Is The New Normal In Sight For Industrial And Retail?

While e-commerce continues to represent a large segment of the retail market, brick-and-mortar is making strides following the hit it took early in the pandemic. A March National Retail Foundation forecast predicted that the retail sector will see sales reach as high as $5.2T in 2023, with online sales contributing as much as $1.4T. 

A second-quarter U.S. market report by commercial real estate brokerage Lee & Associates found that retail is contending with a growing need for space to accommodate the brick-and-mortar comeback. On the flip side, the industrial market, which serves the retail sector, has seen a cooldown following sky-high demand earlier in the pandemic. Despite this, the report says that the quantity of industrial assets is poised for an increase of about 4% in 2023.

Lee & Associates CEO Jeff Rinkov said that while both sectors are showing signs of getting back to normal, CRE as a whole is still grappling with the turbulent economy and the higher cost of capital.

“Economic uncertainty is having an impact on brokerage firms, buyers and sellers, and it has diminished the volume of capital markets activity, sales and investment sales,” Rinkov said. “We’re hoping the Fed will help interest rates moderate in early 2024, and we will see investors become more confident, sellers starting to adjust cap rates and sales prices that will accommodate a larger volume of investment sales.”

Bisnow sat down with Rinkov to discuss the bright spots in the industrial and retail sectors amid economic uncertainty, the comeback of brick-and-mortar and how both sectors are expected to perform throughout the rest of the year.

Bisnow: How have the industrial and retail sectors been impacted by economic uncertainty?

Rinkov: There was an assumption that economic uncertainty would hurt consumer activity more than it has. The consumer has been incredibly resilient in their willingness and interest to be out and to travel, thereby having an impact on hospitality, restaurants and airlines. Experiential retail has been incredibly robust, and the consumer drive and desire to spend and engage with experiential retail has been stronger than both real estate professionals and the Fed expected, which has been interesting to witness.

The industrial sector has experienced a slight cooling. Some of that former e-commerce activity has recently been redirected toward brick-and-mortar retailers as well as restaurants, bars and other experiential retail opportunities. 

There’s been a change in the trajectory of industrial where it’s just starting to slow a bit. We're also finding that increased vacancy rates and sublease space are trends that are now starting to hold, but they're far below historically regular vacancy rates, sublease vacancy rates and sublease availability. Even if the current trajectory of vacancy and absorption of Class-A industrial were to continue, it will be many years before they come back to historically normal rates, but I don’t think that will be the case. We're in somewhat of a lull period where everyone critical to the supply chain is reassessing how their distribution channels will look for retail, given the slight slowdown in warehouse and distribution. 

Developers and landlords that would have typically looked for an exit in this climate have seemed to lack a sense of urgency, which is very positive for the overall strength of the CRE market. The lack of widespread and rampant vacancy helps us avoid deep discounts in asset value and lease rates. The strength of the landlord and the developer, as far as their current debt package with very low long-term interest rates, is going to help them through a potentially longer hold period with strong cash flows.

Bisnow: What does cooling demand in the industrial sector mean for the future of retail, especially e-commerce?

Rinkov: The cooling demand is a confluence of brick-and-mortar receiving some of the finite pool of consumer dollars from e-commerce. From an industrial standpoint, e-commerce is still the largest driver, but retailers such as Walmart have a very strong omnichannel presence and a lot of grocery, refrigerated and freezer space being developed and absorbed. 

The e-commerce trajectory has slowed since the late stages of Covid. For now, e-commerce is going to continue to increase, just at a slower rate.

The continued strength of e-commerce growth will depend on enhancements in logistics and the supply chain and the ability for same-day and next-day delivery, especially for not only staple products but also for nonstaple goods like apparel.

Bisnow: Based on Lee & Associates’ current findings, how do you predict both sectors will perform for the rest of 2023?

Rinkov: There has been robust leasing on the retail side. The consumer continues to outperform and outspend what was projected. Main street retail, high street retail and luxury retail seem to be really flourishing. Some of the largest discount retailers, such as Walmart, Costco and Target, are continuing to perform well in both their online and brick-and-mortar locations. Retail is going to have ongoing advancement, as we have an economy that relies on the consumer, so the consumer pickup and their spend is very positive. 

With industrial, we see strong adoption of Class-A first-gen and second-gen space. Some vacant direct and sublease space will push historically low vacancy rates higher as demand normalizes and moderates. While some sublease space is continuing to come back to the market, it feels like it will be measured. Landlords may struggle to achieve higher initial rates in the near term, but the rates that they're achieving are historically high, even as the rates may be static for a little bit.

Tenant balance sheets continue to strengthen, adding value and stability to assets. It will also create an underpinning of asset value so that when interest rates start to moderate and capital starts to flow more efficiently toward investment sales, those investment sales will be very robust as well. Industrial and retail have strong foundations and fundamentals driven by outsized consumer demand and responsible, well-positioned development.

This article was produced in collaboration between Lee & Associates and Studio B. Bisnow news staff was not involved in the production of this content.

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