Now and Then

The implications for the retail development and leasing landscape in 2024 and beyond.

With persistent economic uncertainty, and a unique constellation of factors shaping the retail development landscape, commercial real estate professionals have spent much of 2023 grappling with core questions about the state of the industry. Developers, retailers, leasing professionals and their clients are working to address the challenges and capitalize on the opportunities presented by the current marketplace, while looking ahead to 2024 to consider what the future holds.

Where do we stand as 2023 draws to a close—and what is on the horizon for retail and development in 2024? What are the trends shaping the marketplace today, and how will those forces play out in the months and years to come?

Headwinds and hesitation

The first step in making an industry prediction is achieving a better understanding of where we are and how we got here. While there is a complex array of economic factors to consider, the biggest commercial real estate development headwinds in 2023 have been higher interest rates, construction costs and availability of debt. While construction costs and supply chain inconsistencies are a frustrating reality, interest rates have had a much bigger influence on the development marketplace. That is primarily because of the downstream implications for values, which remain the biggest question mark. Development has not slowed down because of a lack of demand. Development has slowed down primarily because people do not know where values are. Consequently, there has been a cloud of uncertainty looming over the industry this year.

A mindset shift

The general industry sentiment when interest rates first started rising in 2022 was that it would be temporary. Over time, many participants in the real estate market have come to acknowledge that rates might not be as temporary as they hoped. It might even represent a longer-term structural shift. Extrapolating trends by comparing values across different commercial real estate product types can be challenging because there are so many variables. One of the best ways to recognize the extent of this trend is by looking closer at single tenant net lease assets. With fewer variables between properties, and values based on similar criteria, trends can become clearer. One recent data set showed how asking prices and cap rates have evolved for one prominent national convenience chain (all new construction, with similar lease terms and credit, and comparable management responsibilities). The picture it painted over the last couple of years was dramatic. Cap rates have risen and asking prices have gone down almost every month. While those changes were incremental, they add up over time to become significant.

Commercial real estate developers have enjoyed over a decade of gradual cap rate compression. Is the wave of higher rates cresting, or are we entering a new reality when our perspectives and underwriting will have to evolve accordingly? That question is one of the biggest unknowns that will shape both the near- and long-term future of the industry.

Varying implications

There is a clear distinction that needs to be made when talking about these shifting market dynamics and what they mean for the industry. The impact on different commercial real estate professionals can be quite divergent. Developers are struggling to uncover opportunities with adequate margins of safety during a period of price discovery. On the flip side, changes in rents have had virtually no impact on leasing brokers, whose fortunes are closely tied to transaction volume. Amidst a changing marketplace, the tenant rep and leasing business has remained extremely active, while investment sales brokers eagerly anticipate the narrowing of the bid/ask spread.?

A retail resurgence?

Retail has emerged as one of the strongest asset classes—a noticeable shift in a post-COVID landscape. This is primarily a result of the resilient U.S. consumer against a backdrop of virtually no increase in the inventory of retail space. That lack of new space is compounded by the fact many of older retail projects have been torn down and replaced with multifamily, industrial or other product types. This has resulted in there being less retail per capita nationwide than any other time in the last 20 years. With record occupancy, and a pipeline of new retail that has slowed from more than 100 million square feet in the mid-2000s to the low teens in recent years, owners of quality retail space find themselves in a desirable position.?

2024 and beyond

Regardless of whether or when the Fed lowers interest rates, leasing brokers will remain busy. Quality retail space and the best leasing opportunities will continue to come at a premium. Despite the seemingly diminished potential for a long-predicted recessionary cycle, economic fundamentals remain surprisingly resilient. However, collective uncertainty remains regarding how long the current circumstances will persist, and when rates and values might begin to shift. A kind of stasis seems likely to categorize the first half of 2024. Until we see an alignment of buyer and seller expectations, the current state of uncertainty will continue. Thriving amidst disruption, leveraging relationships, and capitalizing on opportunities in a tough-but-active market will be key for the real estate community.?