Analysis: Economic indicators favor retail growth
Retailers and retail real estate developers investing heavily in renovating and reimagining their brands and properties do so in a marketplace with great promise.
With the economy operating near full employment, job growth will moderate slightly to 1.8 million new hires this year — a 1.2% increase.
The total number of positions available hovered near an all-time high in the low 6 million range throughout much of 2017, illustrating that companies have considerable pent-up staffing needs. Upward pressure on wages will likely mount this year as employers compete for labor.
As a result, competitive compensation packages will be necessary to secure quality talent, and the construction, professional services, and hospitality sectors have been leading the gains. Higher wages should boost consumption, pushing up spending and, ultimately, core retail sales.
This measure, a key economic driver that excludes automobile and volatile gasoline sales, rose roughly 6% during 2017, well ahead of the long-term average. E-commerce and mobile commerce continue to gain momentum, capturing roughly 14% of core retail sales this past year.
Spending levels should also receive a likely boost as the new tax law may lower personal taxes and provide consumers with more disposable income. While actual tax savings will vary depending on a range of variables, the consensus is that most people will receive additional take-home pay, raising discretionary income and boosting consumption.
The new tax law could play a significant role in shaping both the economy and retail demand in 2018. A reduction in the corporate tax rate will be a windfall for corporations, encouraging several retailers to elevate investment in wages, hiring, and infrastructure.
CEO confidence has risen by more than 6% in the past year, stimulating economic growth. Enhanced optimism, higher wages, and strengthened recruiting efforts will support a strong retail market moving forward, and the capital will be available to shopping center and mixed-use developers to take advantage of it.
The finalization of the new tax rules should alleviate uncertainty that held back investors this past year. Many key existing provisions have been retained and the favorable treatment of pass-through entities, such as LLCs, may support an influx of passive capital in 2018; meanwhile, several new investors will enter the market through direct acquisitions.
Some of these funds will turn to retail properties for upside potential; cap rates in the 6% to 7% range can still be found. Less risk-averse investors may target secondary and tertiary markets for even higher yields. The reduction in tax rates could also spark repositioning efforts, bringing more assets to market and supporting liquidity.
Amid concerns surrounding accelerated economic growth and inflation expected to derive from the new tax law, the Federal Reserve has hinted at three to four increases of the federal funds rate during 2018. The potential for higher inflation could prompt a more aggressive approach; however, the Fed will be cautious about pushing rates up too quickly as it does not want to stall the economy.
Inflationary concerns and higher interest rates have driven a recent surge of volatility in equity markets. Investors are worried that rising interest rates will reduce their stock market returns as higher costs of borrowing could cut into corporate profits.
Additional uncertainty regarding the untested leadership of Fed Chairman Jerome Powell contributed to the volatility. His policies have yet to be clarified, though he will likely continue reducing the balance sheet to move long-term rates higher. Despite stable economic metrics, increased concerns regarding recent store closures will lead to a shift in the retail lending environment this year.
National and regional banks have stepped in as key lenders for retail properties as commercial mortgage-backed securities lending eased amid heightened risk aversion in the sector that has persisted since 2016.
In general, credit standards have held steady, a trend that should continue this year as lenders search for deals. Many originators are becoming increasingly selective about big-box retail deals after several national retailers announced closures.
Lenders could tend to favor strip centers with grocery-anchored or service-oriented tenants in the future. Construction lending will remain conservative, and below-average completions will likely benefit retail vacancy and rental rates.
Customers are changing the way they shop and turning to more experience-oriented establishments. Service- and entertainment-oriented tenants are drawing traffic to community and neighborhood centers, making them more than just a shopping destination.
Activity-based tenants and unique restaurant concepts draw experience-driven consumers, while health care providers, fitness centers and grocery stores make the shopping center a one-stop shop for necessities. Owners will continue to realign their strategies to attract these unique retailers that lure consumers and refresh tenant demand.
The healthy performance of specialty retailers has improved overall retail vacancy, despite concerns stemming from the announcements of several select Macy’s and Sears closures. Off-price department, fast-fashion, and discount stores remain successful in the internet age, and many of these companies will lead store openings in 2018.
Range-bound construction falling short of demand will divert many tenants to existing spaces and benefit retail vacancy, dropping the rate to 5% this year and generating moderate rent growth.
A positive outlook that combines a lean construction pipeline, an expanding economy, rising wage growth, and increased consumption should contribute to another year of retail investments outperforming the market. Despite media focusing on the demise of several well-known retailers, store openings significantly outpaced closings and corporate profits in the retail sector eclipsed past records.