Retailers Fight For Space As Sector’s Strong Performance Bucks Doomsday Forecasts

With leasing activity at a five-year high, scant amounts of available new space coming to the nationwide retail market and consumers ready to spend, the so-called retail apocalypse of the 2010s is fading into a distant memory.

Closures are still happening, with giants like Walgreens and Family Dollar shuttering space to the tune of 22M SF this year. But planned expansions and updated takes on what brick-and-mortar stores should be mean those spaces won’t stay on the market for long.

“Because there isn't a lot of new construction going on right now, because there aren't a lot of mass bankruptcies creating holes in the market, the supply is not meeting the demand,” said Jonathan Lapat, Boston-based managing principal at SRS Real Estate Partners who works with several national tenants like Ulta and Raising Cane’s. 

Despite inflation, economic uncertainty and whipsawing consumer sentiment, the U.S. retail sector is thriving. Leasing activity is outperforming recent years despite rising rents as limited availability gives landlords more pricing power, and a sparse supply of new retail space under construction means the retail market is only expected to further tighten.

Retailers leased more than 52M SF from April through July, more than 10% higher than the second-quarter leasing average of the last two years, according to CoStar. Because of a lag in lease recording, CoStar expects to adjust that number upwards of 30%, putting quarterly leasing activity above 73M SF for just the third time in the last five years. 

Construction deliveries fell 37% from the previous quarter to a historic low of 7M SF, outpaced by 7.7M SF in quarterly net absorption, JLL reported. After accounting for preleasing, there is roughly only 1.8M SF of new space being built, said Keisha Virtue, senior research analyst at JLL who covers the retail sector. 

“What is going to be released to the market, 75% of it is already preleased,” she said. “We're only looking at about 25% that's actually available for lease.” 

Retailers are expanding because consumers are spending. The Bureau of Economic Analysis found consumers spent $57.6B on goods and services in June, continuing a trend of rising spending for the last year. Americans’ disposable income also continues to grow, albeit modestly, with a 10 basis point increase in June. 

While consumers are spending more, they continue to hunt for deals to balance against pandemic-era inflation, boosting discount retailers.  

Dollar Tree was the most active retailer in the second quarter, signing 119 new leases, with Five Below in distant second with 30 deals. Rounding out the top five were Harbor Freight Tools, Crunch Fitness and Burlington, according to JLL data.

Discount retailers are expected to continue to drive leasing activity in the near term, with quick-service restaurants driving activity for smaller storefronts, Virtue said. Wingstop, Jersey Mike’s, Starbucks and others are expanding their presence nationally, according to JLL. 

While those store operators have seen strong same-store performance, they’re also the ideal tenants to fill the outparcel sites and freestanding locations being vacated by Walgreens and Family Dollar. 

“The freestanding category has the lowest availability rate at about 3.3%, so we can really expect to see people clamoring for that space when it's freed up,” Virtue said. 

On the opposite end of the market, high-end luxury retailers have also been performing well, in part because their clientele “is not affected by the everyday economic travails,” said Mark Matthews, executive director for research at the industry trade group National Retail Federation. 

There is a distinction between the ultra-luxury market and the more accessible luxury space, Matthews said. Some high-end brands with a broader consumer base have seen year-over-year performance sag, in large part because those buyers had been using the money distributed to Americans during the pandemic on discretionary expenses, he said.

Middle-market retailers are still working to bring back price-conscious consumers who shifted to discount stores during the pandemic, and it is starting to work, Matthews said. With inflation cooling, buyers are slowly becoming less price-sensitive.

“Right now it's great to be in the low-price space, but six months from now that may not be the case,” he said.

The retail sector’s industry-leading performance is a far cry from the doom and gloom that pervaded the marketplace a decade ago as storied American retailers dramatically downsized or closed altogether. Another hammering blow came in the form of pandemic-era restrictions that forced retailers out of business.

But today’s physical storefronts are not only shopping destinations but points of service, Matthews said. Retailers used to treat e-commerce as wholly distinct from physical sales, but that has shifted as storefront pickup has exploded in popularity. 

“No one feels like stores matter less than they did 10 years ago,” he said. “In some ways, they matter more because it's part of one ecosystem where you need to cater to the consumer.”

Outside of the utility of a retail location as a point of sale, retailers are also changing their view of what a store is supposed to be. Operators are investing heavily into turning their in-store experience into an extension of their brand, a place that might draw in a curious consumer who then makes a later online purchase.

Ace Hardware announced earlier this month that it would spend $1B to launch Elevated Ace, a new concept that includes showrooms and an outdoor space with plants and grilling demos. Dick’s Sporting Goods has also opened at least nine new Dick’s House of Sport locations this year, giving shoppers access to batting cages, golf simulators and rock walls. 

“This notion that you had to grow same-store sales by 2% year-over-year or you're failing as a business has gone out of the window because the store is much more important in a lot of different ways,” Matthews said. 

Strong demand for space has given landlords significant pricing power. National asking rents across all retail asset types is up 2.6% year-over-year to $25.02 per SF, according to JLL. 

Rents have exploded in some of the country’s most highly-sought retail corridors, such as in Miami’s Design District, where rents were up 200% since 2019, according to a December JLL report. M Street in Washington, D.C., has seen rents jump 37% over the same period.

When Foxtrot, a chain of high-end neighborhood markets, abruptly closed its locations in April, a retail broker said a “feeding frenzy” ensued for the available space. A similar story played out when discounter 99 Cents Only closed all of its stores in the Southwest. The pace of leasing at shopping centers was at a two-decade high in June.  

Retailers are looking to snap up the space despite shrinking margins as operational costs rise and inflation cools. 

To make the financials work, store operators and landlords are finding creative ways to structure leases, Lapat said. Retailers are signing deals that have a higher base rates but include delayed escalations as a way to control near-term costs. 

They’ve also begun to leverage their ability to bring foot traffic to struggling locations to create package deals with institutional landlords that have a large number of assets. Retailers are agreeing to open in less desirable locations to secure space at both high-performing retail centers, Lapat said.

Successful retailers have been able to absorb the rising costs of operations because their profit margins grew wide during the pandemic and have only recently begun to contract. But the future of the American economy is murky, as the Federal Reserve prepares to cut interest rates for the first time since March 2020.

While landlords today enjoy a tight market, Lapat said that dynamic could just as easily be flipped.

“It's going to be an interesting couple years in terms of how the supply-demand curve plays into things, and whether we hit a breaking point where retailers push back and say, ‘You know what? We just can't pay $60 a square foot in a market that we don't think is worth more than $40.’”