Retail
CUSHMAN & WAKEFIELD RESEARCH
Resilience of U.S. consumers has been a key ingredient supporting economic growth and the CRE retail sector this year. Through September, real personal consumption expenditures (PCE) grew 2.4% from a year earlier and the pace of spending has accelerated from the first half of the year, aided by a slower rate of inflation in recent months. Within the retail sector specifically, consumer activity is similarly trending favorably; real retail sales growth has been positive in four of the last five months. Household savings accumulated early during the pandemic have been largely depleted—particularly for lower and middle-income households—so consumers have been more reliant on incomes and credit to fund purchases.
📣 James Bohnaker, Senior Economist
Healthy job and wage growth have provided a solid bedrock for consumer health. The U.S. economy added more than 2.9 million jobs over the past twelve months (Oct 2023 versus Oct 2022), and wage growth continues to outpace price increases for consumer goods and services. Inflation-adjusted disposable personal income was up 3.5% in September from a year ago. That said, forward looking measures are not as bright, including consumer confidence, which fell to a 15-month trough in October. It is notable that the recent souring in consumer mood has been driven by less optimism in the labor market, with only 39% of Americans reporting jobs as plentiful in October vs over 50% reported earlier in the year. Consumer perceptions of more challenging job-search conditions syncs up with data on job openings, which are down 12% from last year.
Credit usage is also buoying consumer spending but will likely be a drag on household finances in 2024. Outstanding credit card balances surpassed $1 trillion for the first time ever this year, and rising interest rates have made it difficult for some borrowers to make timely payments. The percentage of credit accounts entering early delinquency has risen to the highest rate since 2011, and auto loan delinquencies are also trending up. With a backdrop of slowing income growth, consumers are expected to be under more pressure to meet debt obligations and will likely have to curtail discretionary retail purchases.
Several retail categories including sporting goods, home furnishings, electronics, appliances and home improvement are already experiencing negative sales and foot traffic comps versus 2022 as consumers have been squeezed by higher prices for essentials. Those with the ability to make discretionary purchases have been geared toward dining out, travel and other forms of recreation. Real consumer spending on recreation services has increased 5.3% since last year and we expect that these service-oriented sectors will continue to outperform discretionary goods next year, driven by upper-income consumers with job security and strong finances. This stands to benefit retail centers with an outsize mix of fitness, restaurants and entertainment options catering to wealthy households. At the other end of the spectrum, centers with value-oriented retail are also likely to remain resilient to macroeconomic adversity by necessitating regular visits from shoppers buying essential items at discount prices.
Tenant behavior has closely mirrored these consumer trends. The number of announced retail store openings year-to-date is outpacing closures by a margin of 1,000, thanks primarily to the nearly 1,800 net openings in the discount sector alone. The top three discount stores account for 30% of gross store openings this year and will add over 16 million square feet (msf) of retail space. Providers in the food services, medical, education and fitness sectors are also playing a larger role in retail demand. The share of overall retail leasing accounted for by each of these categories has increased several percentage points from pre-pandemic levels, taking share from financial services, apparel and other core retail. The implication is that a typical shopping center is well diversified today, creating resilience against evolving consumer habits and economic cycles.
These trends bode well for the outlook even in a recessionary environment, but there will undoubtedly be pockets of weakness in some corners of the retail industry. Aggressive expansion plans are easy to justify when retail sales are booming in an ultra-low-rate environment, but those days have passed. Higher operating costs and pervasive theft are additional layers of complexity that retailers will have to navigate. Opening retail stores is a capital-intensive endeavor, and the cost of capital is skyrocketing. Interest rates on corporate loans are pegged to what happens in the Treasury market, where rates have moved significantly higher in recent months and forecast to remain elevated into 2024.
Higher debt burdens are a leading cause of bankruptcy, which is usually a precursor to widespread store closures. Through September, retail bankruptcies have already doubled from the previous year and there is a rising number of retailers with poor credit ratings who are likely to have difficulty acquiring debt should they need it. Scrutiny on the banking sector has led to more cautious lending practices, causing more than one-third of senior loan officers to report tightening lending standards on commercial and industrial loans in the fourth quarter. The scarcity of credit is sure to result in more bankruptcies, limiting retailers’ ability to fund real estate investments; we expect net store closures by the end of next year.
A modest pullback in demand will not be overly impactful for market fundamentals including net absorption or rental price growth, because construction has been so limited. Since 2021, construction of retail shopping center space has totaled just 10 msf per year. That amounts to about 0.2% of inventory per year, compared with the 2011-2019 average of 0.6%. Construction has been subdued during the recent period of healthy demand, leading to historically tight vacancy rates and rental increases. Our baseline forecast projects that net absorption will decline by only 11.4 msf between 2024-2025, less than half of the pullback experienced in 2020. Meanwhile, rental growth is forecast to decelerate from 4.3% this year to 3.3% in 2024 and 1.7% in 2025. Even under downside economic scenarios, rental growth is expected to remain positive given relatively low vacancy compared to past economic downturns.
