Necessity-Based Neighborhood Centers Provide a Buffer Against Pandemic, E-Commerce
The surprising retail sales report for January revealed that retail sales for the first month of the year increased by a seasonally adjusted 5.3% after weak overall spending in December, well above the expected 1.2% consensus. The rebound in spending appeared to be the result of consumers applying the additional stimulus approved by Congress last month to buy a variety of goods.
Spending gains were broad-based, with every major category showing increases. Sectors with the biggest increases include electronics, which increased 14.7%, furniture and home furnishings, which rose 12%, and nonstore retailers, which includes online retailers and increased 11%.
However, one retail sector that has consistently outperformed throughout the pandemic and ongoing recovery is necessity-based retail, with grocery stores being a shining example.
Since February 2020, sales and employment in the food-and-beverage segment have experienced strong growth. Meanwhile, many other retail sectors have seen mixed or even negative employment and sales growth, with restaurants, department stores, clothing and furniture and home furnishing faring among the worst.
The onset of the pandemic and its effect on consumer behavior is only part of the story for the grocery sector. Even prior to the outbreak, rapid e-commerce growth led to an outsize share of announced store closures from traditional retailers. The grocery segment, on the other hand, is less exposed to the threat posed by e-commerce and most major players in the segment have adapted to the threat by building an omnichannel presence, most notably through delivery services.
The most common way for a retail investor to gain exposure to the grocery sector is by acquiring or developing a neighborhood center. Neighborhood centers, which account for nearly 40% of all grocery space in the country, typically measure around 50,000 square feet and serve the day-to-day needs of the immediate neighborhood. In addition, these types of retail centers are typically anchored by a grocer tenant, with around one-third of the average neighborhood center occupied by grocers.
With the record-setting number of closure announcements in 2020, many shopping center owners will have to reconcile with vacant space in the immediate and near term. Malls have a high share of space leased to traditional retailers, which have made up the lion’s share of closure announcements. Despite malls making up less than 10% of total existing retail space, they account for roughly 35% of the existing retail footprints of all of the retailers that announced closures in 2020.
Conversely, with a much higher share of space dedicated to grocers and other essential businesses, neighborhood centers face the least risk of all the center types, despite accounting for the largest share of the retail market among the other major shopping center types. Over the next year, we expect mall vacancies to rise by over 1.5 percentage points, while neighborhood center vacancies should rise by just 0.5 percentage points. High-quality and well-located malls can still outperform in the long term, but based on these projections, neighborhood centers should continue to experience much less distress.
Interestingly, even though neighborhood centers have outperformed in terms of market fundamentals, such as rent collection rates and leasing activity, the share of neighborhood center property sales of total retail transaction volume fell in 2020. This is likely due in large part to investors wanting to hold onto their strongest performing assets. Over the past year, top quality neighborhood centers have traded at a lower rate than in recent years. Because of this, now may be a good time for retail investors to consider value-add opportunities to capitalize on distress in the market.
Incorporating a grocery tenant in an under-performing retail property can add stability and increase the value of a shopping center. Also, based on the performance of the grocery segment, and the long-term trend of the grocery-anchored neighborhood center asset class increasing its share of total transaction volume, investor appetite for grocery-anchored neighborhood centers should not be a concern.
Based on rent collection rates and leasing activity, retail looks to be in the initial stages of recovery. The grocery segment has been a strong performing segment through the ups and downs of economic cycles and should continue to bolster center performance in the coming months. Performance of the overall retail market will largely be tied to the rate of vaccinations, the future of remote working as well as the return of leisure spending, but grocery-anchored neighborhood centers appear to be better positioned to weather any storm.