RENTAL GROWTH RAMPING UP DESPITE UPTICK IN BANKRUPTCIES Q1
As of the close of Q1 2024, overall shopping center vacancy in the Sacramento region stood at 7.7% for the second consecutive quarter. Vacancy peaked at 7.9% in Q3 2023 and has remained stable, despite some notable national chain retailer bankruptcies that have resulted in some local space givebacks. Most notably Rite Aid had shuttered eight local stores in Q4 2023 after their initial October bankruptcy filing when initial plans called for more than 130 closures nationally. They have since increased those numbers as their case works its way through the courts (planned national closures had topped 300 as of March 2024) and have added a handful of additional local units to those closure lists since. As this report went to press in mid-April 2024, the beleaguered drug store chain had still not exited Chapter 11 and has announced plans for two more Sacramento region closures. So far, however, this has not been enough to send vacancy levels upward. Shopping centers across the Sacramento region recorded 99,000 square feet (SF) of occupancy gains in Q1 2024 and have posted over 200,000 SF of positive net absorption over the past six months.
Chain store closures may be up from where they were in 2022, but demand remains strong with store openings continuing to outpace closures both locally and nationally. Strong tenant demand is driving rental rate growth locally, with retail being the only commercial real estate property type to post rental gains in Q1. The current average asking rent for shopping center space in Sacramento is $2.15 per square foot (PSF) on a monthly, triple net basis. This metric has growth by 7.5% over the past year,
with all shopping center types recording growth (including malls). Note that these averages are inclusive of all classes of shopping centers and all sizes of space and are for benchmarking purposes only. Asking rents for small shop space in new construction on a primary corner can easily top $4.00 PSF monthly. But available large, big boxes in weaker locations can go for $1.00 PSF or less.
We are also seeing the return of new retail construction to the region with 299,000 SF of space currently under development across the Sacramento region. Most of this continues to be additional pad buildings or phases at existing projects, though new product is also following the path of new residential development in Roseville, Elk Grove, Rancho Cordova (Anatolia Ranch), and Davis. Just over 230,000 SF of new space has been delivered over the past four quarters, yet during that same period the market has absorbed 255,000 SF of space and vacancy has been trending downward.
Over the past year, all shopping center types except for Super Regional Malls have recorded declining levels of vacancy. We should note that increased vacancy for that sector is mostly driven by one project—Sunrise Mall in the Carmichael/Citrus Heights/ Fair Oaks/Orangevale submarket, which is partially open while
beginning massive renovations that will recreate this project as an open-air mixed-use lifestyle center upon its completion in a few years. undergoing a major reimagining. There is no effective vacancy at Roseville Galleria and the region’s other Class A mall, Arden Fair, is about to redevelop its long vacant Sears department store space that has inflated its vacancy rate for the past few years. But just as the mall outlook has been improving nationally, the focal point of retail’s resurgence post-pandemic both locally and nationally has been driven by open air shopping centers.
Grocery or drug store anchored community and neighborhood centers account for 38.3 million square feet (MSF), or 58.0%, of the region’s 66.0 MSF shopping center inventory and have remained the region’s growth driver over the past few years. This asset class recorded 45,000 SF of positive net absorption in Q1 and has increased total occupancy by 432,000 SF over the past four quarters. Vacancy currently stands at 6.4%, down from the 7.2% reading of one year ago. The current average asking rent for community/neighborhood space in the region is $2.05 per square foot (PSF), on a monthly, triple net basis. This metric has climbed by 5.1% over the past year.
Big box anchored power centers account for 11.2 MSF of local inventory, or 17.0% of Sacramento’s shopping center inventory. Vacancy has fallen slightly over the past twelve months, from 6.4% to the current rate of 6.2%. But the average asking rent for power centers has increased by 5.0% over the past year from $2.00 PSF to $2.10 PSF.
Unanchored strip centers account for 8.8 MSF, or 13.3% of the region’s inventory and currently report a vacancy rate of 7.7%, down from 8.4% one year ago. The average asking rent for strip centers has climbed 5.3% annually and now stands at $2.00 PSF across the region.
CLOSURES & BANKRUPTCIES
TICKING UP BACK TOWARDS HISTORICAL NORMS
Since 2000, the United States has averaged 28 major chain bankruptcies annually. In 2020, the market broke all previous records when 75 major chains filed for creditor protection (roughly
one third of which ended up liquidating, while most eventually re-emerged with reduced store counts and debt levels. In 2021, those numbers dropped to 16 bankruptcies while 2022 set a record for fewest retail failures in this century with only ten. But those numbers have begun climbing again. A total of 24 chains filed for bankruptcy protection last year, with some liquidating. The most notable was Bed, Bath & Beyond (BB&B) and spinoff concept Buybuy Baby.
In what is the clearest demonstration that the market is on much more solid footing now than just a few years ago, roughly 90% of the 896 stores vacated coming out of last year’s biggest bankruptcy have either already been backfilled or have tenants lined up only nine months after those closures. As we mentioned in our last report, when Toys R Us liquidated its national footprint of 735 stores in 2018 (locations like BB&B in both size and quality of sites), it took nearly four years to backfill these spaces. Improved retailer financials, improved retail sales, an influx of new concepts in expansion mode and over a decade of very little new retail space being built all meant the market was in a better position to quickly absorb vacant space. But 24 chains ended up filing for bankruptcy in 2023, and it appears increasingly likely that we match those numbers, if not exceed them, in 2024.
So far, the biggest retail filing of the year has been the early April collapse of dollar store retailer 99 Cents Only, which will liquidate all 371 of its stores across Arizona, Texas, Nevada, and California. Local closures will include stores in Citrus Heights, Folsom, Lodi, Rancho Cordova, Roseville (2), Sacramento (4), and Yuba City. This comes as their discount competitor Family Dollar announced that it would be closing 600 stores in 2024, with an additional 370 closures “over the next few years” as leases expire at some locations. Their parent company, Dollar Tree, added 30 additional
closures of their own in the queue for 2024.
Unfortunately, these are not the only concepts with challenging announcements this past quarter. Beauty concept The Body Shop liquidated its US store presence (resulting in one local closures), while crafts retailer JoAnn filed Chapter 11 (though so far, their plan does not include closing any stores other than roughly a dozen nationally they had already planned to shutter as leases expired this year).
Meanwhile, apparel concept Express was reportedly preparing to file Chapter 11 as this report went to press. The chain operates 330 of its own branded stores in the US, as well as the Bonobos chain (58 US stores) and the UpWest banner (12 units). Credit ratings firm RapidRatings reports that Sleep Number (659 stores nationally), Qurate Retail (Ballard Designs—19 US stores), Peloton (36 showrooms), Wayfair (currently eight stores from multiple banners), The RealReal (15 units) all currently are currently on their bankruptcy watch lists with potential likelihood of filing as high as 50%. Meanwhile, CreditRiskMonitor reports that their monitoring reports elevated risks (though not necessarily imminent bankruptcies) for Petco (1,425 stores), Kirkland’s (344 units), The Container Store (102 stores), Big Lots (1,392).
But while all of this sounds bleak, retailer bankruptcy watch lists are well below pre-pandemic norms. RetailStat (formerly Creditintel) currently has less than ten chains on their watch lists (concepts with credit ratings of D or lower). This is roughly a third of the level that was common in the pre-pandemic period of 2017 – 2020. Most of the concepts currently challenged or on these lists have large debt loads from private equity-driven leveraged buyouts going back years ago (like JoAnn), or that have been struggling for some time (99 Cents Only had not been profitable since 2015).
We are anticipating chain store bankruptcies to continue to create some challenges ahead in 2024, but that total numbers will fall well below the average number of filings (28) that we have tracked since 2000. The real question for landlords will be one of retailer footprint and store size. We continue to track a plethora of expanding tenants in the 20,000 to 30,000 SF range. With 99 Cents Only Stores typically averaging 20,000 SF, these will likely be easier to backfill than Family Dollar units that tend to range between 8,000 SF and 11,000 SF, simply because there are currently fewer active tenants in that size range. Likewise, older Rite Aid stores developed in the 1990s typically were in the 30,000 SF range—where there are multiple options for retenanting. Newer and smaller units that have tended to be closer to 15,000 SF in size may prove more challenging to backfill simply because most of the demand in the marketplace currently is either in the 5,000 SF or less, or 20,000 SF to 30,000 SF range.
There is no doubt that increased closures and bankruptcies will create some challenges ahead. However, we don’t see these as indicative of a worsening retail outlook so much as a return to more normalized patterns. This year we will likely still see fewer retail failures than what has been common over the past 25 years, but the number will probably creep up over what we have experienced recently. There have always been retail winners and losers. New brands emerge, old ones that fail to stay relevant go away. This has always been the case, but normal patterns of retailer life cycles have been distorted in recent years.
LOOKING AHEAD
We anticipate continued strong demand from gym/health club concepts, beauty salons/spas, experiential entertainment-based
concepts, and restaurant chains—particularly coffee, chicken, poke, boba tea, and Asian fusion concepts. Fine dining is also in growth mode, though those numbers pale by comparison. Meanwhile, even casual dining—which had been downsizing throughout the 2010s—is back in growth mode thanks to new breakfast/brunch, craft brewing and wine bar concepts as well as a select few established brands that are connecting with consumers.
Though the national economy is not entirely without its challenges, the consensus view of economists has shifted by 180 degrees over the past year. In early 2023, surveys from the National Association of Business Economists showed that 75% of their members anticipated a recession in the next six months, while 25% thought the proverbial “soft landing” was likely. Those numbers have reversed themselves and consumer spending has remained resilient.
In the meantime, we anticipate that vacancy levels will stay at, or near, current levels. The threat of rising supply levels from new construction is negligible, as development is situated in the market’s most highly sought-after locales and expanding highend shopping centers with little of it done on a speculative basis. Meanwhile, the greatest concentrations of current development are in Elk Grove and Roseville/Rocklin—the two strongest submarkets in terms of population growth.
We see risk from the potential slowing of retail sales (though consumers have continued to defy expectations on that front), as well as the uptick in closures we expect. But we are not expecting this to have a major impact on rental rate growth even if we see some short-term upticks in vacancy rates.
Criteria based on: Retail in a Shopping Center. Includes Existing, Under Construction, Proposed, Final Planning
Gallelli Real Estate is a private firm that specializes in commercial real estate services and property management. We believe that as a boutique firm whose understanding of the business runs as deep as our core values, our advantage is large. We take pride in our unique approach to offer more individual solutions that address the ever changing needs of our clients and the industry. After all, our success is measured by the success of our clients and the strength and longevity of our relationships.
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