Retail conditions cool after a strong first half
Following a very strong first half of the year, the Greater Phoenix retail market leveled off a bit during the third quarter. This is likely a brief interruption in the ongoing improvement cycle in retail real estate as the fourth quarter is typically the period of the most robust retailer expansion.
Since 2010, tenants have absorbed a net of more than 750,000 square feet on average during the fourth quarter in Greater Phoenix; and last year, net absorption during the fourth quarter topped 1.2 million square feet. Assuming an average fourth quarter of tenant demand growth to close this year, net absorption for 2018 will exceed 2.3 million square feet.
Sales of shopping centers accelerated during the third quarter, even as leasing and absorption activity slowed a bit. Despite the recent increase in transaction activity, building sales to this point in 2018 have lagged 2017 levels. Prices have generally trended higher, reflecting the improving property fundamentals, but cap rates have also pushed up, a move that is likely being fueled by rising borrowing costs. These mixed investment trends may hinder sales of shopping centers in the months ahead.
- The Greater Phoenix retail market posted mostly flat performance during the third quarter. Vacancy inched lower but rents dipped a bit as well. Construction has been modest thus far in 2018, a trend that is likely to continue.
- Retail vacancy dipped 10 basis points in the third quarter, ending the period at 7.5 percent. The rate is now 110 basis points lower than one year ago.
- Rents ticked lower in the third quarter, but are up year over year. Asking rents ended the third quarter at $14.90 per square foot, up 3 percent from one year ago.
- The investment market for local retail properties gained momentum in recent months, with more shopping centers changing hands than during the second quarter. Prices dipped a bit, but the median price year to date of $150 per square foot is up 20 percent from the 2017 median price. Cap rates have trended higher in each of the past two quarters.
The Greater Phoenix retail market has had a healthy first nine months of 2018, although net absorption has been more modest than during the same period in 2017. The fourth quarter is traditionally the strongest period for both retailers and for retail real estate demand.
With the local economy remaining quite healthy and the housing market continuing to gain momentum, expanding retailers will sustain the momentum in the market, particularly among restaurants and other small-space users that thrive when household incomes are on the rise.
While property fundamentals have been on a steady path of improvement, investment activity is lagging levels from one year ago. After generally trending lower over the past several years, cap rates have begun to inch higher, particularly as interest rates have pushed higher. During the third quarter, cap rates ticked above 8 percent for the first time in nearly five years. It is possible that the trend of rising cap rates could persist as the year comes to a close, although some of the better properties are still likely to change hands with cap rates in the low- to mid-7 percent range.