Key Points:

• Retail spending is the life blood of retail commercial real estate and it is slowing in real, inflation-adjusted terms. 
  
  
• When compared to pre-pandemic levels, retail rents have not fallen in any of the largest cities and have increased the most in locations with larger population growth.
  
  
• Despite some consumer headwinds, there is very little retail space available to lease and not much in the construction pipeline, which is keeping vacancy rates low across the country.

All retail commercial real estate (CRE) depends to a certain degree on the strength of the consumer. While there are numerous uses for retail space, it is all used to sell some good or service to a consumer. Everything else in the retail CRE ecosystem revolves around this fundamental relationship. If consumers have less money to spend, then retail tenants are limited in how much product they can sell and, in turn, landlords in what they can charge for rent. These leasing dynamics also impact the purchase market - if a landlord can’t charge high rents, they aren’t going to be willing to pay all that much to acquire retail properties in the first place. 

With Black Friday right around the corner, this X-Factor will examine the strength of the consumer heading into the holiday shopping season and how that may impact the retail CRE market in the new year. 
 

“The limited supply of retail space for lease will put a floor on retail property performance and continue putting upward pressure on rents. A strong holiday shopping season will not solve the lack of available retail space, a dynamic that will persist into the new year.”

What Americans Spend Money On

Consumer spending is the largest part of the U.S. economy, accounting for approximately 70 percent of GDP, or $20 trillion. However, as shown in the top part of the following chart, only approximately $8.5 trillion, or 43 percent, of that amount is spent on retail goods and services. The remaining $11.5 trillion of consumer spending is comprised of non-retail items, such as housing, utilities, health care, and financial services. 

As shown in the bottom part of the chart below, the share of consumer spending attributable to retail sales doesn’t change much over time. However, during the pandemic, retail sales rose by four percentage points to account for 47 percent of all consumer spending. This was due to a surge in demand for retail goods during the quarantine period, followed by a surge in demand for retail services when quarantine broadly ended. Since then, retail sales’ share of total consumer spending has reverted to its pre-pandemic levels. 

Consumers Are Really Spending More, but Not on Retail Goods and Services

It’s useful to adjust growth in spending to account for changes in prices. Without inflation adjusting, it’s difficult to know whether spending truly grew or whether an apparent increase was just due to higher prices. A metric that’s inflation adjusted is referred to as “real” and one that isn’t is referred to as “nominal.” 

The following chart shows real growth in both consumer spending and retail sales. Though real consumer spending is increasing – at an annual rate of nearly 3 percent in September – real retail sales are falling. In fact, real retail sales have been declining or stagnant on an annual basis for all of 2024 and most of 2023. This suggests that consumers are buying fewer retail goods and services, the life blood of retail CRE, even though consumers are spending more on non-retail products compared to a year ago. 

The exception to this downward trend in real retail sales occurred during the 2023 holiday season when real retail sales increased in both November and December. Real retail sales may spike again during Black Friday and the 2024 holiday season, but even if it does, real retail sales growth will likely remain muted in the first part of next year given the headwinds facing consumers in 2025.

Where People Go, Their Money Follows

Pandemic-era migration trends typically lured people away from larger, coastal cities towards locales in the sunbelt and southeast. In the following scatterplot, which shows population and retail rent growth for the top 100 cities by population size, this trend can be observed as red and green dots typically appearing below the average national rate of population growth (to the left of the vertical grey bar) and as orange and blue dots typically appearing above that national average (to the right of the vertical grey bar). Cities with greater increases in population have seen stronger retail rent growth compared to cities with smaller population increases. When consumers move, so too does their spending power, and greater retail sales growth lets landlords charge retail tenants more for rent.

Cities that have experienced the most population growth over the past five years also tend to have higher retail rent growth, though with more variability in how much those rents have risen. On the chart, cities with population declines appear as a cluster of closely packed dots in the lower left, where rent growth is lower. In contrast, cities with larger population gains are more spread out in the upper right, showing more variation in rent growth. This suggests that cities that have undergone larger population growth over the last five years have not only had higher retail rent growth, on average, but also greater variability in that growth. Notably, rents have stayed at or above pre-pandemic levels across major cities, except in San Francisco, where rent growth has remained flat.

Retail Vacancy Rates Are Low Across the Country, But Slightly Higher in the West

Retail vacancy rates are low across the country, even in cities performing worse than average. The top half of the following chart shows the 10 cities with the highest vacancy rates. These include San Francisco, Sacramento, and Los Angeles, among others, where retail vacancy rates are all above 5 percent. That said, 5 percent isn’t particularly high given that retail vacancy rates routinely hovered between 4 and 7 percent in the decade that preceded the pandemic. 

The bottom half of the chart shows the 10 cities with the lowest vacancy rates in the country, including Madison, Wis., Miami, Salt Lake City, and Minneapolis. These cities all have retail vacancy rates between 2 and 3 percent, meaningfully below their pre-pandemic levels as well as the pre-pandemic national average. 

So, What’s the X-Factor?

Retail sales, the economic activity that underpins all retail CRE, is slowing. That pattern may reverse during the holiday season after this year’s Black Friday sales are accounted for, but headwinds to retail spending will nevertheless remain in 2025. However, the limited supply of retail space for lease will put a floor on retail property performance and continue putting upward pressure on rents. A strong holiday shopping season will not solve the lack of available retail space, a dynamic that will persist into the new year.