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US retail’s vital signs are looking good again

HFF’s managing director, Bryan Ley, tells us where investors can find value in 2019.

Investors are always asking where the opportunity is in US retail. Most start with the sectors that have been heavily discounted due to vacancy or tenant bankruptcies, or areas that command a higher return today. And those areas are power centers and grocery-anchored neighborhood centers in suburban submarkets.

The power center space has become a tremendous buy opportunity for value-add investors, generating double-digit cash-on-cash returns. This space was hit hard during the large tenant bankruptcy years of 2015-17, so some property values declined 10-30 percent. Investors were a little shy to enter the space. Fast forward to 2018-19, and this space is now experiencing tenant expansion. Those vacant boxes in centers from previous bankrupt tenants are now presenting value creation opportunities for the next owner.

Grocery shopping

The closure of tenants like Toys ‘R’ Us presents many owners with opportunities to lease those boxes at higher rents, or better yet, leasing those spaces to grocery tenants. This is important to investors; adding a grocery anchor creates more daily trips to the center and presents new merchandizing options, with other tenants desiring to lease space at a rebranded center. And that could result in higher pricing when an owner decides to sell.

According to Real Capital Analytics, grocery-anchored centers accounted for more than $9.9 billion of transaction volume in 2018 across the US. For the grocery-anchored neighborhood centers in suburban submarkets, pricing is typically not as rich as in urban centers, so there is less competition from the investment community. This offers a good buy opportunity for investors, as these suburban markets are just outside the core trade areas and in the neighborhoods where people live, raise families and typically have more disposable income.

According to NCREIF, the markets that saw the highest total returns for retail included cities like Nashville, Orlando, Anaheim and Riverside in California, Plano, Texas and Columbia, South Carolina. These suburban submarkets saw the highest compounded annual return growth for investors and strong job growth, which increased incomes and the disposable income available in these markets. That, in turn, generated retail growth, tenants posting stronger sales volumes and owners able to charge higher rents. Demographics are important for any investor or tenant to follow, as average household income and daytime population are two vital metrics when looking at whether or not a trade area can support retail and rent growth.

JLL Research showed there was a 30 percent increase from 2017 to 2018 in grocery store openings in the US. This increase saw many grocery stores enter not only urban trade areas but suburban and secondary markets and, as mentioned, even the power center space. More than 17 million square feet of space was leased in 2018 to grocery tenants, according to JLL Research, and 25 percent of that square footage was leased in California, Florida and Texas. Grocers that are expanding include Aldi, which has plans to open 800 additional stores over the next five years, and Sprouts, which is averaging 30 store openings per year. Another strong growth grocer is Trader Joes, which continues to expand eastward and is planning 30 to 35 stores across the US.

The grocery sector is here to stay; it is a daily needs retailer that keeps customers coming back to neighborhood centers for their essentials and it serves as a dominant anchor tenant in these property assets.

Key takeaways

• Well-located retail assets in strong markets will always have better opportunities for tenancy, rent growth and income growth.

• Suburban submarkets are showing some of the best retail rental growth. There is less investor competition and pricing is usually less than in urban core markets.

• Stay focused on demographic drivers and daily needs tenancy. The ability to add a grocery store will improve overall asset value.