Retail Capital Market Update, Q2 2018

Retail Market: National Cap Rate Trends

The Retail cap rate trend demonstrated as much volatility as the office cap rate trend – although this would be expected given the turmoil in the retail sector. Given all of the store closures in 2017 and thus far in 2018, it is surprising that retail cap rates have held up as well as they have and remained below the 10-year average, as shown by the light blue dotted line in the chart below.

RETAIL CAP RATE TRENDS, Q2 2018 - Graph
However, as we frequently caution, there are a number of things to consider for retail cap rates. First, transaction volume has declined consistently every quarter, and the second quarter was no exception, falling 30% from a year ago. Thus, it is likely that only better properties are trading – and there are plenty of retail properties that have not only survived the e-commerce retail tsunami, but have thrived over the last few years. Secondly, until this quarter, the retail real estate statistics had defied the store closure reports. However, net absorption for retail properties was negative 3.5 million square feet, due largely to the Toys R Us store closings. The retail vacancy rate climbed to 10.2% from 10.0%. Finally, we should add that the retail real estate landscape varies widely by metro. A number of metros have seen negative net absorption in retail space along with declines in retail employment, while others with strong tourism have seen positive occupancy growth and positive retail employment growth. Our data shows that a number of metros with negative net absorption had positive increases in retail cap rates.

Although retail fundamentals are arguably weaker, some investors clearly still see opportunities in retail properties. That said, retail cap rates are close to the ten-year average of 7.9%. They are likely to see further increases in 2018 as the Fed raises rates. Finally, retail cap rates will likely see continued volatility as the gap between the better markets and worse markets could widen over the next few quarters.

 

Retail Market: Cap Rate Trends by Region

The graph below shows glaring volatility in the Southwest due to a wide range of transactions that closed over the last few quarters. This has created significant selection bias in the trend data. It should be noted that the Southwest transactions do not weigh heavily on the national average.

RETAIL CAP RATE TRENDS BY REGION, Q2 2018 - Graph

The West, again, has the lowest cap rates, followed by the Northeast. Retail cap rates in the Midwest had tracked the national average throughout most of 2017 but have since trended higher. Our metro-level retail statistics show that the impact of the negative net absorption and rent declines in the second quarter was spread out across the U.S. – hitting some in the Northeast such as Fairfield County and Long Island; some in the Midwest such as Wichita and Chicago; and some in the South Atlantic including Columbia and Tampa. Many of the West Coast metros were not as affected, and a number of metros saw positive net absorption as well as rent growth and retail employment growth. Thus, the stability in the retail cap rates reflects the fact that better properties remain in demand for investors.