Thursday, November 10, 2011

Retail Demand Continues Steady Recovery, Some Pockets of Pain Persist

With the holiday shopping season getting under way in earnest this month, recession-weary American consumers are setting aside their worries about stagnant U.S. employment, a soft housing picture and the debt crisis in Europe to go shopping. That's providing fuel for the slow-but-steady improvement in retail property fundamentals that has emerged in recent quarters.

Consumers rode out a slow-but-not-stalled economic expansion during the spring, and annualized GDP growth edged up in the third quarter, with lower interest rates beginning to have their intended effect -- encouraging purchases of durable goods like autos and stronger spending by consumers on home improvements, food and beverage and electronics, furniture and appliances, according to data presented at CoStar Group’s Third-Quarter 2011 Retail Review and Outlook.

"Retail spending started out with ‘needs’-based items like health care and general merchandise at Target and Wal-Mart, and it's now widened to include more of the ‘wants’ by consumers," said Senior Real Estate Strategist Suzanne Mulvee, who co-presented the quarterly review with Real Estate Economist Ryan McCullough.

Even as shopping centers and malls logged their ninth consecutive quarter of positive absorption nationally at 17 million square feet, the pace of increase in the third quarter remained muted compared with absorption during the market peak back in 2007. Cautious retailers are leasing space at a much slower rate than they did at the height of the housing boom, and many have weeded-out underperforming stores.

"We’re seeing very light absorption given this period of the recovery, especially considering the retail sales volume," said McCullough. But those retailers that survived the downturn are performing well, reporting higher sales per square foot, he added.

Other chains, such as Best Buy, are shrinking their footprints at existing properties, Mulvee noted.

"They’re looking at demographics and trends like online shopping and wondering how they’re going to grow their top line, and they haven’t quite figured it out yet. Until they do, I don’t think we’ll see a major ratcheting up in demand for physical space," Mulvee said.

CoStar sent questions to retail webinar respondents prior to the event last week to sample their views on the economic forces shaping their local markets, along with which types of product are hot and which are not. Predictably, participants representing core markets were fairly bullish, while many of those doing business in secondary and tertiary locations continued to be discouraged by the retail real estate environment.

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"Gyrations in sales volume appears to be driven primarily from discounting and bargains offered by retailers and are not a reflection of any true improvement," with confidence-lacking consumers still buying what they need and not their desires, said Michael Berube of Berube Company in San Mateo, CA, a view expressed by several other respondents.

Some retailers such as Wal-Mart are rolling out smaller format stores in urban centers to reach out to new customers. As suburban housing expansion has come to a standstill and urban core centers enjoy a rebirth, especially among renters in their 20s and 30s, retailers are finding an tapped market in undersupplied areas.

Restaurant growth is reported as especially strong, with residents eating fewer meals at home, a trend reflected in Census figures that show declining sales of food consumed at home. Sit-down and fast-food restaurants are taking an increasing role on large retail leases, and not just in urban locations, McCullough said.

Wal-Mart and other retailers are adding food to their offerings to take advantage of these shoppers, a trend noted by several e-mail respondents.

"Food has become more prominent at a variety of chains as it brings shoppers in more frequently, driving sales gains. For example, Target at The Pavilions at Talking Stick added fresh foods," said Linda Whitlow, director of public relations, De Rito Partners, Inc. in Phoenix. Whitlow added that unemployment in the area is still high and consumers have fewer discretionary dollars to spend, and are looking for more value for those dollars spent.

"My experience as of late is that retail leasing is very slow, with two distinct exceptions. Restaurant activity has been and continues to be very strong. Also, leasing activity for general retail is very active for large, over 10,000-square-foot, very well situated spaces that have all the other important attributes such as parking and visibility," added Norman Lotstein, vice president, Pyramid Real Estate Group, a retail specialist working primarily in southern Fairfield County, CT.

"Target just added grocery and expanded their stores in this region while Wal-Mart seems to be opening a new SuperCenter every 3-6 months," said David Doerr of Realty USA Commercial Division in Buffalo, NY.

Strip centers and neighborhood centers have been the slowest to see absorption gains, while power centers have performed strongly, with competition and tightening vacancies in some core markets for larger floor plates, CoStar's McCullough said.

Respondents reported that many of the abandoned Circuit City and Borders stores are being replaced by such tenants as fitness centers, seasonal Halloween and Christmas stores and in one case in the San Francisco area, a 10-year lease of a Circuit City store to the Peninsula Ballet Theatre and Conservatory.

However, "I have yet to see any abandoned big box stores replaced by like-kind credit worthy tenants, which was perceived of Borders, Circuit City, etc.," said Jeff Rigg, assistant vice president, Wells Fargo Bank - RETECHS, in Columbus, OH. "A number are temporary season tenants ... but very few national retailers have filled these spaces, most likely due to market overlap."

Denver, a metro at the intersection of technology and energy employment, has seen especially strong gains in absorption, leading the country with 1.3% of total retail inventory, with other strong markets including Seattle/Puget Sound, Boston, Washington, D.C., Houston and South Florida, the CoStar economists said.

In contrast, several metros plagued by large amounts of vacant "zombie" retail space such as Phoenix and Atlanta are plodding along with 25-35% vacancies.

While the national vacancy rate has ticked down slightly in recent quarters from its peak in early 2010, the availability rate -- space being marketed by landlords in anticipation of a tenant’s departure -- is improving at a slower pace, which is not encouraging given that some national chains are still announcing they will close more stores, Mulvee said.

Power centers are the only retail category where vacancies are continuing to edge down, with strip centers, neighborhood center and even community centers, many populated by mom-and-pop businesses, grappling with stubbornly higher vacancy rates.

That said, while the vacancy improvements are modest, they’re also broad-based. About two-thirds of the thousands of submarkets that CoStar tracks saw declining vacancies in the third quarter.

In one interesting exception to the lack of strength in non-core markets, Doerr said the strength of the Canadian dollar and loonie-toting tourists is providing an extraordinary boost to tourism and malls in his area, which includes Niagara Falls.

"In the Buffalo and Western New York retail market, we are uniquely positioned at the Canadian border and have approximately 6 million people within a 90-minute drive which includes the greater Toronto area," Doerr said. "We closely watch the value of the Canadian dollar against ours."

"I think retailers tend to only look at demographics and fail to know how strong our retail sector actually is beyond straight demos," he said.

In fact, in one of the largest investment sales of the third quarter, AWE Talisman sold Fashion Outlets of Niagara Falls to The Macerich Company for $200 million, or $377 per square foot. The 530,000-square-foot center right on the border is 95% leased, taking advantage of the strong cross-border trade.

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