In a commercial real estate landscape still recovering from the rise of e-commerce and the pandemic, a surprising sector is attracting significant investment: the neighborhood strip mall. Specifically, open-air retail centers anchored by a grocery store are drawing billions from investors who see them as a resilient and profitable opportunity.
These centers, which often include essential services like pharmacies and local eateries, have demonstrated a unique ability to withstand economic pressures that have damaged other forms of retail. This has prompted major firms to reconsider a category many had previously written off.
Key Takeaways
- Investors are increasingly targeting grocery-anchored, open-air retail centers, viewing them as a stable asset class.
- Vacancy rates in this subsector fell from 7.8% in 2016 to 4.4% at the start of this year, though they have seen a slight increase recently.
- Major investment firms like Nuveen are raising significant capital, with over $2.5 billion in buying power for these properties.
- The strategy focuses on locations with high household incomes and educated populations to mitigate risks from economic downturns.
The Unlikely Survivor of the Retail Apocalypse
For years, the narrative surrounding retail real estate was one of decline. The growth of online shopping and the effects of the global pandemic created significant challenges, especially for large indoor malls. However, a different story has emerged for smaller, open-air shopping centers.
These properties, centered around an essential grocery store, have proven remarkably durable. According to Chad Phillips, global head of Nuveen Real Estate, which manages over $140 billion in assets, this sector has successfully weathered major market disruptions.
"It survived Covid. It survived the Amazon effect," Phillips stated, highlighting the consistent consumer traffic these centers attract. He noted that Nuveen's own portfolio of well-located, grocery-anchored properties boasts an occupancy rate of over 95%.
The success lies in their convenience and focus on essential needs. Consumers consistently visit for groceries, prescriptions, and quick meals, creating a steady flow of foot traffic that benefits all tenants.
A Shift in Investment Strategy
The renewed interest marks a significant turnaround. Just 15 years ago, real estate investors typically allocated over 30% of their portfolios to retail. That figure plummeted to around 10% as returns weakened. Now, the trend is beginning to reverse, driven by the strong performance of convenience-based centers.
From Overbuilt to Undersupplied
A key factor driving the current opportunity is a market correction. For a long time, the U.S. retail real estate market was considered overbuilt. The rise of e-commerce forced developers to become more disciplined, leading to a slowdown in new construction. This has resulted in what some experts now consider an undersupply of quality retail space, increasing the value of existing properties.
Nuveen's recent activity demonstrates this shift. The firm has raised $1.4 billion in equity for this strategy so far this year.
"That puts us over $2.5 billion of buying power for these types of strategies," Phillips said. "So yeah, I do think that investors are turning their heads."
Unlike massive indoor malls, which are difficult and expensive to buy and sell, these smaller centers offer more manageable, or "bite-sized," deals. This liquidity makes them more attractive to investors seeking flexibility.
Analyzing the Data and the Risks
The numbers largely support the investment thesis. Data from CoStar Group shows a significant drop in vacancy rates for grocery-anchored centers, which fell from 7.8% at the beginning of 2016 to just 4.4% by the start of 2024.
By the Numbers: Grocery-Anchored Retail
- Vacancy Rate (Start of 2024): 4.4%
- Vacancy Rate (Start of 2016): 7.8%
- Typical Occupancy (Nuveen): Over 95%
- Projected Returns: Low double-digits
However, the sector is not without its challenges. Brandon Svec, national director of U.S. retail analytics at CoStar Group, has pointed to a recent softening of fundamentals. Vacancy rates have ticked up for three consecutive quarters, though they remain near historic lows.
More concerning for property owners is a stall in rent growth. After years of strong increases, annual rent growth this year is the weakest in over a decade. This signals that the market may be reaching a plateau after a period of outperformance.
A Selective Approach to a Promising Market
Given the potential headwinds, investors are being highly selective. The strategy is not simply to buy any strip mall, but to target properties in specific demographic areas that can better withstand economic uncertainty.
Phillips explained that his firm looks for key indicators to ensure a property's long-term viability. These criteria include:
- An average household income of over $100,000.
- A population that is largely millennial and well-educated.
- Locations that are central to the community's daily routines.
The goal is to invest in centers that serve a customer base with higher savings rates and more stable employment, making them less susceptible to fluctuations in consumer confidence. This careful selection process is crucial for achieving the low, double-digit returns investors are targeting.
"I do think it’s a lot about convenience and being in the path of that convenience, and that’s where we want to invest," Phillips concluded. With limited new construction planned, the supply-demand dynamics are expected to remain favorable for well-positioned properties, ensuring that the humble neighborhood shopping center remains a powerful player in commercial real estate.
