Earnings Update: Retail REITs (Q4 2023)

We have discussed in the past our view that the American consumer is weakening in the sense that spending power is moderating.

Pent-up savings and fiscal stimulus money accrued during COVID-19 was largely deployed in a strong bout of consumption during the years following pandemic lockdown periods, and eventually, those excess savings were depleted as that money was entirely spent or invested.

While true, this data has to be contrasted with a very low unemployment rate and average hourly earnings growth still above 4% YoY.

The frenzied consumer spending of the post-COVID years may be over, but consumers, especially those in higher income groups, are still spending.

In recent years, they have largely directed their spending at restaurants and bars over other types of goods or services in the retail space, as you can see below.

Data by YCharts

The good news for retail real estate is that there are plenty of restaurants and bars that have been eager to fill vacant space alongside their non-F&B retail peers.

The less good news for the retail sector is that overall growth in the last three years has come solely from rising prices rather than increasing volume.

Since the Summer of 2021, after a spike in spending when the final pandemic-era stimulus checks had been sent out in early 2021, real (inflation-adjusted) retail and food services sales have been flat.

Data by YCharts

Since June 2021, nominal retail and food services sales are up 13%, while real retail and food services sales are down 1.5%.

A lot of attention is paid in the media to average hourly earnings. People believe that it is a major portent about the direction of the economy and inflation.

But consider this: average hourly earnings have grown only about 22% since the beginning of COVID-19, compared to 33% for nominal retail and food services sales.

Data by YCharts

What accounts for the gap there?

The answer, in short, is free money.

The real driver of consumer spending since COVID-19 has been fiscal stimulus money. Wage growth since then has basically just fueled further price increases rather than growth in the volume of units sold.

If you compare the growth in the money supply to retail and food services sales per capita, we find that the latter has basically just been playing catch-up to the former.

Data by YCharts

Note that the orange line above showing retail and food services sales per capita is a trailing twelve month number. If you annualized the most recent quarter, I would bet that the growth of both metrics in the chart above would be roughly equal.

What does all this mean?

We have two takeaways:

1. American consumers are not quite as strong as the prevailing narrative suggests.

2. The US does not appear to be on the verge of a consumer-led resurgence in economic growth.

The depressive effects of exhausted stimulus money still appear to be greater than the stimulative effects of rising wages.

Retail Real Estate Well-Positioned For All Scenarios

We provide the discussion about the strength of the consumer and the source of consumer spending power because these are ultimately what facilitate rent growth for retail space.

The consumer is also what ultimately drives tenant demand for retail space. Unless we understand this, we won't understand why retail leasing volume and rent growth are expected to moderate in 2024 even as vacancy rates hit multi-decade lows.

The good news for retail real estate, which cannot be said of certain other sectors, is that as retail sales are moderating, growth in the supply of retail space nationwide remains extremely limited.

Hence we find that retail square feet per capita is at multi-decade lows:

CBRE

Lack of new supply coming to market makes retail a very resilient sector of CRE, even if consumer spending continues to soften.

Even if retail net absorption was higher in the years prior to the Great Financial Crisis in 2008-2009, the extremely minimal supply growth since then has allowed retail net absorption to consistently outpace supply additions over the last decade or so.

Slate Grocery REIT

This has allowed the vacancy rate to come down to the point where retail space is effectively full. There will always be some amount of vacancy due to tenant turnover and the odd elbow spaces in retail centers that are difficult to lease, so seeing vacancy rates of 5-6% indicates that retail real estate is about as healthy as it can get.

Moreover, keep in mind that when we address "retail real estate" in this update, we are referring to multi-tenant retail such as shopping centers and malls, not single-tenant, freestanding retail buildings that are typically owned by net lease REITs like Essential Retail Properties (EPRT), NNN REIT (NNN), and Agree Realty (ADC).

It is notable that what little new retail space is under development and scheduled for delivery in 2024 is almost entirely in the form of single-tenant, freestanding buildings.

JLL Research

If you account for obsolescent retail space that is torn down or converted to other uses, the net amount of new retail space being delivered to market is virtually zero.

Lack of competing supply coming to market is every landlord's dream come true.

It signifies that even if 2024 sees leasing volume and rent growth slow down from previous years, the overall balance of supply and demand will likely remain favorable to landlords (including our REIT holdings) for many years to come.

With that, let's turn now to the Q4 2023 earnings updates for our 5 retail REITs: