The pace of retail development remains anemic.
In recent weeks, developers have announced plans to build a fortress mall in New Jersey, a large mixed-use center in Boston and dozens of smaller grocery-anchored centers, among other projects.
With retail sales improving and demand for space firming up, is the market for development beginning to heat up?
Since the turnaround time for new projects is usually 18 months or longer, many of the developers announcing projects today are reviving centers that were on the drawing board prior to the downturn. Those projects have been put on the back burner in 2009 and 2010 to allow time for retail vacancies to stabilize.
The new announcements come at a time when retail deliveries remain at all-time lows. In 2010, the industry delivered 45 million square feet of space, according to research compiled by Marcus & Millichap Real Estate Investment Services, an Encino, Calif.-based brokerage firm. In compiling its statistics, Marcus & Millichap combines its own data with that supplied by research firms CoStar Group Inc., Reis Inc. and TWR. Its construction numbers cover retail properties of 10,000 square feet and larger.
According to the CoStar Group, a Washington, D.C.-based research firm, last year's retail delivery pipeline represents the lowest figure the firm has on record for the industry going back to 1958.
Moreover, retail construction starts in 2010 totaled approximately 23 million square feet — one of the lowest years on record and the fourth straight year the figure fell. In fact, the full year figure for construction starts in 2010 was lower than in any single quarter in 2006 or 2007. Even with the seeming burst of new announcements in early 2011, experts predict the high unemployment rate and stringent lending criteria will continue to give most developers pause.
As a result, as 2011 unfolds, the number of new starts will likely end up being the same or lower than in 2010, says Chris Macke, senior real estate strategist with CoStar. And the amount of retail space delivered — including single-tenant construction — will be about 50 million square feet, according to Marcus & Millichap.
“There is still a lot of retail vacancy out there and the retailers themselves are still gathering” strength, says Alan N. Pontius, national director of commercial leased investment properties with the firm. “So I would expect [this] to be a similar year to 2010.”
Deliveries versus starts
When it comes to the development pipeline, timing is an important question. There's a difference between supply hitting the market today — when vacancies remain perilously close to all-time highs — and projects being announced that will open after the industry has had time to heal.
In assessing the existing pipeline, Marcus & Millichap estimates that in 2011, most of the space delivered will be in the form of larger multi-tenant properties, accounting for 27 million square feet. Developers will also deliver 13 million square feet of neighborhood and community shopping centers and 10 million square feet of single-tenant retail.
For its part, Reis Inc., a New York City-based research firm, estimates that the retail industry will see 14.6 million square in neighborhood shopping center and community center space come on line this year (the firm doesn't track construction statistics for other retail formats), after a record low of 4.1 million square feet in 2010. Even with the constrained amount of new supply, many of the new centers have been struggling to secure tenants, notes Victor Calanog, vice president of research and economics with Reis. Reis tracks properties that are 5,000 square feet or larger.
In terms of projects being announced today, many developers have started to look to outlet centers as an avenue for growth, while lifestyle centers have fallen out of favor after some struggled during the downturn.
“I expect the outlet centers are going to be playing a larger role because people have discovered that you can build them closer to the main area,” Macke says. “And you are starting to have a blending between outlet centers and power centers, which have discount retailers. I call them inlet centers — it's an outlet center, but it's in the traditional trade area. I think you are going to see more of that.”
Another popular project type going forward will be centers anchored by large discount tenants such as Dollar Tree, Big Lots and Burlington Coat Factory, Macke adds. Surprisingly, there may even be enclosed regional malls in the development mix, according to Calanog. But opportunities will be limited for those kinds of projects because there aren't a lot of areas that can support fortresses that contain 1 million square feet or more.
When it comes to power centers, there was little speculative building during the most recent boom. Going forward, both retailers and landlords will likely stick to planning stores in markets that meet return hurdles from day one.
According to Brian Smith, president of Regency Centers Corp., a Jacksonville, Fla.-based REIT that runs a 53.1-million-square-foot retail portfolio, approximately 15 percent of it in power and community centers, before Regency embarks on a new project it opts to pre-lease 100 percent of its anchor space. The firm also builds a small amount of in-line shop space — under 20,000 square feet — to make sure that it could easily find smaller tenants.
“I think a lot of mistakes were made over the last couple of years, including on our part,” Smith says. “I think what you'll see today is that both the developers and the retailers will go where they can be successful. And that means higher incomes, denser populations, areas that are harder to enter into. It's good for the retailers because they'll be able to generate more sales and good for the landlords because they can get higher rents.”
Currently, power center development remains at a trickle. The amount of power center space under construction dropped from a peak of 33.92 million square feet of space in the third quarter of 2007 to just 1.68 million square feet as of the fourth quarter of 2010. In addition, the amount of space delivered in 2010 was just 3.56 million square feet — about one-tenth the amount delivered in 2008, when the industry constructed 33.4 million square feet of power center space. The lack of new supply helped the sector recover over the past year. But with demand still not anywhere near pre-recession levels, the ramp-up in new power center projects be gradual.
What's in store
Developers will be wary of putting new centers on the drawing board as long as the unemployment rate stays in the high single digits, the experts say. (The national unemployment rate stood at 9 percent in January.) Meanwhile, it also remains difficult to secure financing for all but the most solid retail developments, notes Calanog. The banks might have more money to lend than they did in the past two years, but they still want to see great demographics and low loan to value (LTV) ratios before agreeing to fund new construction.
In addition, lenders normally insist that at least 75 percent of the project be pre-leased and that it should have committed anchor tenants, says Pontius.
“We've had six quarters of positive leasing absorption in retail, so we are heading in the right direction,” says Macke.
“But it's the rate at which corporations hire that will determine the rate at which new retail will be built,” he says. “Otherwise, you don't have the increased demand to justify new retail.