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