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Gloom, Not Doom :
Retailers Suffer Alongside Consumers

As the entire U.S. struggles with a weak economy, residential slump, credit crisis and an upcoming presidential election, Americans must grapple with increasing unemployment, higher food and gas prices and restricted access to credit.


These factors have created a very challenging environment for retailers and caused retail real estate fundamentals to soften. Retail property values are also showing signs of softening, which could create some interesting opportunities for investors later this year and into 2009, according to Jamie Stolpestad, managing director of GE Real Estate's North America Equity group. "Of all the major property types, there is more headline risk in retail, but that should eventually translate into a great window of opportunity to invest," he adds.

Shaky confidence
Unlike the previous recession after Sept. 11, 2001 where businesses pulled back on their spending while consumers continued to open their wallets, this economic downturn is very different. Not only are businesses pulling back, consumers have too.

Across the country, Americans are worried about three major issues: loss of wealth due to the housing markets; inflation; and the general economic health of the nation. "If you're at risk of losing your house, you're going to be a different kind of consumer," Stolpestad says.

A recent study by the International Council of Shopping Centers determined that for every 10 percent increase in home demand, real consumer spending increases by slightly more than 0.5 percent, and falls similarly on the decline. Much of the combined impact of the drop in housing demand has already been absorbed through declining consumer spending.

Stolpestad says the Inland Empire region in Southern California, along with Phoenix and South Florida, have suffered the most turmoil related to the housing downturn. In these regions, housing related retailers are really suffering. For example, first quarter sales at furniture and home furnishing stores fell by 6.1 percent, according to the Commerce Department.

Consumers are also being impacted by significant inflation in basic commodities including food and gasoline. "Everything feels a lot more expensive, and that's causing people to make hard choices about where and how they spend their money. So, discretionary spending is down," Stolpestad says.

Energy and food prices were up 17 percent and 4.5 percent, respectively, in March 2008 compared with a year ago, according to the Bureau of Labor Statistics. Core inflation, which excludes food and energy, remains moderate, up just 2.4 percent. In general, economists are expecting inflation to subside as the economy softens, but they warn that inflation could be a greater problem in the next expansion cycle than it has been in recent years.

Beyond the housing downturn and inflation, consumers are feeling very depressed about the broader economic climate including job losses and continued discussion of the credit crisis. In February 2008, the Census Bureau revealed that the economy shed 63,000 jobs, more than expected and the biggest monthly drop in five years.

The Reuters/University of Michigan Index of Consumer Sentiment for April found that consumer confidence was at its lowest level since 1982. And, the percentage of Americans who tell the Gallup daily tracking poll that economic conditions in the country are getting worse, at 85 percent in mid-April, is close to an all-time high.

"The retail environment is as challenging today as it's been for a very, very long time," says Steve Dawkins, president of retail corporate solutions for Staubach Retail Services. "The consumer is keeping more dollars in their wallets, taking fewer shopping trips, and that's causing retailers to slow down expansion."

Dawkins recalls that the recession after Sept. 11, 2001 was challenging for retailers, but the recession in the early 1990s was much more difficult. He, along with other industry experts, is unsure just how deep this recession will cut.

So far this year, retail sales are up over the previous year. The U.S. Census Bureau reported that U.S. retail and food services sales for March were $381.4 billion, an increase of 0.2 percent from the previous month and 2 percent above March 2007. Total sales for the January through March 2008 period were up 2.9 percent from the same period a year ago.

Limited Expansion
But, retailers are pulling back. "The economic conditions have caused a lot of retailers to take a breath," Dawkins says, adding that retailers have either decreased their store opening plans or have completely cut out any expansion. For example, one of his clients, a national retailer, had plans to do 600 units in 2008, but scaled back to 200 units instead. "All the demand that was there for the new space has been cut dramatically," Dawkins notes.

Emerick Corsi, executive vice president of development for Forest City Enterprises, says the velocity of retail development has been tempered. The Cleveland, Ohio-based company, for example, is actively developing several projects for a 2009 and 2010 delivery but has pushed several new projects into the next development cycle.

Moreover, many national retailers have announced store closings, and the closing aren't limited to any one particular retail category. Movie Gallery, for example, recently announced that it would close another 160 stores after previously announcing more than 900 closings. On the apparel side of things, Talbot's, CHICOs and Ann Taylor are all closing stores. Even organic grocer Whole Foods is looking to dispose of a few locations.

Smaller regional retailers and mom-and-pop operators also are stressed. The question now is how long these less liquid retailers hang on, Dawkins notes. "Retailers are saying that they've got to get out of the non-performing stores and doing everything they can to shed space," he says.

Stolpestad points out that retail real estate usually lags changes in consumer and retail markets so it will take a while for the full impact of retailers' pullback to show up in occupancies and rental rates. But, recent data from REIS Inc. shows that retail absorption is down and vacancies are up across the country.

The first quarter 2008 saw the first instance of negative net absorption since REIS began tracking the retail sector in 1980. Net absorption fell to -1.2 million square feet in the first quarter from 8.5 million square feet in the fourth quarter 2007.

More than 4 million square feet of retail space was completed during the first quarter, and the last two and a half years' steady increases in the vacancy rate have been largely attributable to the development of new retail space. Last quarter, REIS reported a vacancy rate of 31.6 percent for newly-completed retail space, as compared to the market vacancy rate of 7.5 percent.

The national vacancy rate of U.S. neighborhood and community shopping centers increased by 20 basis points, to 7.7 percent in the first quarter of 2008. This is the highest vacancy rate since 1996 and marks the twelfth consecutive quarter of flat or deteriorating retail occupancy at the national level, according to REIS.

During the first quarter 2008, rent growth slowed markedly, falling to just 0.4 percent (1.7 percent at an annualized rate) - its lowest rate since the first quarter of 2002. Effective rent growth slowed to an even greater extent, falling to 0.1 percent (annualized 0.5 percent) in the first quarter. At just under 10 percent, the gap between asking and effective rents is at its highest level since 1989. In that year, the mid- and late-1980s construction boom had pushed the national vacancy rate to 10.7 percent.

Indications of stress are visible in regional mall performance as well. The regional mall vacancy rate increased by 10 basis points in the first quarter, from 5.8 percent to 5.9 percent, its highest level since the fourth quarter of 2002, according to REIS. Asking rent increased by just 0.4 percent in the first quarter.

The outlook for the rest of 2008 is somewhat grim: REIS projects that the national vacancy rate will rise to 8.3 percent, while asking rent growth will remain weak, registering gains of just 1.9 percent in 2008.

Cautious investors
As the overall fundamentals of retail real estate have softened, investors have begun to evaluate retail assets far more stringently and are balking at high prices and low cap rates.

"Everyone is approaching the market with caution," says Bernard Haddigan, managing director of Marcus & Millichap's National Retail Group. "Retail is less appealing today than it was 18 months ago in the eyes of the investors. Multifamily is the darling because most people are betting that apartments have the best opportunity for rental upside."

During the first quarter 2008, nearly $6 billion worth of retail properties changed hands, according to New York City-based Real Capital Analytics Inc. The average cap rate was 6.81 percent, up 20 basis points from 2007's average cap rate. Last year, $74.8 billion of retail real estate was sold and in 2006, $53.8 billion was acquired.

Although most industry players expect values to decline for most retail assets - anywhere from 50 to 150 basis points depending on quality and location - investors are again seeing a differentiation between quality assets and those of lesser quality. "We're going back to a market where quality, format and individual tenants matter," Stolpestad says.

Despite the anemic investment activity, most industry experts hasten to point out that retail properties are still good long-term investments. Jim Koury, senior vice president & national director of Jones Lang LaSalle's Boston office, says that investors still have a lot of confidence in the retail sector. "Today, investors are much more bullish on the majority of retailers surviving the economic downturn than they were in the mid-90s," he contends.

In fact, Koury doesn't feel that investors have given retail the so-called "cold shoulder". "The problem is that they just don't know how to price it," he says. "No one wants to be the guy who paid too much."

And, Koury points out that long-term investors shouldn't be overly concerned about short-term price volatility. "In the long-term, we all expect that real estate values will rebound and continue to escalate," he says.

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