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Has the Retail Apocalypse Finally Started Hitting the CRE Market?

Feb 18, 2020 by Matthew DiLallo
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Many retailers have had to shutter locations over the past several years because more consumers are shopping online. All these store closings, however, haven't had much impact on the owners of retail properties, particularly neighborhood and community shopping centers, because they have been able to find new tenants to fill the vacated space.

That was until the fourth quarter. At least that's according to the latest property data on the sector from Moody's (NYSE: MCO) real estate analytics arm REIS. Here's a closer look at the sector's numbers during the quarter and what they might mean for investors in retail real estate this year.

A tough quarter for retail real estate

Several retailers closed locations during the fourth quarter, including Kmart, which shuttered an additional 16 stores in 13 different metro areas. This additional supply of rentable retail space proved to be too much for the market to bare as vacancies in neighborhood and community shopping centers edged up 0.1% from the third quarter to 10.2% (though that was unchanged compared with the year-ago period). Because of that slight uptick in vacancies, rent growth was a paltry 0.1% in the period, which was the lowest since 2012.

On a positive note, while the 16 Kmart closings helped add 1.48 million square feet (sf) of available rentable space during the quarter, the market absorbed nearly all of it. Overall, the total net absorption for neighborhood and community shopping centers was only negative 3,000 sf during the quarter. That's because a variety of new tenants -- fitness centers, grocery stores, home furnishing stores, and trampoline parks -- continue to gobble up retail space at legacy locations as well as newly built ones.

While neighborhood and community shopping centers had largely escaped the retail apocalypse until the fourth quarter, regional malls haven't been so lucky. The vacancy rate in that subsector rose another 0.3% to 9.7%, which was its highest in a decade. Because of that, rent growth in malls stagnated.

A speed bump or a sign of things to come?

The weaker data across the sector in the period led REIS to pose an interesting query: "Given these numbers, one cannot help but wonder if this was the start of the retail downturn or was it simply one weak quarter?"

On the plus side, employment data in the sector remains healthy. Overall, retail added 42,800 jobs during the quarter as stores geared up for the holidays. Meanwhile, several segments posted gains for the full year, including:

  • Grocery stores (37,000 jobs added in 2019).
  • Restaurants (290,000).
  • Fitness and recreation (23,000).
  • Sports teams and personal services (25,300).

Further, retail sales grew 2.1% overall after netting out e-commerce, gasoline, and auto sales, led by:

  • Health and drug stores (up 3.4% in 2019).
  • Grocery stores (3%).
  • Restaurants (4.3%).

However, several trouble spots remain, which is a concern for investors in retail properties. Clothing and accessory stores, for example, slashed 40,000 jobs last year, while department stores cut another 25,000 jobs. Meanwhile, sales slumped in:

  • Department stores (down 4.9% year over year).
  • Sporting goods stores (down 2.8%).
  • Electronics (down 4%).

Unfortunately, 2020 isn't starting much better as several retailers have already announced store closings, including Pier 1 (NYSE: PIR) and Macy's (NYSE: M). These closing will have an impact on investors who own properties linked to these companies, including those who own shares of retail real estate investment trusts (REITs) SITE Centers (NYSE: SITC) and Kimco Realty (NYSE: KIM), since Pier 1 is a major tenant of both companies.

While these REITs have been able to stay ahead of the retail apocalypse by quickly finding new tenants to take up vacated space, that's getting harder to do as more stores close. Because of that, many retail property owners like SITE Centers and Kimco Realty are investing money to convert some of their locations to other uses, like residential and office space, to help offset the impact of continued store closings.

2020 could be another tough year for retail property investors

Last year was exceptional for many real estate investors, especially those who owned REITs as the average one produced a 28.7% total return. Retail REITs, however, underperformed that number as the average one only generated a 10.7% total return, due to abysmal performance by regional mall REITs.

Given REIS' data during the fourth quarter, that underperformance could continue in 2020, with neighborhood and community shopping centers at the greatest risk of producing lackluster returns. Because of that, investors need to carefully evaluate how the continued weakness in the retail sector might impact a potential property investment before they put money into a deal or buy a REIT focused on owning retail properties.

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Matthew DiLallo owns shares of Moody's. The Motley Fool owns shares of and recommends Moody's. The Motley Fool has a disclosure policy.