In a recent episode of America’s Commercial Real Estate Show, the show’s host sat down with veteran economist Jim Costello of MSCI to explore the latest trends, challenges, and opportunities in the U.S. retail real estate sector. With over 30 years of experience analyzing market cycles, Costello provided valuable insights into how retail is faring in the wake of shifting interest rates, inflation concerns, evolving consumer behavior, and macroeconomic uncertainty. Note that this discussion is national in scope, thus aspects may be less relevant to South Florida commercial property.
Signs of Recovery in Retail Transactions
One of the most notable themes from the conversation was the recent rebound in retail property transaction volume. According to Costello, Q4 2024 saw a meaningful uptick in sales—not driven by a single blockbuster deal, but rather by a healthy spread of “singles and doubles.” This signals renewed confidence and activity among investors who have spent much of the past two years waiting out market volatility caused by rapid interest rate hikes.
He emphasized that while the market isn’t back to the heights of 2021 and early 2022—when low interest rates fueled record valuations—it’s stabilizing. Investors are gaining clarity on pricing, with many recalibrating expectations around cap rates and future growth, rather than chasing a return to pandemic-era peaks.
Interest Rates and Investor Mindset
The conversation naturally turned to interest rates and their impact on investment behavior. The host noted that some buyers and sellers are still in “wait-and-see” mode, hoping for rate cuts. Costello explained that while the Fed has signaled a cautious approach to lowering rates, uncertainty around inflation and federal policy continues to widen the spread between the 10-year Treasury and the Fed Funds Rate.
Despite this uncertainty, Costello stressed that well-located assets with stable cash flow remain attractive. He added that private investors have been leading the charge in recent retail acquisitions—perhaps due to their greater flexibility compared to institutions, which often face reputational risk if they move too early.
Fundamentals: Rent Growth and Occupancy
Retail fundamentals are proving more resilient than many had expected. Costello shared data from MSCI’s U.S. Quarterly Property Index showing that high-quality malls and lifestyle centers have bounced back dramatically from their COVID-era lows. As of late 2024, NOI per square foot for these assets was nearly 100% above pre-COVID levels.
Meanwhile, neighborhood and community centers—which tend to be anchored by grocery stores and essential services—have shown steady performance, with NOI per square foot up over 12% from pre-pandemic figures. These more utilitarian retail centers have remained relatively insulated from economic fluctuations, further boosting investor confidence.
Triple Net Retail: The Outlier
One area lagging behind is the triple net (NNN) retail segment. These single-tenant properties, often leased to national brands, are typically structured more like bonds, with limited rent growth. As Costello noted, they’ve seen significant cap rate expansion in the past year, rising from the 6% range toward 7%, with no clear sign of stabilization yet. Investors are pricing in bond-like risk, especially in a higher-rate environment.
Tariffs, Inflation & Consumer Spending
The discussion also touched on macroeconomic risks—particularly tariffs and their potential inflationary effects. Costello explained that while previous tariff rounds were largely absorbed by companies (hurting corporate margins rather than consumer wallets), the current economic climate may not be so forgiving. If businesses pass those costs onto consumers, retail spending—and by extension, retail property performance—could take a hit.
Despite these risks, anecdotal signs point to resilient consumer behavior. The show host observed that retail spaces in markets like Atlanta remain busy, reinforcing the strength of experiential retail and mixed-use developments that combine living, working, and entertainment.
Construction, Supply Constraints & Labor
Another factor supporting retail’s recovery is the slowdown in new supply. High interest rates, rising construction costs, and labor shortages have dramatically reduced new development activity. Costello also highlighted a long-term structural trend: declining retail space per capita. Much of the oversupply built during the 20th-century suburban boom is being demolished, which helps concentrate demand and support rent growth for surviving properties.
Where the Opportunities Are
Looking ahead, Costello sees opportunity in several areas:
- Triple Net Retail: While currently challenged, this sector could present upside once interest rates stabilize and investors reprice risk more accurately.
- Distressed or Underperforming Assets: Buyers with operational expertise can add value by improving management or repositioning assets.
- Credit Funds & High-Yield Lending: With some deals facing funding gaps, private credit funds are stepping in to provide mezzanine debt or bridge capital.
- Aggregations & Efficiency Plays: As the market matures, there may be room for portfolio consolidations that yield operational synergies.
2025 Outlook: A Market in Transition
Overall, the outlook for retail in 2025 is cautiously optimistic. The worst of the interest rate shock appears to be behind us, pricing is beginning to stabilize, and demand fundamentals remain strong in many segments. However, uncertainty around inflation, policy shifts, and tariffs means that investors must continue to build scenarios into their underwriting.
Costello’s final takeaway? Success in the current market will rely less on passive cap rate compression and more on savvy asset selection, efficient operations, and creative capital structuring.