An outdoor shopping center in Richmond, Virginia.
Courtesy of Nuveen
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It would be an understatement to say that commercial real estate has fallen on hard times. It started with the birth of e-commerce and intensified with the Covid-19 pandemic. Its recovery has been fragmented, given the diversity of retail subsectors, from large indoor malls to big-box centers to outdoor malls anchored by grocery stores.
It’s this latter subsector that Chad Phillips, global head of Nuveen Real Estate and responsible for more than $140 billion of equity and debt investments in commercial real estate, says is the big opportunity today.
“We have relied heavily on this resilient and open strategy over the past two years,” Phillips said.
These are grocery centers with, perhaps, a CVS, pizza place, etc. Vacancy rates in these spaces were 7.8% at the start of 2016, but fell to 4.4% earlier this year, according to data from CoStar Group.
“He survived Covid. He survived the Amazon effect,” Phillips said. “Our portfolio of conveniently located, open-air grocery stores are more than 95% leased.”
Each time a tenant closes, Nuveen is able to quickly restock the space due to high demand, Phillips said.
He admitted that commercial real estate had been overbuilt for a long time in the United States. Eventually, promoters became more disciplined, especially with the birth of e-commerce. This led to a correction that created a sort of undersupply today.
“THE [capitalization] the rates at which you can buy them are quite attractive,” Phillips said. “So the total returns are good. You are buying at a price well below replacement cost. So you put it all together, and it’s a very resilient, critical real estate need where we can generate strong, risk-adjusted returns. »
As traffic at larger indoor malls increases, especially at high-end malls, Phillips said he likes this smaller sector because it’s “small business.” You can sell them easily. They are liquid. Shopping centers are not.
It’s also a simple factor of supply and demand. About 15 years ago, retail allocations topped 30% for real estate investors, but that figure has fallen to 10% due to low yields, according to Nuveen. Now, in just the last 12 months, returns have improved and investors are turning their attention to this sector again.
“I wouldn’t say they’re coming back, but we’ve increased since the start of the year [for] retail practice $1.4 billion in leveraged equity,” Phillips said. “That gives us over $2.5 billion in purchasing power for these types of strategies. So yes, I think investors are turning their heads. »
This does not mean that this sector, like any other, is not without risk. After a few years of outperformance, it starts to slow down.
“After five years of steady demand and rent growth, the fundamentals are softening,” Brandon Svec, national director of U.S. retail analytics at CoStar Group, wrote in a recent company newsletter, noting that vacancy rates in grocery-anchored open-air spaces have increased for three straight quarters. (Although they are still near all-time lows.)
But Svec added that the broader retail leasing environment tells a different story.
“With little new retail space expected over the next few years and availability conditions near historically tight levels, retailers remain active in their search for new locations,” Svec said.
He also said there are concerns about the state of the overall economy, consumer confidence and spending.
After strong rental growth in previous years for the outdoor grocery subsector, growth has stalled this year, with the lowest annual rental growth in more than a decade. This is a clear difference compared to previous years, Svec emphasized.
Phillips explained that this is why the strategy requires investors to be particularly picky about properties.
Consumer confidence fluctuates, and this impacts their decision to visit these centers for coffee or a manicure. The existing customer base, namely those with a higher savings rate and able to withstand higher unemployment, is key to choosing where to invest.
Phillips said an average household income of more than $100,000 and a largely millennial, well-educated population are among the criteria he looks for.
Competition among investors is intensifying, but not to the point where good deals can’t be had, he said, citing low, double-digit returns.
He added that low levels of new construction help reduce vacancy rates and the spaces attract consistent crowds.
“I think it’s all about convenience and being on the path to that convenience, and that’s where we want to invest,” Phillips said.