Retail REITs: Near Term Capex Caution Despite Strong Fundamentals

E-commerce Impact on Retail - E-commerce has significantly influenced commercial real estate, shifting the narrative from the "death of brick-and-mortar" to the importance of an omnichannel strategy [1][2] - Retail sales in the U.S. have grown at an average rate of approximately 4% since 2001, with e-commerce growing at 17.1% annually, leading to e-commerce sales comprising over 15% of total retail sales in 2023 [2] Retail Development Trends - 2024 is projected to be the third consecutive year with more physical retail store openings than closings, marking a shift from the previous decade's retail apocalypse [1] - New retail development has been minimal over the past decade, with construction and financing costs suppressing activity, resulting in a strong demand-supply imbalance in commercial real estate [1][12] Rental Growth and AFFO Challenges - Despite strong rental growth, factors such as increased interest expenses and elevated recurring capital expenditures are hindering adjusted funds from operations (AFFO) per share growth [1] - Retail REITs often highlight impressive leasing metrics without adequately addressing the associated costs, which can obscure the true economic gains from leasing activities [1] Tenant Retention Strategies - Increasing tenant retention is crucial for reducing recurring capital expenditures and enhancing long-term AFFO growth, even if renewal rental increases are lower than new leases [1][15] - The focus on retaining existing tenants can minimize downtime and associated costs, ultimately driving stronger cash flow growth [15] Market Dynamics and Future Outlook - The retail leasing environment is currently strong, with double-digit re-leasing spreads observed last year, but higher rents have not consistently translated to improved bottom lines due to various costs [4][18] - The potential for a ramp in retail activity is anticipated around late 2025, but current analysis does not support a significant overweight in the sector [1][18] Case Studies and Examples - Target's online sales increased from approximately 9% in 2019 to 18% in 2023, highlighting the importance of physical stores for fulfillment and profitability [2] - Brixmor Property Group (BRX) has successfully repositioned its portfolio, resulting in a 34% increase in average rents since 2015, although the stock price has not reflected this improvement [13]