The 2006 holiday sales numbers, which posted the weakest growth in four years last week, are a sign of what’s ahead for the United States’ retail market in 2007 – a year of modest expectations. Experts expect retail real estate to remain a stable investment, but it will no longer yield the high returns as experienced in 2004 and 2005.

California remains the top market as far as demand and pricing goes. Average cap rates are at 6.33 percent, while the Midwest region is near the bottom because of troubles in the manufacturing sector. Cap rates there range between 6 percent and 8 percent.
The top five destinations for retail investment this year, based on population growth, will be Washington, D.C., Dallas/Fort Worth, Los Angeles, Houston and Las Vegas, according to the 2007 Real Estate Forecast produced by brokerage firm Grubb & Ellis. This mirrors last year’s forecast, when Washington, D.C., Los Angeles, Phoenix, Ariz., Dallas/Fort Worth and Las Vegas ranked in the top five.

Top 5 Markets 2006 Top 5 Markets 2007 Cap Rate (12-months average) Washington, D.C. Washington, D.C. 6.1 percent Los Angeles Dallas/Fort Worth 7.2 percent Phoenix Los Angeles 6.2 percent Dallas/Fort Worth Houston 7.2 percent Las Vegas Atlanta 7.2 percent Source: Grubb & Ellis

On the operating side, owners can expect another year of modest rent increases, says Robert Bach, senior vice president for research and client services with Grubb & Ellis. In 2006, he says, asking rent increases across the nation averaged 3.5 percent. Outperforming markets included Dallas/Fort Worth, where asking rents rose 10 percent, to $22.25 per square foot. Also, Orange County, Calif., Jacksonville, Fla. and Nashville posted 10 percent increases in asking rent, reports Grubb & Ellis.

“We are still in an expansion cycle,” says Bach. “Retail sales have held up pretty well through 2006 and there weren’t any factors to cause any markets to really sink to the bottom or rise to the top.”

Meanwhile, the two factors that are causing investors’ headaches – the slowing housing market and the mixed forecasts for the national economy – won’t have as much of an impact on the retail sector as many fear, cites Grubb & Ellis. The firm estimates that employers will create an average of 100,000 new payroll jobs a month in 2007, compared with 135,225 per month in 2006, that will keep cash registers ringing.

But job growth and economic health vary across the nation.

“Overall, I think the economy will continue to muddle through and create jobs,” Bach says. “But the manufacturing sector has weakened, so that can have an effect on retail spending and development in manufacturing-sensitive areas.”

Bernie Haddigan, managing director of the national retail group with Marcus & Millichap, an Encino, Calif.-based broker says, coastal and sun belt states and densely populated areas will continue to do well in 2007.

“Michigan and Ohio have gotten their noses bloodied a bit because investors are not as interested in those older, industrial locations,” says Haddigan.

Investors, Haddigan says, are staying in prime markets and concentrating on centers that are anchored by high credit tenants. That is a shift from 2005 and early 2006, when properties in secondary and tertiary markets would entertain multiple bids.

Average cap rates for multi-tenant retail properties hit bottom in the first quarter of 2006, at 6.61 percent, and slowly rose throughout the rest of the year finishing at 7.12 percent, according to Marcus & Millichap.

But investors will be not be flooding the market. Haddigan expects another year of declining deal volume in 2007. In 2006, there were $41.43 billion worth of retail property transactions in the domestic market, down 18 percent from $50.50 billion in 2005, according to Real Capital Analytics.

Meanwhile, real estate investors continue to look for higher returns in developing markets in Asia and Eastern Europe.

Asia’s GDP growth is projected to reach 7.9 percent in 2007, according to the international financial services firm Credit Suisse, while Eastern European countries will experience growth rates averaging between 5 percent and 6 percent. The global rate of growth for 2007 is expected to be 4.9 percent.

By Elaine Misonzhnik