Retail Property Investors Should Look Beyond Tenant Risk To Analyze Shopping Center Types
The past three years have revealed winners and losers within the retail sector, not just among retailers themselves, but also among shopping center types. With several prominent exceptions, shopping malls continue to lose value. Meanwhile, leasing at neighborhood, community and strip centers has returned to pre-pandemic levels and lowered the average vacancy in those types of centers to 10-year lows.
As cracks continue forming in the macro-economic environment, including weak retail sales reported in November and December, consistently low consumer sentiment, and an unsustainably low personal savings rate, retail property investors would be wise to keep a closer eye out for risks and opportunities within their existing portfolios beyond tenant risk and incorporate center types in their analysis.
In the early days of the pandemic, social distancing and store closures took a significant toll on many retailers, leading to a record 160 million square feet of announced retail space closures in 2020. This had an outsized impact on the mall sector, while smaller shopping center types showed resiliency.
As shoppers and retailers adapted to the new environment and the economy recovered, not only did store closures slow, but many retailers actually expanded. By early 2021, retail leasing had returned to normal levels and the average retail vacancy rate began trending down. Retail vacancy rates are even lower now than before the pandemic in 2019. However, when looking at the data closer, it becomes clear that not all center types have been performing equally.
Regional and super-regional malls have struggled the most over the past three years, with an average vacancy rate expanding by 3.4%. This compares to a much-smaller 0.4% vacancy rate increase for lifestyle centers, which are open-air malls. Power centers, community centers, neighborhood centers, and strip centers all have lower vacancy rates now compared to 2019 by 0.4% to 1%.
The mall segment had been struggling since 2017 and suffered increasing vacancy, in large part due to the growth of e-commerce. The pandemic accelerated that trend, as e-commerce as a share of total retail sales increased from about 12% to over 16% in just one quarter. While its overall share of retail sales has come down to 14.8% as of the third quarter of 2022, e-commerce penetration is still about two years ahead of where it would have been had the pandemic not occurred, based on its pre-pandemic growth rate.
The growth in e-commerce has been especially detrimental to malls, which have a high concentration of space leased to apparel retailers. Other center types, such as strip, neighborhood and community centers, which have proven to be resilient in recent years, generally have more restaurants, service tenants and grocery stores, which have less competition from e-commerce.
This trend has been evident in leasing data as well, with regional and super-regional malls struggling to attract tenants in each of the past three years. Leasing for smaller center types, such as strip and neighborhood centers held up better in 2020 and bounced back to pre-pandemic levels over the past two years.
Importantly, retail property pricing has adjusted in response to these leasing and vacancy trends. According to the National Council of Real Estate Investment Fiduciaries, the value per square foot for super-regional malls in its NCREIF Property Index has dropped 24% in the third quarter of 2022 from the first quarter of 2020. Regional malls were down 8.9%, power centers were down 7.6%, neighborhood centers were up 4.4%, and community centers were up 5.6%.
With mall valuations this depressed, especially compared to other center types, opportunistic investors may find pricing low enough to be attractive for certain mall deals. However, the greatest opportunity within the mall sector to earn favorable long-term returns will likely be in high-quality malls and lifestyle centers.
Based on the recent retail vacancy and leasing data trends, there appear to be much safer shopping center types for investors to consider. Neighborhood, community and strip centers all have vacancy rates at 10-year lows and leasing back to pre-pandemic levels. Based on their typical tenant make-ups, they are also better positioned to weather a pullback in discretionary spending, as the U.S. economy has seen over the past few months. And taking that approach one step further, the resiliency offered by grocery-anchored retail is especially appealing as a likely recession looms.
Understanding and monitoring performance at a center-type level will help investors make more informed retail decisions in a constantly evolving market.