As seen the the CREJ Retail Properties Quarterly

The strong economic rebound over the summer triggered a rapid recovery in retail investor demand, and this momentum is expected to continue well into next year. Tenants’ sales increased, delinquencies are down, and the majority of landlords are back to pre-pandemic collections. Although headwinds remain with supply chain issues and labor shortages, strong consumer demand is forecast to continue and strengthen in 2022. While some rents are being reset, the majority of recent retail loans we’ve closed indicate pre-pandemic rents are holding or increasing. Retail development historically has been tempered compared to other product types. With the addition of inflationary costs to build, combined with higher land values, new retail supply will be limited.

At the peak of pandemic uncertainty, contrarian investors were able to acquire quality, essential anchored retail properties with sustainable cash returns above 7% at an attractive basis below replacement cost. However, cap rates have compressed for grocery-anchored centers as well as credit tenant leases, and the window to take advantage of market dislocation has started to close. For a while, lenders were able to get rate premiums of 50 to 100 basis points and cherry-pick high quality properties with experienced borrowers. Now mainstream lenders are opening up to a wider range of retail properties vs. grocery or essential tenant anchor criteria.

The outlook for retail six months after the economy reopened has become less uncertain, especially when compared to office properties, for example. Unlike office product, the acceleration of e-commerce was playing out well before the pandemic hit, and retail already was rapidly evolving; investors were able to underwrite the risk. The combination of these factors has resulted in more demand for quality retail with sustainable cash flow.

The need for lenders to achieve higher returns in their mortgage portfolios intensified over the course of the year. Balance sheet lenders like insurance companies and banks have expressed frustration and fatigue chasing asset classes with the lowest risk (multifamily, industrial, self-storage) and competing at spreads that have been driven down to historic lows. The common thread for lenders financing retail properties is the need for a sustainable cash flow story and good supporting data. An attractive story typically includes strong ownership experience, no remaining COVID-19 relief and increasing tenant sales. Properties occupied by essential tenants along with inline tenants serving the rooftops are in the most demand. Unanchored neighborhood strip centers located in good demographic infill locations with an internet-resistant tenant mix serving the trade area typically are the next best story.

The COVID-19 pandemic accelerated e-commerce trends, and the lockdowns and mask mandates devastated many retailers and restaurants. However, the silver lining is investors have more clarity on how to underwrite risk compared to a year ago. Pricing discovery has been occurring, and cap rates have compressed recently on higherquality grocery-anchored properties, which suggests investors are shifting to alternative risk-adjusted returns in retail. Reduced uncertainty in the retail sector, higher equity demand and a normalizing labor market/supply chain in the coming months will bring more lenders back into the market and increase capital for retail investments in 2022. In the meantime, we’ll have to hope that Santa’s reindeer can pull the cargo ships to shore in time for the holidays.