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ENCINO, CALIF. — 2011 is already half gone, nearly two years since the recession officially ended. While it is true that the economy has been in recovery since late 2009, the after effects of the commercial real estate collapse are still very much a part of daily business in the industry. Rising energy prices and continued unemployment continue to keep consumer confidence at bay, and a double-dip in the single-family housing market likely won’t see sustainable recovery for at least 12 to 24 months.

With all of that said, the situation for retail real estate is nowhere near dire, and Marcus & Millichap hosted a webcast Tuesday afternoon to outline its analysis of the retail market in particular, pointing to what is the firm refers to as a “soft patch” in the recovery, rather than a double dip.

How the Macro Economy is Affecting National Retail

Marcus & Millichap Managing Director Hessam Nadji outlined the economic factors surrounding the current state of the commercial market. While GDP was healthy in the third and fourth quarters of 2010, it appeared to stall in early 2011. Part of the reason for this, he said, is the transition off government programs that were implemented in the wake of the market crash. Displaying moderate but not fast growth, the private sector is standing on its own, and Nadji doesn’t predict a double dip for retail.

“The biggest concern is the idea we’re headed for self-fulfilling prophecy,” Nadji said. “Growth is actually pretty good, but if you keep adding to concerns and negative headlines, overreaction is the biggest threat. I don’t expect a double dip here by the numbers we analyze.”

Recovery in general has been broad based, with the private sector adding jobs and strength in retail sales growing. Retailers are reporting healthy first quarter after-tax profits and sales, firming rent growth and occupancies.


“We can’t lose sight of the fact that even though online retail is increasing exponentially, traditional in-store retail is recovering, which correlates closely to net absorption that has recovered nicely,” said Nadji, referring to the chart above. “Retail in particular overbuilt going into the recession because of its relationship with rooftops and the housing boom, and that didn’t stop until 2009. This trend pushed vacancies to record highs, and while it’s stabilizing now, we expect a pretty dramatic fall because of this stall in new construction and moderate increase in demand.”

Nadji also discussed the top (and bottom) retail markets in the U.S., and what to expect from those in the coming quarters. While the top markets generally shouldn’t see dramatic changes because of the supply constraint, both Miami and New York showing rapid recovery and are gaining momentum.


On the other side of the coin are markets hit hard by housing overbuilding, and Midwestern markets affected by manufacturing drop-off. Texas in particular, though leading in job growth, has a tendency to overbuild. Therefore, these high construction markets like those in Texas, and Phoenix and Atlanta, for example, over next 2 to 3 years will outperform because they will fill up space while the pipeline is emptied out.

Healthy Capital Markets Create a Positive Investment Environment

Though relying on consumer confidence to drive the market is an unknown and unpredictable variable, Bill Hughes, Marcus & Millichap Capital Corporation’s managing director, shared positive news from the capital markets and their effect on investment.

“Reliable and attractive sources of acquisition financing will stimulate deal velocity for remainder of the year,” he says. “The attitude has stayed stable, and the best market opportunities are transactions, where a low cost of debt is supporting values. There are historically high spreads between interest and cap rates, and it’s a good buy to transact.”


While many of the deals are getting done in larger markets, especially for grocery and drug-anchored, well-secured properties, there are value opportunities in second-tier markets. Not surprisingly, however, underwriting is demanding proven revenue streams as the entry level. Debt yields are approximately 9 to 11 percent for a loan-to-value of 60 to 75 percent.

“Taking the broad brush, the numbers are likely to continue climbing, and we’re seeing nice, steady growth,” says Bill Rose, national director of Marcus & Millichap’s national retail group. “Ninety percent of volume is coming from private capital — that’s volume, not velocity — and while the REITs are not a big percentage of the whole now, they are moving in.”


On the public side of the investment spectrum, shopping center REITs are showing positive growth, as they control necessity-based retail operators such as grocery and drug anchored product, says Rose. Regional mall REITs have the financial strength and reasonable debt to equity ratios. “These trends are a canary in a coal mine, all trending upward from the bottom,” Rose adds.

One remaining concern is the level of legacy debt and distressed properties. Hughes cites that there is $2.3 trillion in outstanding commercial debt; however, of that number $60 billion is distressed retail. More than half of that has been sold, refinanced or restructured, and actual REO retail covers approximately $14 billion.

“According to the ICSC, there are 108,000 shopping centers in the U.S., and number of deals in distress is about 2,400,” says Rose. “We don’t need to be worried it will stall the system.”

In effect, Marcus & Millichap concluded today that there are several encouraging factors shaping investment in retail real estate. Though the distressed market isn’t out of the woods yet, in the near term multi-tenant shopping centers are showing the greatest momentum through year end. Many retailers are recording profits for first quarter and good sales volume, and though the outstanding variables within the greater economy will play a role in the pace of recovery, the fundamentals are strong and provide a positive outlook for the retail sector.

Dan Marcec

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