Suburban Retail Proved To Be More Resilient During Recent Recession, but Urban Retail Has Long-Term Potential
The COVID-19 pandemic is a once-in-a-century event and the ensuing recession was unlike any other in recent memory, with very different outcomes affecting retail properties located in urban and suburban locations.
In the past, retail space in urban business districts enjoyed a higher consumer spending potential than suburban properties, on average, due in large part to its higher share of sales from office workers and tourists. During past recessions, having a diverse consumer base served as an asset for urban retail space.
However, once the pandemic kicked into high gear, that reliance on office and tourism became a liability. The first quarter into the pandemic, vacancies across the retail market started to expand, and urban retail was one of the hardest hit. As store closure announcements piled up throughout 2020, the rising vacancy rates accelerated, with urban rates climbing faster.
Suburban vacancy rates began decelerating toward the end of 2020, while urban vacancy rates aren't expected to begin doing so until after the second quarter of this year. Remote working remains at elevated levels, robbing urban retailers of an important source of sales even as tourism is in the midst of a strong recovery.
In addition to vacancy, urban retail rent has also struggled recently compared to suburban retail rent. Throughout the previous cycle, annual rent growth in urban business districts consistently outpaced that of the suburbs, at times seeing a growth rate nearly 1.5 percentage points higher. After the pandemic hit in 2020 and continuing through the next several years, CoStar forecasts stronger retail rent growth in suburban areas than in urban business districts.
Promising Signs of Recovery
While urban retail has underperformed recently, one promising sign is the recent bounce-back in leasing. Retail leasing in suburban areas held up slightly better than in urban areas, and it recovered earlier. In the most recent month, however, urban business districts saw a significant increase in space leased, well outpacing the five-year average.
Another promising sign for urban retail is the improving situation for the U.S. hotel industry. Hospitality demand has reached 90% or more of the 2019 demand level, and hotel room occupancy recently reached an 85-week high.
This demand is heavily skewed toward tourism as occupancy in hotels that cater to groups and meetings has not bounced back, and this portion of hospitality demand is also affected by the comparatively slower return to office.
Furthermore, the compound annual growth rate for residential buying power per occupied square foot over the next five years is expected to be stronger in urban areas than in suburban areas. With tourism starting to come back and workers returning to the office, total spending potential will be on the rise and will have a more significant impact on retail property in urban business districts.
The diversification of spending sources within urban business districts is ultimately a boon, despite the recent short-term pain. Although the pandemic caused distress for the entire retail market, capitalization rates for retail property sales have fallen in the suburbs and only expanded for urban retail.
With this adjustment in pricing, and the positive signs of recovery, now may be an opportune time for investors to reconsider urban retail investment. Given the historical outperformance of retail in urban business districts, it remains viable as a long-term play.