Increasingly Sophisticated Retailers Deploy Range of Growth Strategies

 

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RETAIL SALES APRIL 2019
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Research Brief
Increasingly Sophisticated Retailers Deploy Range of Growth Strategies
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Retail sales showing consistency as year progresses. Softened consumer confidence in March had little impact on spending as core retail sales advanced 3.6 percent year over year. A second consecutive month of moderate yet steady growth can be traced to the healthy job market, rising income levels and increasing spending power. Though overall consumption grew at a stable pace, sales growth was concentrated in a few areas, including e-commerce.

Reinvestment takes priority as companies aim to improve shopping experience. As a historically cold winter subsides, shopping at home-improvement and lawn and garden stores is picking up. Over the past year, spending at these retailers rose 6.0 percent as warming weather kicked off projects such as residential housing starts and remodels. Companies like Home Depot and Lowe’s are making shopping at their stores more convenient by strengthening their omnichannel capabilities. In-store pickup has been widely popularized by home-improvement vendors, leading many other retail segments to adopt the concept. Like many retailers, home-improvement companies are focusing heavily on reinvestment into current operations rather than expansion.

Drugstores multiply offerings to gain wider audience. Spending at health and personal care retailers grabbed headlines in March, with sales rising 5.2 percent during the past year, well outpacing the 10-year average. Investor interest in these assets remains strong, particularly as they evolve into one-stop shops for health-related products and services. Leading the way are CVS and Walgreens, who are exploring new layouts and services to help drive foot traffic. These retailers have added primary care clinics and dental services and are beginning to offer more traditional grocery items at some locations to grow front-store sales. Cap rates for drugstores remain relatively tight, dipping below 5.0 percent for high-credit tenants in heavily trafficked areas.

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Developing Trends
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Employers stay on recruiting trail. Initial claims for unemployment benefits registered 192,000 in March, beating expectations and marking a near 50-year low. With job openings outnumbering job seekers roughly 10 percent, those looking for work are finding plenty of options.

Lowe’s reevaluates business model as sector evolves. Lowe’s has trimmed its brick-and-mortar portfolio in recent months, closing 51 underperforming locations in the U.S. and Canada as well as all 99 of its Orchard Supply stores. Increasingly sophisticated customer tracking has helped some retailers optimize their locations, boosting local revenue and profitability metrics.

Pharmacies taking on new role. As drugstores continue to bolster in-store healthcare, more customers are preferring these retailers over their family physicians and dentists. Pharmacies hold a key advantage in that they are typically open evenings and weekends, expanding services beyond typical healthcare business hours.

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3.6%
Core Retail Sales Growth Y-O-Y
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6.0%
Building Materials & Garden Equipment Sales Growth Y-O-Y
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* Through March
Sources: Marcus & Millichap Research Services; Marcus & Millichap MNET; Bureau of Labor Statistics; The Conference Board; CoStar Group, Inc.; Creditntell; Retail Dive; U.S. Census Bureau

 

 

Labor Deficit Boosts Wages; Invigorates Hiring in Tertiary Markets

 

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EMPLOYMENT APRIL 2019
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Research Brief
Labor Deficit Boosts Wages;
Invigorates Hiring in Tertiary Markets
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Job growth rebounds in March; pace of hiring moderating. Removed from the disrupting effects of the partial government shutdown and winter storms, U.S. employers created a combined 196,000 jobs last month, well above the 33,000 personnel who were added to payrolls in February. Employment gains for the first quarter bring the average monthly total to 180,000, down 19 percent from the first quarter of 2018. The decline in hiring is in line with the current year-end forecast of about 2 million jobs.

Labor shortage curbs onboarding but lifts wages. Employers’ aggressive hiring plans are being thwarted by a shortage of people looking for work, slowing employment growth. The labor shortage works to the advantage of commercial real estate by adding upward pressure to wages. Average hourly earnings improved 3.2 percent over the past 12 months. Such a sustained period of growth has not occurred in a decade. Higher wages are bolstering discretionary spending, increasing the demand for retail stores, apartments, and other properties.


Employment gains coming to smaller markets.
In contrast to earlier in the economic cycle, the majority of jobs are going to the country’s smallest metros instead of the largest. Since 2016, nearly 50 percent of new positions have been in tertiary markets. The current labor deficit has motivated some companies to move to where the prospective hires reside instead of trying to recruit prospects to major cities. Employers can recoup some of the expenses of an office relocation or expansion through the lower operating and living costs often found in these smaller settings. Investors benefit as well. Since much of the post-2010 commercial development has been confined to primary metros, less new supply is being added in several of these more modest cities. While some businesses are building to suit, others are renting existing space, driving down vacancies and lifting rents.

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Developing Trends
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Data suggests the economy is at effective full employment. The unemployment rate remained flat month-over-month, at 3.8 percent, and has not moved out of the 3.7-to-4.0 percent band in a year. Other measures of joblessness, such as the total number of people marginally attached to the labor force and the underemployment rate, remained little changed in March. These factors suggest that the economy is at effective full employment, with little slack left in the labor pool to propel vast hiring.

Employment growth fuels new economic activity, benefiting commercial real estate. The creation of 2.5 million jobs over the past 12 months at a 3.2 percent higher average wage has supported the formation of 1.3 million households, $10 billion in additional core retail spending, and 85.5 million square feet of new office leases. The added jobs and discretionary spending have also boosted both commercial and leisure travel, lifting hotel occupancy to the highest level on record dating back to 1988..

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180,000
Average Jobs Added
Per Month in the First Quarter
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3.2%
YOY increase in Avg.
Hourly Earnings in March 2019
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* Job Seekers as of March; Job Openings as of January
Sources: Marcus & Millichap Research Services; Bureau of Labor Statistics

 

 

Retail Powerhouses Maintain Dominance Despite Tempered Consumption

 

RETAIL SALES

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.

2.9%

Core Retail Sales Growth Y-O-Y

4.6%

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

 

FEDERAL RESERVE

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.

2.25%

Current Fed Funds Overnight Rate

1.9%

Core PCE in February 2019

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