12 months. On the surface this appears that the retail market is weakening, but looking at the data more closely 81% of the negative absorption occurred in the 2nd quarter of this year when 99 Cent Only went bankrupt and closed over 60 locations in the Inland Empire comprising over 1,000,000 square feet. Furthermore, Big Lots, Rite Aid, and Walgreens have closed numerous locations in the market. Based upon these closures this year, being negative only 541,000 SF is looking pretty good.
Vacancy Rate: The vacancy rate has climbed from a 15 year low of 5.3% at year end 2023 to 5.9% today. A 5.9% vacancy is the equivalent of 11.9M square feet vacant on a base of 203M square feet. But most owners are primarily focused on shop space as this type of space is what they are most likely to have available. When you pull out all spaces available greater than 5,000 SF, the vacancy rate drops to a mere 2.0%! For a guy that remembers driving this market 15 years ago and easily seeing 20 shop spaces available for every 100 spaces, this is remarkable!
Higher Rents and Higher Triple Net Charges: This low vacancy is pushing rents higher. At the same time, triple net charges are trending higher due to increasing insurance costs, utility costs, and costs related to services that involve labor. So as long as demand remains up, lease rates will continue to increase, BUT if demand goes down, the lease rates will have to also go down because triple net costs are not negotiable. For now, the market is holding and tenants are absorbing both cost increases.
Overall Sales Volume: Overall sales activity (which includes Leased Investment and Owner/User properties) in 2024 is on track to be the slowest year by volume for the past 10 years except 2020 ($946M). The sales volume in 2024 is projected to be $1.03B based upon sales through the first 9 months of the year. However, total sales volume in the 3rd quarter was $374M, the highest of the last 6 quarters and completely in line with the average quarterly sales volume of the past 10 years ($375M).
Leased Investment Sales by Number of Transactions: It is easy to focus on sales volume as this is the figure that tends to be most talked about (partially because it is easiest to obtain), but for this blog we dug much deeper into the data and counted all the transactions between January 1, 2014 and the present for retail properties that sold between $2M and $20M that had an assigned cap rate. This is the best way we could capture the leased investment data that matters most to our clients. It should be noted that not all investment sales transactions are included in this data. For some reason, Costar omits cap rates on some sales even though they have the data because the property was originally listed on Costar with a cap rate. As I have said for many years, their data is not perfect, but so long as it is consistently imperfect it can be relied upon. With that disclosure in mind, please note the following:
- The average number of leased investment retail transactions per year in the Inland Empire was 139 transactions.
- 2022 was the record year with 175 transactions
- 2023 was the record low with 92 transactions
- YTD through the first 3 quarters of 2024, 52 properties have traded which would equal 69 properties if annualized. This would be a 60% reduction off the peak and a 25% reduction off what was the previous record low. It’s been a tough year for investment sales.
With long term interest rates having stabilized, short term interest rates decreasing, a substantial amount of capital sitting on the sidelines, and cap rates trending higher, a reversal of the last two years seems likely in 2025.
Conclusion
It is my opinion that the leasing market from a shop space demand perspective will continue to remain strong. The anchor/sub-anchor market is more mixed. Quality real estate is in strong demand but for those properties that do not immediately get interest it could take a while to absorb the vacancy as the larger the space the smaller the tenant pool.
On the investment sales side we are expecting a much stronger investment sales market in 2025. This belief is based upon the election being behind us (regardless of who wins), short-term interest rates coming down and long-term rates being stable. Bottom line, understanding the fundamentals in Southern California’s Inland Empire is critical to successfully navigating the retail market. Our team takes great pride in keeping our clients informed of the most current data. As always feel free to reach out to me at Brad@progressiverep.com or 909-230-4500 if we can help you with your retail real estate needs.