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Retail real estate has undergone significant changes in recent years, with the impact of the COVID-19 pandemic and online shopping becoming a major driver of retail revenue for the first time. As economic uncertainty has emerged as a multicycle challenge, development teams must stay up-to-date on the latest market trends to identify opportunities with the biggest ROI potential.
Although the current commercial real estate marketplace is highly volatile, leading analysts believe these three factors will significantly shape the performance of the retail asset class in 2023.
Inventory Will Remain Limited Nationwide
The amount of retail space has been on the decline for decades in the U.S. due to the growing popularity of e-commerce. The shift in consumer preference, driven by the unrivaled convenience of shopping online, resulted in a secular decrease in demand, with 50 million square feet of space leaving the market since 2003. CBRE expects the trend to continue in 2023, even though brick-and-mortar vacancies hit a 15-year low in 2022.
Owners and tenants alike are opting to hold onto existing spaces rather than risk investing in new ground-up development projects. And with interest rates at a historic high and cap rates unstable, banks, REITs, and institutional investors are hesitant to make serious financial commitments into the sector. Until economic conditions stabilize, and challenges like the labor shortage improve, inventory availability will remain tight.
The secular trend of inventory limitation had served as the qualitative bedrock for the retail real estate market for decades, driving rent growth, low vacancies, and positive absorption of new property. Then the COVID-19 outbreak happened.
As the world adjusted to the pandemic, certain asset class segments saw an upswing in activity. While not significant enough to suggest a tectonic shift in foundational value, it did signal the start of a new cyclical trend.
The Rise of Retail Experiences and Its Impact on Mixed-Use Demand
The rise of retail experiences in the U.S. came about because of an inevitable demographic shift, accelerated by exceptional circumstances.
For the better part of a decade, Millennials' unique purchasing preferences have been aggressively upending American consumer culture. Because the generational cohort has a strong affinity for experiences, their emergence as the nation’s largest consumer demographic indirectly pushed several long-established brands into near extinction a few years back. Their tendency toward risk aversion delayed the homebuying surge that usually accompanies a new generation’s entrance into the marketplace. But their interest in novelty created space for CrossFit’s lucrative reimagining of fitness centers.
So, what caused that unusual purchasing behavior? A financial analyst would tell you the emotional trauma of living through the Great Recession.
Along similar lines, a spike in luxury purchasing by Generation Z last year translated into a flurry of footprint expansion by high-end retailers in 2023. As opposed to their older siblings, Zoomers went all-in on acquiring expensive clothes, spa days, and electronics once they entered their peak earning years. But, they share Millennials’ taste for the experiential. The $366 billion they used to buy non-essentials last year created what Steiner + Associates SVP Spencer Jordan SVP dubbed “a huge explosion of growth in openings at higher price points” in the mixed-use segment.
For project teams looking for a competitive edge this year, properties that can accommodate residential and commercial occupants have robust long-term earning potential. A protective approach to meeting the needs of 140.79 million consumers is a good idea.
Inflation is Curtailing Consumer Spending
Despite the Federal Reserve’s utilization of historic interest rate hikes last year, inflation is still stubbornly high.
The consensus among market watchers is the unpleasant reality of 2023 introducing more cost of living increases is eroding consumer spending. The high-level thinking is a new recession is reviving the conditions that defined the 2008 economic landscape. Household budgets are tightening, and consumers are allocating more of their income towards necessities such as food, rent, and healthcare.
From the 30,000-foot perspective, leading industry players see the downturn as having a cascading effect on the retail real estate market. The prevailing view is that recession-related anxiety is again pushing consumers to become more cost-conscious, driving returns for value-centric brick-and-mortar retailers.
While that’s a good outcome for tenants, it's creating new challenges for owners and developers.
Landlords are reconsidering their pricing and leasing strategies to retain existing clients and potentially acquire new ones. They also facing mounting competitive pressure as the marketplace is cultivating more favorable conditions for occupiers as inflation makes property value bolstering renovations more costly.
Complicating matters, there’s no consensus view among analysts, policymakers, and seasoned industry players about if the national economy has contracted, when it began shirking, and the time frame of a return to growth. The reason being the U.S. federal government officially designates recessions retrospectively, which makes it hard for industry players to gain market visibility.
That’s why depending on data-driven insights created by proven service providers is a critical best practice in a volatile landscape.
Want more clarity about the state of the commercial real estate industry in 2023? Download our 2023 CRE Project Manager Survey to find out how PMs across the country view the market.
Tag(s): Real Estate Development
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