Retail Powerhouses Maintain Dominance Despite Tempered Consumption



APRIL 2019

Retail Powerhouses Maintain Dominance Despite Tempered Consumption

Retail spending slows amid economic concerns. A moderating economy became more evident in February as core retail sales advanced 2.9 percent annually, following a revised gain of 4.3 percent one month earlier. Unresolved trade tensions as well as a weakening international economy continue to weigh on domestic growth, straining retail sales in the process. Over the past few months, spending habits have been sporadic as they moved with shifting levels of consumer confidence.

Retailers shake up growth plans to broaden customer base. Despite softened spending across several categories, general merchandise vendors performed well in February, posting a 4.6 percent yearly jump. This includes companies like Target and Walmart, which are making significant changes to match evolving consumer trends. Target is ramping up the expansion of small-format stores, straying from suburbia as it looks to plant roots in dense, urban areas and near college campuses. These stores will help the retailer draw shoppers that would have been out of reach in the past. Cap rates for small-format locations sit in the mid-5 percent band, up to 300 basis points below their suburban counterparts. Walmart is also refining its growth strategy, strengthening its online platform to better compete with Amazon. The retail sector continues to gain investor interest as more companies adopt an omnichannel model.

Heightened economic optimism pushing consumers out of their kitchens. With wage growth picking up and consumer confidence maintaining historically high levels, spending at bars and restaurants remains strong. This subset is averaging 6.5 percent growth over the past year following a 2.8 percent reading during the previous 12 months. Food and drink establishments keep finding ways to make their space more experiential as an additional layer of defense to e-commerce. For many retail centers, restaurants are viewed as a new type of anchor tenant due to the foot traffic they can generate.

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Developing Trends

Consumer confidence fluctuates as economic matters remain in question. After rising 8 percent in February on a monthly basis, consumer confidence dipped almost 6 percent in March. Confidence still sits historically high despite several matters weighing on economic optimism.

Target takes next step to win over urban shoppers. In 2019, Target will open 30 small-format stores in markets like Los Angeles, New York City and Washington, D.C., in addition to a number of college campuses. These new layouts will average approximately 40,000 square feet, one-third the size of Target’s conventional design.

Online sales surge for world’s largest physical retailer. Walmart’s vastly improved digital infrastructure is beginning to pay dividends as the company reported online sales growth of 40 percent for 2018. A better search functionality on the retailer’s website and quicker delivery remain focal points in Walmart’s ongoing competition with major online retailers.


Core Retail Sales Growth Y-O-Y


General Merchandise Growth Y-O-Y

* Through February
Sources: Marcus & Millichap Research Services; Marcus & Millichap MNET; Bureau of Economic Analysis; The Conference Board; CNBC; CoStar Group, Inc.


Fed Signals End of Tightening Cycle; Interest Rates Reignite Opportunities



MARCH 2019

Fed Signals End of Tightening Cycle; Interest Rates Reignite Opportunities

Interest rates fall as Fed shifts policy outlook. At its latest meeting, the Federal Reserve signaled an end to rate hikes this year, while reserving the potential for one increase in 2020. The Fed also announced its intention to end the runoff of its balance sheet, a process referred to as quantitative tightening. These steps have coincided with considerable financial market volatility and robust demand for Treasurys, which has pushed the 10-Year Treasury below the 2.5 percent range, matching the lowest yield since the beginning of 2018. The Fed continues to balance the prospects of slowing economic growth with inflation hovering in its target range. This has allowed for a more flexible approach to monetary policy, yet has led many economists and investors to consider the possibility of a rate cut from the Fed before year end or early next year. Domestic data continues to sustain a growth outlook this year, with job creation keeping unemployment low and bolstering retail sales. Data tied to business and manufacturing that could be influenced by the slowdown in Europe and ongoing trade negotiations with China presents a potential downside risk.

Drop in interest rates invigorates investors; reopens opportunities. As borrowing costs have fallen, buyers are revisiting previous opportunities that didn’t pencil last fall. The sharp drop in Treasury rates rewidened the spread between cap rates and lending rates, which had previously proved to be an impediment for select acquisitions, particularly in primary markets. As a result, sales activity could be invigorated by the more attractive yield spread. While some buyers remain cautious on the forward outlook for the economy, commercial real estate trends remain favorable. Increased purchasing power in the millennial cohort bodes well for the continued strong performance of the apartment and industrial sectors, while limited development of retail and office has allowed for declining vacancy and rent growth.

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Developing Trends

Inflation pressures muted. Despite historically low unemployment and rising wage growth, inflation pressure remains subdued. Core CPI recently reached 2.1 percent, while the Fed’s preferred metric, Core PCE, hit 1.9 percent. Both metrics provide room for the Fed to operate monetary policy without being overly concerned with rising inflationary pressure.

Conservative underwriting restraining development pipeline. Supply pressures in some markets and property types has begun to seep into the underwriting environment, with lenders exercising more caution than in previous years. Loans for new construction projects have been even more conservative than other areas of the market, diminishing the future pipeline. Together with rising labor and materials costs, these factors should restrain the construction pipeline of apartment, self-storage and industrial properties, which have all reached cyclical highs.


Current Fed Funds Overnight Rate


Core PCE in February 2019

*Through February
Sources: Marcus & Millichap Research Services; Bureau of Labor Statistics; Federal Reserve Bank


Retail Sales Back on Track as Discretionary Spending Remains Strong



MARCH 2019

Retail Sales Back on Track as Discretionary Spending Remains Strong

Retail sales bounce back after December lull. Following a lackluster end to 2018, core retail sales rebounded in January, climbing 3.7 percent on an annual basis. At the same time, average hourly earnings are rising, posting 3.4 percent yearly growth in February. Increased take-home pay is sustaining optimism in the economy, enabling consumers to make more discretionary purchases.

Retail sector generating notable gains. Retailers continue to benefit from the gradual uptick in earnings, producing especially strong results for many vendors selling products that cater to discretionary spending. Clothing retailers sit at the forefront of this movement, attracting consumers with the latest store concepts and fashion trends. Digitally native brands like Bonobos and Indochino are making a strong impression within this segment as they seek to develop an omnichannel platform by adding brick-and-mortar locations. This is creating more demand for retail space, further driving down vacancy. With more refined business models, the retail sector continues to gain stability, boosting investor confidence and pushing deal flow. As a result, transaction volume has increased each of the past six years, signaling the growing strength of the sector.

Elevated consumer confidence prompts heightened consumption. Like clothiers, electronics and appliance retailers are also benefiting from an increase in discretionary purchases. Over the past several months, this category has witnessed sales swell amid historically high levels of consumer confidence. Spending on these items advanced 4.0 percent in January, indicating sustained economic momentum as the increase sits well above long-term averages. These retailers will remain sought-after tenants for investors in the coming months, serving as viable strip center anchors as well as complementary tenants in power centers.

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Developing Trends

Earnings stay on upward trajectory. The nation’s average hourly earnings ticked up to $27.66 in February. In the past 12 months, this figure has averaged 3.1 percent growth, following regular mid-2 percent bumps over the previous two years.

Physical retail a key ingredient to success. The shift among online companies to brick and mortar is an increasingly popular trend. During the next several years, digitally native brands are expected to open hundreds of stores largely due to the impact the move has on sales. Opening a physical store within a market has proved to have a significant effect as that retailer’s local web traffic jumps by an average of 37 percent in subsequent months.

Optimism in economy picks back up. Consumer confidence fell slightly to start the year but rebounded in February. The confidence index climbed 8 percent on a monthly basis, reflecting continued optimism in the economy.


Core Retail Sales Growth Y-O-Y


Consumer Confidence Index
Growth Y-O-Y

* Through January
** Through February

Sources: Marcus & Millichap Research Services; Bureau of Labor Statistics; The Conference Board; ICSC; Moody’s Analytics; U.S. Census


Low Unemployment Fuels Housing Demand, Favors Apartments



MARCH 2019

Low Unemployment Fuels Housing Demand, Favors Apartments

Tight labor market curbs job creation. The U.S. economy added 20,000 jobs in February, the lowest monthly total since September 2017. While the partial government shutdown and winter storms contributed to last month’s meager showing, the pace of hiring should recover in March. Still, the very tight unemployment rate will likely limit 2019 job creation to the low-2 million range. The total number of unemployed people now stands at 6.2 million, well below the 7.3 million current job openings. With qualified candidates hard to find, employers are facing significant recruiting challenges.

Declining underemployment supporting apartment demand. The tight labor market is helping those who have had a difficult time finding a job in the past attain new opportunities. This is reflected in an 80-basis-point drop in the broad-based underemployment rate, the largest single-month decline in the measure’s history. The rate accounts for people who are normally excluded from the standard unemployment rate, such as discouraged individuals who have not looked for work in recent months and part-time employees seeking full-time positions. As more of these workers find full-time employment, new households will form, boosting demand for apartments. Class C units in particular will benefit as they offer inexpensive housing options. While Class C monthly rates have appreciated 33 percent over the past 10 years, Class A and B rents rose by greater margins. The gap between the average Class C effective rent and Class A or B rent is wider now than it was a decade ago. This could direct more potential renters toward that option, reducing availability. The Class C vacancy rate fell to 4.1 percent at the end of 2018, its lowest level since 2000 and 50 to 100 basis points below comparable measures for Class A and B units. In general, the unemployment rate and the Class C vacancy rate have tended to move together over time. This poses a risk for investors should the economy lose substantial momentum.

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Developing Trends

Government shutdown distorts joblessness. Despite limited hiring, the total number of unemployed fell by 300,000 in February. About 225,000 people were temporarily laid off from work in January, including government employees furloughed by the shutdown. The return to full federal operations brings the unemployment rate closer to what it may have been in January without the shutdown.

Contained inflation grants Fed maneuvering room. Another byproduct of the tough hiring conditions are rising wages. Average hourly earnings improved 3.4 percent over the past year, the fastest pace since April 2009. Greater take-home pay, however, has not sparked increased price inflation, granting the Federal Reserve more latitude in their management of economic growth. The Fed will maintain a data-driven approach to monetary policy this year as it considers a range of tools to use if needed.


Average Jobs Added Per Month over the Past Year


Unemployment Rate in February 2019

Sources: Marcus & Millichap Research Services; Bureau of Labor Statistics; RealPage, Inc.