Higher Interest Rates Weigh on Larger Deals, While Sales of Smaller Centers Stay Active
Private investors have been scooping up smaller retail centers but deals for larger centers have been put on hold. (iStock)The retail space market is enjoying its strongest operating environment in over two decades. However, despite historically low space availability and virtually no threat from new supply, sales of retail properties remain sluggish, with the sector seeing a significant 51% drop in sales volume in the second quarter compared to the same time last year.
This sharp decline is mostly due to the reduction in the sale of large shopping centers typically involving institutional investors, which coincided with the Federal Reserve’s decision to increase its policy rate starting in early 2022.
The retail property investment market has always included a large number of smaller deals, with transactions under $3 million constituting about half of all sales activity in certain years. However, during the peak of COVID-19, sales of smaller retail centers accounted for only 33% of the total sales volume. In contrast, higher-end deals, those with prices above $25 million, which typically comprise less than 10% of the market, surged to 15% in the fourth quarter of 2021.
These days, the retail market is readjusting to a more balanced state, with private buyers now driving 46% of market activity in the second quarter of 2023. This shift is a result of capital flows slowing at the upper end of the market while private investors maintain their pace, undeterred by the Federal Reserve’s policy rate increases. Many of these smaller investors prefer all-cash transactions, which makes them less influenced by interest rate movements.
Property values for assets priced above $10 million peaked in late 2021 and early 2022, but they have since experienced double-digit price declines in the face of higher borrowing costs. Meanwhile, smaller retail properties valued below $10 million have seen much smaller price changes. For those deals at the lowest end, asset values have held steady and may still be on the rise in some cases.
But as nearly half of all property deals are for less than $3 million in the retail sector, aggregate price changes do not fully reflect the downward pricing trends seen at the top end of the market.