Market Reports_Q2 2023 Retail

8.1%

3.9% 4.5% ±189,000 SF

±47,000 SF $1.95 PSF 3.6%

RETAIL MARKET OVERVIEW

As of the close of Q2 2023, overall shopping center vacancy in the Sacramento region stood at 8.1%. This is up from the 8.0% rate recorded three months ago and reflects the second consecutive month in which vacancy has crept upward. In terms of occupancy growth, the market recorded 47,000 square feet (SF) of positive net absorption this quarter with demand trends remaining positive. However, new construction outpaced that total with 102,000 SF of new product that came online. Most of this new inventory was in the form of additional pad buildings within existing shopping centers, though the first structures of the new Anatolia Retail Center in Rancho Cordova (Highway 50 submarket) were also completed in Q2. The net result was a modest uptick in vacancy.

This quarter’s occupancy gains tempered some of the losses posted in Q1; the market recorded negative net absorption to the tune of -211,000 SF in Q1. Year-to-date totals now stand at -163,000 SF. While leasing velocity has slowed from the breakneck pace that was experienced in the pandemic rebound of 2021/2022, deal flow remains brisk. Retail real estate demand continues to hold its own, despite the continued economic headwinds posed both by inflation and the Federal Reserve’s attempts to cool it. For example, we tracked over 734,000 SF of gross absorption, or deal activity, in Q2. This was roughly double what we tracked in Q1. This included some larger transactions (Nordstrom Rack inked deals in both Davis and Elk Grove for new stores that will open in 2024), but it remains dominated by smaller tenant deals below the 3,000 SF threshold.

We continue to see active interest from off-price apparel, grocery (particularly smaller format grocers), and eatertainment (Dave & Buster’s inked a deal at the Palladio in Folsom), car wash concepts and quasi-medical (from urgent care providers to veterinary hospitals).

But, by far, the most active segment are restaurants—particularly QSR/fast casual concepts. Coffee, beverage (especially boba and juice concepts), chicken and new Asian QSR concepts all remain highly active in the marketplace.

AND THEN THERE WERE TWO…

In Q2, all the major shopping center types in the Sacramento region recorded positive net absorption and declining levels of vacancy— except for regional/super regional malls. Mall vacancy climbed from 15.5% to 20.7% in Q2, though most of that was spaces vacating at Sunrise Mall as that project is readied for its long-needed reimagining as a mixed-use lifestyle center.

The challenges of malls over the past two decades have been well documented, though the story has often been told without proper nuance. The rise of eCommerce, the diminishing relevance of the department store, and the growing consumer preference towards easily accessible outdoor shopping venues were already posing unprecedented difficulties to the mall space prior to the pandemic.

Select Sacramento Region Retail Leases

The US had 1,400 malls in 2016 and that was down to just 1,250 by 2020. Roughly 350 of those are Class A malls where sales levels average $600 per square foot (PSF) or more. Those premier and trophy centers have been driving more than 70% of all sales for the sector and they have become the primary focal point of tenant mall demand. For the remaining 900 +/- enclosed malls in the US (Class B and C properties) the situation has become one of evolution vs. extinction. Including Sunrise Mall, we are currently tracking over 400 projects across the US undergoing some sort of redevelopment or reimagining. These are overwhelmingly projects that are primarily being transformed into mixed-use lifestyle centers with significantly reduced

retail components but feature the addition of housing and typically some additional mix of hospitality, office, medical or other uses. These shifts densify centers and also allow them to pivot retail tenancy towards uses that are more eCommerce resistant—restaurants, grocery stores, entertainment concepts, personal needs retail, etc., while still leaving space for new, relevant up-and-coming chains.

The Sunrise Mall plan currently calls for creating a walkable “Main Street” outdoor retail district where the main body of the existing enclosed mall currently is situated. Plans call for the reimagined center to have 320,000 SF of retail, 2,220 residential units, 450,000 SF of

Sacramento Retail Market Shopping Centers Q2 2023

Sacramento Retail Market: Supply/Demand/Vacancy

community/institutional uses, up to 960,000 Sf of office space and up to 480 hotel rooms with phased development over the next 20 years.

Incidentally, within Sacramento and Placer Counties there were six malls as recently as 15 years ago: Arden Fair, Roseville Galleria, Country Club Plaza. Sunrise Mall, Downtown Plaza, and Florin Mall. Country Club Plaza and Florin Mall were converted to Power Centers in the 2000s. Downtown Plaza is now DoCo, the lifestyle/entertainment center that is home to Golden 1 Center. Sunrise is up next.

Emblematic of these shifts would be fact that in Q2 mall retailer Tommy Bahama decided not to renew its lease at the Roseville Galleria and is moving across the street to outdoor lifestyle center The Fountains.

MARKET STILL FAVORING GROCERY-ANCHORED

The largest inventory subset of the local shopping center market are community and neighborhood centers. These types of shopping centers, typically anchored by grocery or drug stores, account for 38.5 MSF of the region’s 66.0 MSF of inventory, or 58.3% of all local product. They faced the least amount of disruption from the rising tide of eCommerce during the “retail apocalypse” era of the 2010s, they were least impacted by mandated closures during the pandemic, and they continue to outperform not just all other retail asset classes.

The region’s greatest occupancy gains in Q2 came from community and neighborhood centers which recorded 189,000 SF over the past three months. Following occupancy losses in Q1, this quarter’s performance brought year-to-date net absorption back into positive

territory to the tune of 59,000 SF. Overall vacancy for community and neighborhood centers in the Sacramento region fell from 7.7% to 7.4% in Q2. There is just over 2.8 MSF of currently vacant space within this category—including only 12 spaces that are above the 30,000 SF mark. This point is critical because we continue to see extremely strong demand for smaller spaces of 3,000 SF or less and we also see it for mid-size box space in the 20,000 to 35,000 SF range (small format grocers and off-price apparel leading the categories demanding that size footprint). It is when availabilities cross the 40,000 SF threshold when the pool of potential tenants for that space significantly diminishes.

The current average asking rent for community and neighborhood product is $1.90 per square foot (PSF) on a monthly triple net basis. However, as this average extends across all sizes of available spaces and all classes of product, this number is best utilized as a benchmark only. It is not uncommon for secondhand large box space in Class B or C locations to have asking rents as low as $1.00 PSF or less, nor is it uncommon for newly constructed small shop space in premium locations or centers to have asking rates of $3.00 PSF or more.

LOOKING AHEAD

ISince April of last year, economists have been debating whether the Federal Reserve could engineer a “soft landing” in its attempts to curb inflation, or whether a recession was simply a given. In August 2022, 72% of the members of the National Association of Business Economists (NABE) anticipated a recession by early 2023. By February of this year, 58% of NABE panelists were predicting that a downturn would still occur this year—but over the final half of the year. So far, the economy has proven to be far more resilient than

LOOKING AHEAD CONTINUED

expected. Both consumer spending and labor market performance have consistently defied forecasts and outperformed for more than half a year now.

However, after two years of high inflation, consumer spending has finally been coming back to earth in recent months. We anticipate that it will begin to show negative annual growth sometime during the final half of 2023 for the first time since the early months of the pandemic. While we believe this will be a shortlived phenomenon, it will likely result in some retailers temporarily slowing down or putting the brakes on physical expansion plans.

Meanwhile, though a solid 209,000 jobs were created in June—this was the lowest level of employment growth the US has recorded since December 2020. While a “soft landing” scenario is still possible, most economists put the odds at greater than 50/50 that a recession is in the not-too-distant future (although most concur that if one happens, it will likely be brief and shallow).

The reality is there is a considerable lag time that occurs before the impact of interest rate hikes fully hits the economy. The Federal Reserve’s current campaign to tame inflation is not just the most aggressive we have seen in 40 years; it is also the fastest—with the effective funds rate having been raised a full five percentage points in one year. We have not felt the full impacts yet— which raises the risk that the Fed will overdo it (assuming they return to rate hikes again) or that they may already have.

Meanwhile, the Bed, Bath & Beyond (BB&B) saga has ended with bankruptcy and looming liquidation of both of the company’s banners (BB&B and Buybuy Baby). Buybuy Baby initially had some buyer interest, but a deal never materialized. Both companies have sold their intellectual property rights off—BB&B was purchased by Overstock.com which will be rebranding itself online over the final half of the year—but all remaining stores are being shuttered. Two had already closed as this report went to press, leaving four stores between the two concepts that will go dark in Q3 adding approximately 120,000 SF of vacant box space to market.

2023

The good news is that our brokers report that this space already had multiple suitors on standby. There are multiple off-price apparel users in expansion mode already in search of quality sights in that size range. However, macroeconomic conditions could potentially hold the potential to slow the process over the next few months. Looking forward, we anticipate modest increases in vacancy, and a possible slowing of deal velocity. But we do not anticipate additional outsized space givebacks—the likes of which were increasingly common in the runup to the pandemic. Look for rental rates to hold firm.

Laguna Crossroads - Elk Grove, CA

Criteria based on: Retail in a Shopping Center. Includes Existing, Under Construction, Proposed, Final Planning

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Criteria based on: Retail in a Shopping Center. Includes Existing, Under Construction, Proposed, Final Planning

GALLELLI BROKER TEAMS

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