2022 Retail Real Estate Market Signals Good News for Brick-and-Mortar | CBRE's Karly Iacono

CBRE Vice President and CRE Fast Five Host Karly Iacono is here to share good news for retail! According to Karly, we have flipped the script of brick-and-mortar doom and gloom, and are seeing double the number of announced store openings vs closings for 2022.

On this episode, we discuss all things retail real estate including consumer trends, BOPIS and how migration during the pandemic has impacted the markets, as well as Karly’s predictions for where is real estate headed in the near and long term.

About the guest: Karly Iacono is a Senior Vice President in CBRE’s Capital Markets, Investment Properties group and the host of the widely followed commercial real estate video series CRE Fast Five, which offers a weekly overview of the most pressing topics in commercial real estate.

Karly is also a senior advisor within the exclusive Net Lease Property group, comprising a national team of top level brokers located in major metropolitan areas across the United States that specialize in transacting single-tenant assets and net-lease portfolios nationwide.

Be sure to check out CRE Fast Five at: https://www.youtube.com/c/CREFastFivewithKarlyIacono

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Hosted and produced by Gabriella Bock

TRANSCRIPTION

Gabriella Bock:
Thank you so much for joining the show today, Karly.

Karly Iacono:
Gabriela, thank you so much for having me. Great to be part of it.

Gabriella Bock:
And it’s great to have you here. As we start, I would love it if you could just kick us off a little bit by telling us about your professional journey and your role in the commercial real estate and retail industry.

Karly Iacono:
Absolutely. I’m a Senior Vice President at CBRE and I’m part of the Capital Markets group. What that means is I represent owners of commercial real estate, specifically in retail, across the country. We work with everyone from private clients who own a single asset, all the way up to real estate investment trusts and funds that own portfolios of retail assets. Also, very active in structuring sale lease back strategies for retailers or businesses that are looking to monetize the real estate. So, anything to do with retail and real estate and the intersection of those two worlds.

Gabriella Bock:
Excellent, and you also host a show on YouTube. Can you tell our listeners a little bit about that?

Karly Iacono:
Absolutely. We host a weekly video series called CRE, Commercial Real Estate Fast Five. CRE Fast Five. The genesis of that was actually pre-pandemic. We wanted a way to educate new investors, reach new clients, and just really add value on a broader scale. I found I was having a lot of the same conversations over and over and there’s only so many hours in the day, so wanted to really expand our reach. That’s how it started. It has grown exponentially, and it’s now a mix of very short format interviews on our Secret Sauce part of the show, and then investor education on the core CRE Fast Five episodes, and Tenant Spotlights, where we highlight different companies and retailers from an investment angle.

Gabriella Bock:
Excellent. Super smart idea. I love the format. It’s, to your point, quick, easily digestible, which I’m sure a lot of your clients and our listeners, who are also busy professionals, would also appreciate, so listeners be sure to check out Fast Five on YouTube and we will add a link in the description of this podcast episode. All right, let’s start things off high level. Could you share your perspective on what is the current state of the market? And actually, I’m sure many of us have heard by now, or even experienced the current crazy residential housing market, so I am curious to know how in sync these two markets are with one another.

Karly Iacono:
I would say the similarity between the two markets is tied to interest rates and inflation. The larger economic factors will, of course, influence all real estate, residential or commercial, but there are very significant differences in the subsets, even within commercial real estate. Industrial has performed different than retail, which has performed different than office, in the last two years. Each asset class really has its own story to tell, but for today’s purposes, we will stick with retail, and it’s a very, very interesting time in the market. We have this confluence of factors that I don’t think we’ve seen, definitely not in the last 10 years, and I’ve been in real estate for longer than I care to admit. So, it’s a time where we have inflation. We have rising values. We also have rising interest rates, which depresses investment volume. Just to put some numbers behind it, total U.S. commercial real estate volume increased 45% year over year in Q1.

Gabriella Bock:
Wow.

Karly Iacono:
45%. That’s astronomical. We’re at 150 billion now. The market by that measure, if you look at that in a vacuum is the strongest it’s ever been. We have retail property prices that have increased 16% year over year in Q1, 2022. Prices are going up, volume is up, yet last year was a banner year, but we have some challenges, too. We have some headwinds, we have rising interest rates, like I mentioned, which are making properties a little more difficult to finance. We have just a lot of uncertainty in the world, so we have investors who are coming into commercial real estate looking for stability, and then we have some that say these prices are very, very inflated. We’re going to sit on the sidelines and wait and see what happens with the fed and rates throughout the rest of the year. So, it’s a mix right now.

Gabriella Bock:
Yeah. So then, would you say that these rising rates, are they directly tied to the pandemic or were these increases predictable? Are we seeing any trends prior to the pandemic that you can speak on?

Karly Iacono:
Retail is really having a rebirth resurgence. We had two years of pandemic with tremendous headlines. Everyone heard retail’s dead. Obviously, we couldn’t go to stores for a period of time, so that didn’t help, and it was time for retail to reinvent itself. I don’t think anyone knows this probably better than you in your role, speaking with retailers and companies every day, but there’s been so much change in the last two years, much of it was overdue. We had a period of pause where investor sentiment was not great on retail. Companies weren’t really sure what they were going to look like post pandemic, and now that we are on the other side of that, it’s an incredible time for retail real estate. We have a ton of new tenants opening, faces we’ve never seen, companies that were digital only are opening bricks and mortar locations. We have new investors who are diversifying from other property types. Maybe they had only bought office or hotels or industrial, and now they’re coming into retail. So, it’s a tremendous amount of attention to retail right now from all sides. It’s a very good time for retail in general, as an asset class.

Gabriella Bock:
Excellent. I love to hear it. And then, what are we seeing in terms of store openings and closings? I know during the start of the pandemic, it was very doom and gloom on the store closings. No one will survive, was what the headlines were suggesting. What are we seeing? Are we seeing more closings than openings? Are we seeing more openings than closings? Do you have anything you can share with us?

Karly Iacono:
Absolutely. Store openings announced in January 2022 were about 8,000 new stores, which doubled the currently announced closures, which were around 4,000 as of March 29th. We have flipped that script of doom and gloom, and we now have a lot more store openings than we do closings, and now we have a supply issue, the opposite. We thought retail vacancy was growing. It was with all the closures and we have all this excess space. Now, there’s not enough space, so it has really transitioned from pandemic to post-pandemic in a very big way, and we are seeing much higher demand, which is putting upward pressure on rents and certainly, more openings than closings.

Gabriella Bock:
That’s great to hear. I did want to know, if we’re talking on the trends that are then impacting these shifts, there was a lot of migration away from large cities during the pandemic, and so, wondering how that’s impacting the markets? Are we seeing retailers expanding their footprint in smaller markets at a greater rate in large scale cities, and maybe at a greater rate than before the pandemic?

Karly Iacono:
That’s a great question. We definitely saw a shift in demand to the Sun Belt states over the last two years. Southeast, Southwest, it was following the population migration. That also is starting to reverse, and in fact, in the last four quarters rolling, New York was the largest market in terms of total investment volume at 63 billion, followed by LA. Again, that doesn’t tell the story of growth, but total activity, total investment dollars are still going to the core markets. Now, Orlando was actually the fastest growing market in terms of investment dollars. Although that’s a little different than the store opening metric, it follows. They’re tied together. The locations where retailers are opening is where more investment from the landlord side is happening, so they are correlated. I definitely think the core cities that we thought were going to be depressed for a lot longer are not. The attention has shifted back to those A markets. Now, there’s still growth in Austin, Dallas, and a lot of these key cities, but that does not mean it’s at the expense of activity in the core cities, core markets.

Gabriella Bock:
Are there any other consumer trends that we’re seeing impacting these shifts -like drive up? How is that impacting the way companies are going about selecting their properties?

Karly Iacono:
Tremendous demand for drive throughs, or drive up or pick up. A lot of tenants are reevaluating their use of space. We have unique tenants who want to control the real estate that never really thought it was necessary. Tenants coming out of malls, even out of inline space, to freestanding, single tenant, which is my world, investment properties. So, a tenant that let’s say, an Aspen Dental, maybe would’ve been an in line and is now a freestanding, standalone property. Even Macy’s is doing smaller format, standalone stores. Part of this is driven by the desire for long term flexibility. If you are the only tenant on a parcel, you can use your parking lot a lot more fluidly. You can create a drag through window. If the zoning allows for it, you have more options long term. We have increased demand for the single tenant format from a lot of different types of tenants because of that really need or desire to be able to pivot long term. I think overall smaller format stores is something we’ve seen for a few years that we do expect will continue.

Gabriella Bock:
Definitely. And if we’re talking about retailers and shifting to off-mall sites, do you have any insight into how those old properties are being used now? I know we have a lot of dead mall space in the country and we’ve heard a lot about how those properties could be turned into warehouses or housing. I just wanted to get your take on that, and if you’ve seen anything there.

Karly Iacono:
Absolutely. Not surprisingly to me, but surprising if you read the headlines, A malls are having their absolute best years ever. Their sales are higher in many cases than pre pandemic. It’s really a tale of multiple markets in multiple asset classes, A, B, and C, which is typically how malls are designated. So, A malls, phenomenal performance. Your B and C malls are often being repositioned, which is not a bad thing. That doesn’t mean they’re going away. That doesn’t mean it’s going to be just dead space. It’s really, what’s the highest and best use for this piece of property, and maybe it’s a retail component with housing, like you mentioned. Maybe there’s a medical, or med-tail, as we call it, which is the merging of medical and retail concept. Maybe it’s more community meeting space for events or food trucks. It’s very much market in niche area specific as to what’s happening.

Karly Iacono:
Some malls are being repurposed to distribution sites as a lot of companies want that last mile distribution closer and closer to the consumer, and typically retail is right in the heart of the consumer, whether that’s a mall or a smaller retail strip. Industrial is an option, too. That’s a bit challenging from a zoning perspective, but has been done. I don’t think there’s one easy answer. I think the takeaway is that, malls have a lot of life left and they are certainly being repurposed in some very interesting ways when necessary, but that’s not across the board. The standard core malls are actually very in demand and performing quite well.

Gabriella Bock:
Yeah, and I would imagine that has a lot to do with people wanting to get back out and shop in person after several years of being cooped up inside, so that’s great to hear that people are out and about and traveling to malls again. I want to shift now a little bit to yourself and how you help tenants. I wanted to know, maybe what’s some questions that you would want tenants to ask themselves before leasing or purchasing commercial real estate?

Karly Iacono:
My team specifically, does not represent tenants from a leasing perspective. We represent investors or landlords on a property purchase sale or sale lease back. A sale lease back is a scenario where a company owns the real estate and operates the business and they sell the real estate while maintaining their tendency at the property long term. That is a great way to monetize real estate, be able to take the working capital and invest elsewhere. There are many benefits to sell lease back. In that instance, we do work with businesses of all shapes and sizes to structure that if they currently own the real estate. Now on the leasing side, we work closely with our leasing teams across the country, and of course, can connect anybody who needs assistance to the right resources there. The one thing I would say to keep in mind from a tenant perspective is that, rents are rising. We’re seeing this across the board. So, locking into what may be a longer lease than they think they want, or purchasing real estate or structuring a sale lease back now to keep their rents consistent long term, could be a very sound way to control costs moving forward. Just watching rent levels as they’re tied to inflation change is something I think every retailer or tenant should be aware of.

Gabriella Bock:
Interesting. So then, how do you help your clients? When they come to you, are they looking to purchase space that’s been already built up? Are they looking to purchase land that needs to be developed first? How does that work, and then how do you help them scout those areas based on their needs?

Karly Iacono:
Sure. Great question. We typically represent owners and buyers of stabilized net lease properties. A net lease property is a freestanding building in which the tenant pays the three nets, taxes, maintenance, and insurance, in addition to rent. When you have a net leads property where the tenant is maintaining, they’re paying expenses, it is a very passive investment for the landlord, which is why it’s so attractive. Everything is fixed and modeled out. Our clients come to us looking for passive income and long term holds. They will then have specific criteria on price point, return they’re looking for, the types of tenants they’d like to be a landlord for, and then we will look for, if we’re representing buyers, the right type of investment for them nationally. If we’re representing sellers, the valuation process, it could be a Walmart, it could be a CVS, a Popeye’s fast food restaurant, really anything that you see when you drive down the street, that is a freestanding building, is almost with very few exceptions, certainly owned by an investor, could be private or a public investor, with a tenant on a net lease of some variety. Almost every company, which most people don’t realize. You drive down the street and you see a Wendy’s, that’s an investment property. You see an urgent care. That’s an investment property.

Gabriella Bock:
Interesting.

Karly Iacono:
Every national company with again, very few exceptions, are tenants. They do not own the real estate. That’s where we come in to match the investors to the right type of tenant and property that’s already built. Now, we do work with developers who have land sites and then our leasing team matches the tenants. And then, we sell those when the properties are completed because that’s the standard developer model. Build the property, get the tenant, and then move on to the next project. We do work with a lot of developers, but we don’t typically source the raw land.

Gabriella Bock:
Even Walmart? I think I just assumed that Walmart owned the land where they’re located. If that’s not the case, as far I know, you guys work with the developers and the investors, but typically how long do those leases tend to run with these large corporate entities like Walmart?

Karly Iacono:
Great question. It’s very tenant specific and national tenants will have their standard lease forms that are fairly consistent across different states. CVS, for example, will typically do a 20 or 25 year base term, which is the guaranteed portion of the term, and then have another 25 to 50 years of options. From the tenant perspective, you are taking over a property that’s usually a build to suit, to their specifications, which is why most CVS’ look the same across the country. It’s built just for them. And you understand what your real estate costs are going to look like for up to the next 75 years. Very, very long time. As an investor, you have incredible stability, which is why so many people target net lease as an investment, especially in their later years for estate planning and passive income, because it really is completely managed by the tenant. Now, there are certain tenants that do shorter terms. 7-11 typically does a 10 or a 15 year base term on a new build. Fast food will be 15 to 20 years. Again, those are the guaranteed, or base terms it’s called. And then, there are options beyond that, which are at the tenant’s option. Verizon, I believe does a 10 year base term. It really varies by the type of tenant and their preferred lease structure.

Gabriella Bock:
Interesting. That’s quite a long time.

Karly Iacono:
Yes.

Gabriella Bock:
Yeah. As you mentioned, a lot of stability then, for those investors. I am curious. How often do retailers and tenants, do they leave after those leases are up? Besides foot traffic, what kind of factors would prompt them to leave?

Karly Iacono:
More often than not, we see them exercise their options because moving and creating another build to suit property, working with a developer, is expensive. Even if the development costs are being born by the developer, the only way that the numbers pencil out is if the retailer pays significant rent for that built to suit property. Often, companies, no matter who it is, will stay put because it’s a much more affordable option than moving and creating another build to suit property, but considerations at the end of their base term would be the actual location, how has the market changed in the 20, 25, 30, 40 years they’ve spent there? A lot can happen over that much time.

Karly Iacono:
Are the demographics still meeting the tenant’s needs? Are the access still acceptable, the ingress and egress of the property, or has development in the area made it such that it’s too hard to get to their property now? Have the rent levels in the market gone up or gone down to where their rent is above market and it actually would be a savings for them to move? That’s rare, but that’s one consideration as well, or do they frankly, want a bigger space or a smaller space? Is the retailer’s store footprint changing to where they need a different type of site? Because as you know, retailer prototypes change every 10 years, usually substantially. If the square footage needs change significantly, it might not be possible to renovate on the existing site, so they might have to go to a new site, whatever that means for rent, whether it be up or down.

Gabriella Bock:
We touched upon it a little bit, inflation and the rising pricing in the market, but I did want to get your take on with these factors and with the shift in consumer behavior and expectations, generally speaking, where do you think the market is headed long term?

Karly Iacono:
It’s very positive. We have less development underway than we’ve ever had for many factors. The cost of construction, limited available space, the challenges of the last few years of approvals, and COVID shutdowns. Right now, there is the lowest level of new construction that we’ve seen in a very, very long time. What that is going to do is create competition for available prime space, which it already is. That in turn, is going to boost rents, which is great for investors, makes the properties more attractive as the income grows over time. I think because of all those factors, we’re going to continue seeing multiple bidders for well positioned quality retail assets, and bricks and mortar is not going away. We’ve heard time and time again over the last year that eCommerce loan is not profitable for companies. It is a much better strategy to be omnichannel or even more focused on bricks and mortar from a profitability standpoint. I think we’ll continue to see the shift back, and in fact, in store sales are growing faster than eCommerce sales are growing right now. I think that’s going to continue. I do, despite the challenges economically and much bigger picture in the world right now, geopolitical, et cetera, I think retail is very well positioned to be a sleeper surprise for people that it will outperform in the next few years.

Gabriella Bock:
Just following up really quick on your point on rising rents, how do you foresee that impacting small businesses, mom and pops?

Karly Iacono:
That’s the biggest challenge. We see the most of those opening right now and I think that has something to do with The Great Resignation or whatever they’re calling it now, The Great Reshuffling, I think, was the new term I heard this morning on The Labor Market. There will be some challenges to small businesses who are starting out and trying to find good space at rates that are comfortable for them. I do think that will be a challenge and it’s going to be a bigger chunk of sales than rent used to be overall. It will be very important for small business to be careful and really model out their expenses and make sure that they’re comfortable with where they are. It is going to be a challenge. I don’t think there’s an easy answer right now. I think everyone will be banking on higher sales and the inflated prices, which are often passed on to the consumer to boost the profitability and cover those additional expenses.

Karly Iacono:
Costs are going up everywhere. Like I mentioned, the construction costs are rising. So, even the cost to renovate a space when a tenant moves out and a new one comes on. That’s called TI, or tenant improvement dollars. That’s much higher than it was two years ago. The landlord costs are higher, which necessitates rents being higher, or it doesn’t make sense to be a landlord, so we’re seeing increased pressure from a cost perspective everywhere, and that hopefully will be eased over time, but also, with growing sales will trickle down and assist the tenant, which then will allow them to pay their rent to the landlord who then can do the necessary improvements and maintain the properties, et cetera.

Gabriella Bock:
Yeah. That makes sense. Even the cost of materials is going up, so costs up all across the board, but it’s certainly good insight and good advice to SMBs, and it’ll certainly be interesting to see how the retail landscape changes over the next decade. Karly, I just want to thank you so much for joining today, and if our listeners wanted to connect with you, how would they do that?

Karly Iacono:
Sure. Happy to connect in any way. They can find us on YouTube by searching CRE Fast Five or on LinkedIn or Instagram at Karly Iacono, or of course, phone or email. Happy to be a resource, however we can be.

Gabriella Bock:
Excellent. Well, thank you so much for joining the show today. It was great to have you on, and again, everyone check out Fast Five on YouTube. You’ll certainly learn a lot.

Karly Iacono:
Gabriella, thank you so much for having me. We really appreciate the opportunity and it was wonderful to speak with you.

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