Retail properties have been a relative bright spot in a commercial real estate (CRE) market that’s otherwise been disrupted by higher interest rates. Though there are lots of different types of retail properties, they all share one thing in common: their success is driven in part by strong consumer retail spending. But, beyond the strength of the consumer, the fundamentals of the retail property market remain in comparatively good shape. There’s demand for tenants to lease retail space, but there is only so much space to go around. In this X-Factor, we’ll analyze the drivers of these positive retail fundamentals, and whether they are likely to continue.

“The retail sector is not a monolith, and while there is some truth to the ‘death of the mall,’ other parts of retail have proven resilient. With consumers still spending, retail space remains in high demand and limited in supply.”

Wage Growth Has Outpaced Inflation

Even though the excess stock of consumer savings accumulated during the pandemic has likely now been entirely depleted, the American consumer has nevertheless remained quite resilient. While it’s true that the consumer faces some headwinds in the second half of this year – such as rising credit card debt and delinquency rates – real wage growth remains positive compared to pre-pandemic levels. Real wage growth, which accounts for inflation, is one of the best indicators of the consumer’s ability to continue spending.

The chart below shows cumulative, nominal (not inflation adjusted) wage growth for all private employees and service sector employees, as well as cumulative inflation, since the fourth quarter of 2019. Whenever the blue or green lines are above the grey line, it indicates that real wage growth is positive. Though inflation is still front of mind for consumers who remain frustrated with higher prices compared to four years ago, wage growth is, on average, outpacing inflation.

Vacancy Rates for Most Retail at Multi-Year Lows

When consumers have money to spend, retailers can sell them more products. This, in turn, increases the demand to lease retail space. The result has been multi-year lows in retail vacancy rates for most types of retail space. Malls have been the exception, and some malls continue to struggle due to a continuation of pre-pandemic trends. However, malls only account for approximately 7.5 percent of all retail space. Strip and other centers account for approximately 37 percent of all retail space. The remainder, including single-tenant retail, is shown in the chart below as the “all other retail” category. While vacancy rates for malls are above 8 percent, those for other types of retail locations vary between approximately two and five percent.

Limited New Retail Supply Coming to Market

Strong demand to lease retail space combined with a limited supply of space to rent has driven down retail vacancy rates. Compared to other asset classes, very little retail space is being built. Retail space under construction only accounts for approximately 0.4 percent of existing inventory, compared to 1.1 percent for office, 1.9 percent for industrial and 4.1 percent for multifamily. 

What’s more, a substantial quantity of retail space is being demolished to clear the way for redevelopment or for conversion into other types of space. In the second quarter of 2024, retail space demolished was equal to approximately 30 percent of gross new space delivered. This was only outpaced by office space, which has undergone a structural shift as a result of remote work. Both industrial and multifamily space demolished remains very low relative to new deliveries.

Demand to Own Retail in the Suburbs has Grown

As a result of the strong demand to lease retail space, and the limited supply of new space, prices for retail properties have held up relatively well since the onset of the pandemic. Only highly walkable, central business district (CBD) retail locations have had prices fall, sinking 12 percent cumulatively over the last four years. Interestingly, the farther away retail space is from CBD locations, the better prices have held up. Prices for highly walkable suburban locations remain essentially flat, whereas those for car-dependent suburban locations are up by 18 percent, compared to pre-pandemic levels. This suggests that demand to own retail properties in suburban locations, especially ones that aren’t particularly walkable, has increased relative to locations in the urban core. 

So, What’s the X-Factor?

Before the pandemic, many anticipated that rising eCommerce sales would lead to the coming “death of retail.” The retail sector is not a monolith, and while there is some truth to the “death of the mall,” other parts of retail have proven resilient. With consumers still spending, retail space remains in high demand and limited in supply.