Bernard J. Haddigan
The retail sector is in the midst of a perfect storm caused by the crash in housing, frozen credit markets and the worst job loss cycle since World War II. The excess spending of 2003 to 2007 has swung to what appears to be extreme caution by consumers and businesses, wiping out numerous retailers and driving most others to contract and go into survival mode. Retail real estate, a mirror reflecting the economy and credit markets, is in turn feeling the pain. While the recession has become self-sustaining in many respects — toxic assets on bank balance sheets have led to tighter credit markets, reduced liquidity in the marketplace has caused businesses to reduce payrolls, and lagging consumer confidence has resulted in falling sales for retailers — unprecedented government intervention is expected to eventually help stabilize the system and re-establish capital flows.
Nationwide, retail construction is expected to slide by more than 30 percent in 2009; however, the decline will not prevent vacancy from increasing substantially due to store closures and reduced retailer expansion. Major tenants are making significant efforts to renegotiate leases already in place to avoid closures. For quality tenants, many owners are ceding, aware that the loss of anchors could impact the performance of entire shopping centers. As a result, we expect the greatest decline in rents on record this year as new shopping centers come to market with vacant space and existing properties face ongoing operational challenges. Pre-leasing at properties under way suggest approximately two-thirds of the space will hit the market occupied. It is likely that more space will come to market vacant, however, as retailer bankruptcies are set to rise, leading to an increase in lease cancellations.
Closures and bankruptcies have become broad-based, ranging from department stores and electronics retailers, such as Mervyns and Circuit City, to smaller mall chains. As a result, there is not a segment of the retail property market that is immune to the current downturn, although core infill neighborhood/community centers will fare much better than the retail market as a whole. Some of the hardest-hit properties are those recently delivered in perimeter locations that relied on thousands of new homes that were either never built or now stand vacant. These properties have become difficult to lease and sell, as land values have slipped and establishing market rent is nearly impossible. As fundamentals continue to weaken across the country this year, owners will need to closely monitor expenses to help preserve NOI. Many will uncover money-saving operational measures that can increase efficiencies. One of the nation’s largest mall owners already has announced plans to cut hours at some of its shopping centers following the worst holiday season in recent history, allowing retailers to save on staffing and reducing energy costs.
Retail completions are forecast at 90 million square feet this year, down from 131 million square feet in 2008 and the lowest amount of space added since 1995. Reduced development will help stabilize the market in 2010 before a moderate recovery starts in 2011. New mall development is slowing, with only 6 million square feet slated to come online nationwide this year. This figure may decline, as the majority of malls scheduled for completion in 2009 are being developed by General Growth Properties, which is facing significant debt-related issues. Many existing malls continue to struggle, but some are finding success retenanting vacant anchor space with nontraditional tenants, such as grocery chains or warehouse clubs.
National vacancy is forecast to rise 180 basis points to 10.2 percent in 2009, following a 120 basis point increase last year. Much of the spike is expected to take place in the early part of this year, as many retailers will likely shutter stores after the weakest holiday season in decades. Average retail center asking rents are forecast to decline by 4.5 percent in 2009, after holding steady last year. Effective rents slipped 1.1 percent in 2008 and are projected to drop 5 percent this year. Many oversupplied markets will record steeper declines.
Following years of robust consumption, individuals are curbing spending significantly. Steep job losses, declines in net worth and tightening credit markets are presenting challenges to retailers, many of which are closing stores and/or drastically scaling back expansion plans. With tenant demand for space easing throughout the country, the performance of individual markets in the near term will be determined largely by recent supply trends. Traditionally supply constrained markets such as San Diego, San Francisco and Portland will outperform this year, while markets where developers delivered space with the assumption of continued population growth, including Phoenix, Sacramento and Atlanta, will record significant vacancy increases and considerable rent declines.
Top Retail Markets
With retail fundamentals weakening throughout the country, the top portion of Marcus & Millichap’s 2009 National Retail Index (NRI) is dominated by markets where vacancy is low to start and should remain below average, allowing owners to keep rent declines modest. San Diego advanced five positions in the ranking to secure the top spot due to tight vacancy and relatively mild contraction in the local job market. Last year’s leader, San Francisco, also will record low vacancy, but fell one place in the index as a result of employment losses in the metro’s financial sector. Washington, D.C., (Number 3) rose two spots in the NRI this year, supported by an employment market that will shed workers at a far slower rate than the national average and a considerable decline in deliveries. Increasing construction and a forecast for weaker employment pushed San Jose (Number 4) down one spot in the index. Portland rose three spots to Number 5 due to a healthy household growth forecast that should minimize the decline in space demand. Job cuts in banking and finance will weigh on property performance in New York City (Number 6), but supply constraints continue to restrict construction, keeping vacancy in check and supporting one of the more modest rent declines in the country this year. Several high-profile employers announced layoffs in the Puget Sound region for 2009, causing Seattle to drop five spots to Number 7. In Orange County, California (Number 8), construction is easing and job losses are moderating, trends that fueled a five-spot jump.
Retail property performance typically has held up well through downturns in Los Angeles, a trend that we expect will continue in 2009, allowing the metro to retain the Number 9 spot. Rounding out the top 10 is Austin, where job losses are forecast to be moderate due to technology spending as a part of the economic stimulus package. While retail construction is slowing in response to waning demand for space in most markets, there are a handful of areas where supply continues to expand. Typically, these markets fared poorly in the index this year. Sacramento (Number 36), St. Louis (Number 41) and Kansas City (Number 43) all will record increases in deliveries in 2009 and fell four, three and four spots, respectively, in the NRI. In contrast, some of the markets where completions are dropping off most significantly, including Salt Lake City (Number 13) and New Haven, Connecticut (Number 28), made some of the greatest upward moves in the index, rising 11 and eight places, respectively. San Antonio (Number 24) and Dallas/Fort Worth (Number 26) improved nine and two spots, respectively, in the index this year due to employment forecasts that are far better than the national average. A lack of barriers to construction remains the primary concern