Standing Tall:
Retail markets in the U.S.
As credit has tightened and Americans have pulled back on their spending, the retail market has suffered significantly. Retailers have been forced to scale back on their expansion plans, and in many cases, they’re shuttering stores.
As retailer demand for space weakens, shopping center vacancy rates are on the rise across the country, and asking rents are falling. Although new development completions are forecast to drop 30 percent this year, retail vacancy is expected to increase 180 basis points to 10.2 percent, according to Marcus & Millichap. Meanwhile, asking rents are forecast to fall 4.5 percent in 2009, while effective rents are expected to drop 5 percent on average, according to the firm.
However, the performance of individual markets in the near term will be determined largely by recent supply trends. Traditionally supply-constrained markets will outperform this year, while markets where developers delivered space with the assumption of continued population growth will record significant vacancy increases and considerable rent declines, according to Marcus & Millichap.
The national brokerage firm recently released its 2009 National Retail Index (NRI), which is a snapshot analysis that ranks 43 retail markets based on a series of 12-month forward-looking supply-and-demand indicators.
Historically tight markets with limited supply growth fared better in this year’s NRI. With retail fundamentals weakening throughout the country, the top portion of the 2009 NRI is dominated by markets where vacancy is low to start and should remain below average, allowing owners to keep rent declines modest.
The NRI bases its market rankings on various indicators, including forecast employment growth, vacancy, construction, household formation, retail sales, rent growth and an additional analysis of local housing market conditions. Taking into account both the forecast level and degree of change over the next year, the index is designed to indicate relative supply and demand conditions at the market level.
The top five retail markets according to Marcus & Millichap’s 2009 NRI are:
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San Diego
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San Francisco
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Washington, D.C.
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San Jose, Calif.
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Portland, Ore.
“For the most part, the top markets are desirable places to live, with high household incomes and high levels of education,” says Bernie Haddigan, national director of Marcus & Millichap’s National Retail Group. “They also have high barriers to entry and strong demand, which bodes well for shopping center operations.”
Haddigan says the top markets in the NRI are not high-yield markets, but rather stable and dependable markets. “In the market we’re in, we’re observing broad flight to quality,” he says. “Over the past few years, a lot of investors had been chasing secondary and tertiary markets. Today, investors are looking for safer, more secure investments and are returning to infill markets.”
San Diego
San Diego claimed the top spot in the NRI due to modest development activity and the nation’s lowest forecast vacancy rate.
Despite weakness in the local economy, the San Diego retail market will remain tight because of limited supply. Roughly 200,000 square feet are expected to be delivered in 2009, down from 480,000 square feet last year, according to Marcus & Millichap. Completions will account for a 0.2 percent increase to metrowide inventory.
Developers are responding to weaker retail conditions and have delayed their projects. For example, the proposed 950,000-square-foot Oceanside Pavilion was originally slated for completion in 2009 and now is expected in 2011.
The impact of reduced consumer spending on space demand will result in an 80-basis-point rise in vacancy this year to 4.6 percent. A 50-basis-point increase was recorded in 2008. Asking rents are forecast to decline 2.1 percent to $28.35 per square foot in 2009, while effective rents are expected to fall 2.4 percent to $25.63 per square foot.
Marcus & Millichap says San Diego’s track record of strong operating conditions will attract investors, though a buyer/seller disconnect persists. For single-tenant properties, average cap rates hovered in the low to high 6-percent range as 2008 came to a close, while multi-tenant assets were trading in the mid 6-percent to low 7-percent area. In 2009, cap rates for all retail properties in the metro are expected to creep higher.
John Hickman, managing director for NewMark Merrill Companies’ San Diego Division, says there is very little new development because of land constraints and strict zoning, but there are plenty of opportunities to acquire retail properties.
“There are opportunities to acquire existing assets and reposition them, especially car dealerships and other distressed properties that can be converted to retail once the retail market stabilizes,” Hickman explains.
San Francisco
Last year’s leader, San Francisco, also will experience low vacancy, but it still fell one place in the index as a result of employment losses in the metro’s financial sector.
Although layoffs in the financial sector will contribute to a net loss of 22,500 jobs this year, a 2.3 percent decline, San Francisco’s retail market will outperform much of the rest of the country, supported by limited competition from new inventory and steady tenant demand in core neighborhoods.
Retail deliveries will be minimal, with roughly 75,000 square feet scheduled to come online in 2009. Despite limited construction, vacancy is expected to creep up 70 basis points to 4.6 percent this year, following a 30-basis-point decline in 2008. Asking rents are forecast to drop 2.4 percent to $33.38 per square foot in 2009, while effective rents are projected to end the year at $30.55 per square foot, a 2.6 percent contraction.
Marcus & Millichap notes that high-profile retailers continue to expand in the Union Square District, a premier tourist destination. Retailer demand also remains relatively stable on trendy neighborhood retail strips such as Chestnut and Fillmore streets.
Tourism spending and the affluent neighborhoods that surround core shopping districts support San Francisco’s potential for a swift recovery and will sustain investor interest in the local retail market. Cap rates average in the mid to high 5-percent range and will likely edge higher in 2009, especially for assets located in the outer fringes of the city, where retenanting has been slow and will remain a concern through the downturn.
Marcus & Millichap says investment opportunities may emerge near the proposed Eastern Neighborhoods Plan, which is expected to rezone 2 million square feet of industrial space in the Mission District, Potrero Hill, eastern South of Market Area and central waterfront neighborhoods. The plan calls for the development of roughly 10,000 residential units, which will spur retailer demand over the long term.
Washington, D.C.
Despite expected job losses, Washington, D.C., finished near the top of the NRI ranking because of low vacancy. The market rose two spots based on the fact that the employment market will shed workers at a far slower rate than the national average and a considerable decline in deliveries.
In 2009, vacancy is projected to rise 130 basis points to 6.6 percent; last year, vacancy increased 170 basis points. With vacancy edging higher, asking rents are forecast to fall 3.8 percent in 2009 to $26.51 per square foot, while effective rents decline 4.3 percent to $23.88 per square foot.
Although vacancy in this area is expected to rise, a drop in completions will limit the increase. Developers delivered 5.4 million square feet of retail space in 2008 and are forecast to complete 3.2 million square feet this year, a marked deceleration in supply growth from the annual average of 4 million square feet recorded each of the past three years, according to Marcus & Millichap.
“Historically, Washington, D.C., has been an attractive market for both foreign and domestic investors,” says Jim Koury, executive vice president of Jones Lang LaSalle. “It has the ability to withstand downturns with high barriers to entry and a lot of people within a constrained region with strong demographics.”
In Virginia, cap rates on older shopping centers start in the low 8-percent range, while Class A assets can trade at 7.2 percent to 7.8 percent. Cap rates on newer properties, though, may inch up, as rents on new leases could be lower than rents on expiring deals. In Prince George’s County, where a significant influx of jobs will occur, multi-tenant assets pricing with cap rates from 8.0 percent to 8.5 percent will draw buyers’ attention. As 2009 began, however, investors in the county were demanding higher cap rates for properties close to the District.
Although sales of multi-tenant properties have slowed, reflecting investors’ concerns about competition from recent supply additions and the challenges of re-leasing space in older assets, properties in northern Prince George’s County will receive greater investor interest this year, according to Marcus & Millichap. The near-term transfer of 20,000 workers to Fort Meade just beyond the county line will enhance retail spending and traffic, potentially raising operating incomes.
San Jose, Calif.
Increasing construction and a forecast for weaker employment pushed San Jose down one spot in the index to #4.
However, vacancy in San Jose will remain well below the national average, keeping the metro area in the top five of the ranking. Moreover, Marcus & Millichap predicts that strong demographics will mitigate a significant downturn and support an eventual rebound in San Jose retail fundamentals.
Major employers such as Yahoo and eBay announced layoffs late last year, and continued struggles in Silicon Valley’s technology sector will result in the loss of 20,000 positions in 2009, a 2.2 percent reduction, according to the brokerage firm.
Developers are slated to bring 750,000 square feet of new space online this year, up from 350,000 square feet in 2008. However, that pipeline is still minimal when compared to the overall metro inventory.
Vacancy is expected to climb 190 basis points to 5.8 percent this year due to increased deliveries and easing tenant demand, according to Marcus & Millichap. In 2008, when deliveries were more modest, vacancy rose 70 basis points.
Asking rents are projected to fall 3 percent to $30.55 per square foot this year, while effective rents are forecast to decline 3.6 percent to $27.49 per square foot. However, shopping centers in established trade areas of Silicon Valley, including Palo Alto and Los Altos, should continue to perform well because of their favorable demographics.
With that in mind, the average cap rate for multi-tenant properties ranges from the mid to high- 6-percent range. However, initial yields for B and C properties could rise significantly due to concerns about backfilling empty space. Single-tenant cap rates currently are in the low 6-percent range and are expected to increase marginally through the end of this year, according to Marcus & Millichap.
The brokerage firm says investment activity will move forward at a moderate pace this year in the San Jose retail market with investors displaying greater caution with lower-tier strip centers in need of rehabilitation in underperforming areas like East San Jose and Morgan Hill.
Marcus & Millichap says investors may want to explore opportunities near the ongoing redevelopment of Sunnyvale Town Center, which is scheduled for completion later this year. Plans for this once-vacant mall include 900,000 square feet of retail space, 315,000 square feet of office space, nearly 300 condos and a 200-room hotel. Elevated foot traffic could spur increased demand for other retail properties in the area.
Portland, Ore.
Healthy household growth and continued demand for retail space pushed Portland up three spots in Marcus & Millichap’s NRI to #5.
Given Portland’s tough zoning and entitlement environment, new supply is modest. Developers will reduce construction activity this year, with roughly 450,000 square feet of space slated to come online, down from 1.4 million square feet in 2008.
However, a slowdown in tenant demand will push vacancy up 100 basis points to 7 percent in 2009. Even so, the market will post one of the smallest vacancy increases in the country, according to Marcus & Millichap. Last year, vacancy rose 130 basis points.
“Portland consumers are highly sophisticated and more affluent than many would think,” says Jeff Green, president of Jeff Green Partners, a Mill Valley, Calif.-based retail consulting firm. “These consumers appeal to a number of retailers, especially lifestyle retailers.”
Owners have begun to offer increased concessions in order to sustain occupancy. Asking rents are expected to dip 2.1 percent to $19.85 per square foot this year, while effective rents retreat 2.7 percent to $17.42 per square foot.
Marcus & Millichap says dense infill neighborhoods in the Northwest and Pearl districts will outperform as residents migrate toward close-in employment centers. Meanwhile, recently completed neighborhood and community centers in the outlying areas of Clackamas and Clark counties are expected to have difficulty securing tenants, and vacancy in both areas is forecast to push past 10 percent this year.
Cap rates for single-tenant deals average in the mid to high 6-percent range and are expected to trend up in 2009, according to Marcus & Millichap. Initial yields in multi-tenant properties are roughly 30 basis points higher and also are projected to rise. Core assets with national-credit tenants in established neighborhoods, however, will likely achieve premium pricing, with cap rates remaining fairly stable in the mid 6-percent range.
In particular, stabilized infill properties in the urban core, where new high-end apartment and condo developments have increased population density, will continue to garner attention from buyers. Marcus & Millichap says investment opportunities may emerge in strip centers along the Interstate 5 corridor, as investors who are able to put additional capital into assets can benefit from the area’s tight conditions and above-average rents.