RETAIL BUILDING

The rebound in brick-and-mortar retail sales this past year is expected to continue in 2023. Although high inflation, rising interest rates, and labor shortages will remain headwinds, high construction costs and tight availability ensure that retail fundamentals will remain stable.

With more than $70 billion in direct spending in the state in 2022, Texas accounted for almost 20% of nationwide commercial real estate sector contributions to the economy.

And more than 1 million jobs in Texas were supported last year by the commercial property business, according to an annual study by the NAIOP Research Foundation. NAIOP formerly the National Association of Industrial and Office Parks is a commercial real estate development association with 20,000 members in North America.

Direct commercial property spending more than doubled in Texas from 2021 levels, along with jobs supported. Texas is the highest-ranking state in the U.S. for overall contributions of commercial real estate to state gross domestic product with $184 billion, $70.3 billion in direct spending, $69.2 billion in personal spending and 1.2 million jobs supported in 2022.

Texas ranks first in the country for office, industrial, and retail building activity, according to the NAIOP study. Nationwide, the commercial property business contributed $362.6 billion in construction costs last year.

The annual report stated that nonresidential building construction expenditures surged 41.6% in 2022 and are up 74.2% from 2020 levels. Total construction spending was up an estimated 10.8% in 2022 and accounted for approximately 20.7% of total GDP.

A slowdown in commercial real estate construction and sales is forecast for 2023 due to higher loan costs and tighter borrowing standards by lenders. NAIOP estimates the industry last year contributed $2.3 trillion to U.S. gross domestic product and supported 15.1 million jobs. Texas led the country in total job gains last year with an almost 650,000 employment increase.

Dallas-Fort Worth led the country in commercial real estate investment in 2022 with more than $42 billion in property deals. And North Texas is the top U.S. market for the construction of industrial buildings and apartments.

Retail fundamentals saw recovery from the damage caused by lockdowns, but high inflation in many markets is cutting into discretionary spending and is disrupting continued recovery. While short-term rates are expected to fall and long-term rates to remain sticky.

Compelling opportunities are emerging to redevelop dated retail for the highest and best use, such as grocery-anchored, lifestyle, and open-air service-oriented retail offerings and last-mile logistics.

The appeal of necessity retail extends to lenders. The quality of a tenant is an important factor in obtaining financing for a retail investment acquisition. While discretionary consumer spending is projected to take a step back in 2023, sales at necessity retailers should remain sound. As such, grocery-anchored centers, as well as single-tenant properties net-leased with long terms to personal and health care vendors such as pharmacies and convenience stores.

 

Distress may become relevant in 2023. Despite declining loan delinquency overall, distressed sales may become more prevalent later this year. Some properties face maturing debt in an environment of much higher capital costs. So far distress has held well below global financial crisis peaks, exiting last year around 2.7 percent.

Retail’s broad-based strength warrants attention. Reflecting the impact of rising interest rates and more stringent lending standards, sales activity moderated across the single- and multi-tenant segments in the second half of last year. A similar financing environment anticipated through at least the first few months of 2023, along with the potential for softening consumer spending, may translate to comparably tempered transaction velocity this year. 

Nevertheless, retail property performance suggests the sector will be targeted by a diverse mix of private and institutional investors active in the marketplace. Nationally, the retail sector is expected to record the smallest vacancy fluctuation among major commercial real estate property types in 2023, while also registering the lowest annual inventory increase.

Domestic tourism elevates. Urban retail corridors reliant on outside visitors may receive a boost as domestic airline passenger volume is slated to grow by 6 percent annually, reaching a pre-pandemic level of demand. The impact of this gain, however, may be tempered by international visitorship, which is not projected to fully recover this year.

Retailers expand their reach. Smaller store formats and other experimental concepts will play a larger role in major retailers’ growth strategies as these vendors attempt to reach larger or new consumer bases. Short-term pop-ups and smaller store layouts will represent a boon for malls and other shopping centers attempting to combat recent move-outs. In contrast, store-within-a-store layouts may have a negative impact on space demand, as retailers expand by occupying space already net-leased to another company.

Corporate pullbacks impact stores. After returning to two-thirds of its pre-pandemic level last year, domestic business travel may temper in 2023. Aligning with corporate hiring freezes and potential job cuts, firms are expected to limit non-essential business travel, acting as a counterbalance to the positive impacts of higher domestic tourism.

As informed investors we should understand the risks associated with real estate investing and that there is no guarantee. Please do your due diligence.