The retail sector remains particularly vulnerable as the economy endures and attempts to recover from the coronavirus recession. The gradual reopening of the economy and the relaxation of social distancing restrictions has modestly lifted consumer attitudes, and confidence and sentiment metrics showed hints of stabilization through 20Q2. However, increasing infection rates throughout many Southern states could threaten the recovery path and stability while adding uncertainty to retailers who were already grappling with reduced revenues and limited liquidity. As a result, tenant and landlord sentiment remains on a fragile footing, and market indicators continue to signal weakening and cautionary warning signs.
Leasing activity remains a shadow or just half of the pre-pandemic trends. Negative net absorption continues to mount, as retailers and restaurants shutter their doors amid unprecedented financial stress. Retailer bankruptcies continue to be concentrated throughout the apparel and department store subtypes. However, the profile of retailers experiencing distress has expanded to fitness centers, furniture stores, home décor retailers, sporting goods, restaurants, and even discounters. The wave of retail bankruptcies is expected to continue, and COVID-19 will accelerate the trend of both bankruptcies and retailers downsizing their footprints. Tenants with essential-oriented offerings have thus far weathered the storm and arisen as a modest source of positive demand. However, it will not be enough to offset weakness in order tenant segments.
Vacancy has risen alongside swelling negative net absorption, and occupancy is poised to erode further. Even landlords with fully occupied buildings struggle, as many tenants have found it difficult to make rent, either seeking rent deferral, rent amendments, or rent modifications. Rent growth downshifted to below 1% during the second quarter, registering its slowest growth pace since 2013. The escalation of tenant move-outs and softening in demand will generate negative rent growth across all forecast scenarios.
Financial Crisis vs Covid 19
The virus has taken a profound toll on the economy, consumer confidence, and retailers' financial health. The outlook largely depends on how quickly economic activity returns and how smoothly reinfection rates can be mitigated.
Leasing activity has improved since hitting a trough in mid-April. However, activity remains less than half of its pre-pandemic trend.
The development cycle remains muted at the national level, which has helped keep vacancy in check at around 5%. Under a research based case scenario, upwards of 84 million SF will go dark throughout 2020, causing vacancy to rise over 100 basis points to 5.6%, still well below the peak rate of 7.3% seen during the global financial crisis.
Rental Rate Forecast
The consequences of the pandemic and recession on tenants and landlords are already being felt throughout many markets. With vacancy on the rise, rent growth downshifted 90 basis points, from 2.4% in 20Q1 to 1.5% through 20Q2, marking the first time rent growth has registered below 2% since 2013.
Rent growth varies significantly across markets and subtypes. In terms of subtype, malls and power centers continue to bear the brunt of e-commerce exposure and weakening sales, weighing heavily on occupancy and rent growth. Meanwhile, neighborhood, strip, and general retail centers have benefited from more resilient forms of demand, supporting rent growth. Retail performance remains property-specific, and landlords that have successfully created thriving town centers and experiential components to the retail centers have had considerably more leverage in driving rents.
Meanwhile, not all rent growth metrics are grim; markets such as Charlotte, Orlando, Tampa, Nashville, and Phoenix continue to register stronger growth thanks in part to substantial demographic growth generating relatively more stable retail tenant demand.
The wave of retailer closures and space give-backs will continue to create a challenging environment for landlords, translating to rent losses in the forecast, upwards of -12% in the Base Case, and -18% in the Moderate Downside.
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