The narrative around brick & mortar retail has changed dramatically over the last few years, particularly relative to the outright negativity from the late 2010s. At the time, mounting concerns that ecommerce would quickly dominate the retail industry – compounded by high-profile bankruptcies such as that of Toys R Us or Sports Authority – prompted retailers to aggressively scale back store opening plans and redirect resources toward investments in supply chain and technology. A secular decline in retail real estate rents was then anticipated. But the pandemic, and perhaps time itself, has reversed fortunes, bringing retail real estate back into favor.

A Turn For The Better 

The now widespread use of ecommerce delivery methods such as ‘buy online, pickup in-store’ or ‘ship-from-store’ have reintroduced physical stores as a central hub for distributing goods.

At the same time, iconic digital brands have struggled to reach profitability and have turned to physical stores as part of the solution, underscoring the importance of this traditional channel. Hybrid work-from-home schedules have also strengthened strip center fundamentals, driving increased demand from retailers seeking to serve the needs of consumers while at home. The importance of brick-and-mortar retail has been reaffirmed. 

Shovels On Hold

Despite the resurgence in demand for retail real estate, new developments have not taken off. From ’01 to ’08, prior to the Global Financial Crisis, bulging new supply averaged approximately ~2.5% of the total stock annually, more than any other traditional real estate sector. In the following decade, new supply was muted at about 0.5% of the existing stock per year, but tenant bankruptcies, particularly in the late 2010s, flooded the industry with vacant space.

Most recently, in the post-pandemic era, strip center development starts have been minimal, averaging just 0.3% of the existing stock per year. And more importantly, unlike prior cycles, the lack of new supply has coincided with strong retailer demand for space, setting off the strong backdrop we enjoy today. New supply may increase some going forward but is likely to remain a tailwind for the sector.

While strong retailer demand for space, along with stabilizing construction costs, are threatening to change the narrative, conditions required to drive new developments on a broad scale are still distant.  

A Perfect Pairing: Strong Demand, Steady Supply

Strip center occupancy for institutional quality portfolios is handily above pre-pandemic levels, at heights not seen in over 20 years. Additionally, the backlog of leases signed but not yet commenced is above historical levels and is poised to drive strong NOI growth over the next 18 months, granted tenant retention remains high. The successful backfilling of former Bed, Bath & Beyond stores in '23 and '24 is more evidence of strong retailer demand. The space has been re-tenanted faster and at a lower cost than in prior anchor bankruptcies such as that of Sports Authority in 2016.

* Leased occupancy for REIT portfolios covered by Green Street.  

Additionally, driven by the lack of availability of high-quality real estate, retailers have been willing to take over the leases from bankrupt tenants, allowing minimal disruption for landlords. The table is set for healthy rent growth going forward. 

Outlook 

The outlook for strip centers is brighter than in the past. A strong demand-supply backdrop is expected to lead to healthy rent increases of ~3% annually over the next five years and sustained high levels of occupancy. The outlook may not exactly set hearts racing but is much better than what the industry experienced in the last two decades: a rent growth CAGR of 1% during the decade from ’14 to ’23, and flat growth during the prior decade, from ’04 to ’13.

Our forecast leans conservative due to the typical cyclicality of retail – tenant failure is a constant in the industry – and the strong bargaining power still held by some national anchor tenants, including grocers. But given the strength of current fundamentals, and the resilient store opening plans of retailers despite macroeconomic uncertainties, the sector seems poised for positive surprises.