Retail’s Rollercoaster

While Christmas is the season to be jolly it’s especially true for retail stores, because they book 1/3 to ½ of their profits during the holidays.  But also, just as true, January is the month for retailers to declare bankruptcy, because they just booked as much business as possible and with their balance sheets already impaired. This means January will be as good as it will get to declare BK before things go from bad to worse. It’s been a rough decade for retail stores.

 

The assault of eCommerce

 

First, there was the assault from eCommerce on bricks-n-mortar stores with Amazon et. al. doing a fantastic job and even bringing in Wal-Mart to online sales. The Death of the Mall was rumored, but instead these battlers became battle-buddies with online sales being made from stores, online purchases being picked up in stores, and eCommerce-only companies changing to actually open physical stores. Antagonists united to cooperatively serve us all better.

 

This truce only came after the pandemic caused a surge in store closures. Back in 2020, there were about 9,700 stores that closed when only 3,700 stores opened, according to the research of Coresight. The next year there were only a couple of hundred closures, net of openings. In 2022, the number of openings surged to nearly 5,400, with about 3,800 closures, and then, in 2023 openings and closures were about even at 5,843 to 5,548. And now in 2024, 7,100 store closures have been announced through the end of November, a big surge taking back the excess openings in the Covid period of 2022.

 

Bankruptcies of 2024

 

Here’s a sampling of this year’s casualties. Bankruptcies include Red Lobster/TGI Fridays, Big Lots, Joann Fabrics, Conn’s, Lumber Liquidators, True Value Hardware, Rue 21 Tupperware and Party City. Container Store, just announced its bankruptcy, but only to reorganize in order continue in business. This year many major retailers have downsized and closed stores.

The list includes Family Dollar, CVS Health, 7-Eleven, Walgreens (1,200 stores in the next three years), Dollar General, Macy’s, Bath & Body Works, Dollar Tree, Soft Surroundings, Burlington Stores, Stop & Shop, and Office Depot. But then, in the ever-turning retail wheel of fortune, 7-Eleven will close more than 400 stores worldwide while planning to open an additional 600 fast-casual food spots across North America by the end of 2027.

 

Retail Occupancy

 

Entering 2025, Retail is in a very odd and confusing place just now. Overall occupancies are actually at record highs, over 96%, despite all these closures. This is partly due to a big slump in retail center construction, with high construction costs, land costs, interest rates and even insurance expense conspiring to make new development barely profitable. Many tenants operate on razor thin margins so that higher rent costs can drive them out of business. Thus, fewer new centers are being built and only where new homes are being developed that need new retail services. Certainly, the stores that close, as listed above, are usually well-located and lend themselves to re-development. In some areas, malls have been repurposed into Amazon depots and even multi-family development. Location, location, location.

 

Thus, there is a smaller supply of new properties being built, causing occupancy rates to exceed 96%. Normally, such strong occupancies would lead to new development, but not this year and probably not next year, either. So, Landlords want to raise rents to renew and re-tenant, but the store owners can barely afford any increases, so creating new value through higher net operating incomes is difficult.

As with all commercial property, new retail development is extremely capital intensive and not for the faint-of-heart. Those centers that are now being built are commanding record high rents, which are needed just to make the numbers work for investors and lenders, who are pretty careful and risk adverse.

 

So, in summary, we have record high occupancies, despite higher-than-normal bankruptcies and a slump in new construction. Expanding retailers are having a hard time finding space to lease and mom-and-pop tenants are facing higher rents. Uncertainty is certainly logical.

 

Retail investment property sales volumes

 

Let’s pivot to Retail investment property sales volumes which have been very low despite fundamentals being very strong. According to Foresite Commercial Real Estate of San Antonio, there were 74 sales transactions in 2022, 24 in 2023 and only 17 in 2024 thru October, illustrating the severe decline in sales volume. Some of this is due to fewer properties coming to market. Owners don’t become sellers when they face lower sales prices than they anticipated. Sellers are now being generated from estate sales, partnership expirations and the occasional refinancing emergency. Owners would prefer to curate their properties, waiting for a better selling season in maybe 2026.

 

Interest Rates

 

For an example of how capitalization rate expansion affects an investment property, consider a 25,000 SF shopping center that would have sold for a reasonable 5.25% cap rate two years ago, and would have been worth $5,000,000. However, currently that cap rate would have expanded (i.e. the value of the property declined) and now exceed 6.5%. This produces a sales price of $4,000,000, a million-dollar hair-cut. Ouch! The expectations have been for interest rates to begin to decline in 2024. Well, they did dip in Q3, but blipped back up in Q4. Now, there is even an expectation of higher for longer, maybe even increases by the FED. Consequently, buyers and sellers have remained on the sidelines, trying to understand the trend for at least the next year, and they are not getting that clarity.

In the Real Estate Wheel of Fortunes, every seller usually becomes a new buyer, and the wheel keeps turning. One investor is a value-add guy and buys a dilapidated property, fixes it up, re-tenants and sells so that he can look for another property to fix-and-flip. And the buyer for this fixed-and-flipped property is a long-term holder looking for a core asset, a stabilized property. One investor wants a higher return for doing a lot of work and taking a lot of equity risk while the other investor wants lower risk, less hands-on work and is willing to take a lower return. So, the rebound for investment sales volume may be delayed awhile longer.

 

2025, A Better Year

 

Overall, the market seems to have bottomed and 2025 should be a better year. Co-Star reports that their index of private commercial transactions has risen each month for the past four months, which hasn’t happened since mid-2022. However, it is still down 2.5% for the year ending in November.

The volatile publicly traded real estate market as reflected in Vanguard’s broad-based VNQ fund, is flat for the year, having risen strongly into November, but selling off in December. Generally, I see positive attitudes in the commercial market in San Antonio with positive expectations.

We remain a goldilocks market, continuing on a stable upward path. Drive to thrive in 25′!