Retail properties have shined during a time of economic uncertainty and turmoil. Intense demand for quality, well located properties has pushed up prices, compressed cap rates and tipped the scales in the seller's favor. Low interest rates, a lack of alternative investment choices, a shrinking construction pipeline and expectations of improved economic conditions in the latter part of the year will encourage continued strong investor interest.
To help investors evaluate markets nationally, Marcus & Millichap has designed a National Retail Index (NRI), which is a snapshot analysis that ranks 38 retail markets nationwide based on a series of 12-month forward-looking supply and demand indicators.
Markets are ranked based on their cumulative weighted-average scores for various indicators, including forecast employment and household growth, vacancy, construction, personal income, new home construction and rent growth. Taking into account both the forecast level and the degree of change over the forecast period, the index is designed to indicate relative supply and demand conditions at the market level.
Users of the index must keep several important points in mind: First, the NRI is not designed to predict the performance of individual investments. A carefully chosen investment in the bottom-ranked market could easily outperform a poor choice in the top-ranked market. Second, the index is geared toward a short-term time horizon. A market facing difficulties in the near term may provide excellent long-term prospects, and vice versa.
Third, a market's ranking might change from one year to the next even if its fundamentals remain unchanged. This can happen when conditions are stable in one market while shifting in the market's peers. Finally, because the NRI is an ordinal index, differences in specific rankings should not be misinterpreted. For example, the second-ranked market is not necessarily twice as bad as the top-ranked market, nor is it five times better than the 10th-ranked market.
Retail investors familiar with the Washington market will not be surprised that the nation's capital topped the NRI for the second year in a row. Posting top-10 marks in every category but one, Washington's strong fundamentals point to another year of superior returns in 2003. The capital's unemployment rate was just 3.5 percent in early 2003, the lowest rate in the nation. Strong consumer fundamentals have served to keep retailers healthy, while attracting retail expansion to the area. D.C.'s vacancy has tightened to 6 percent, down from 6.7 percent in 2001.
Two highly regarded Southern California markets hold down the next two spots. Orange County's (No. 2) slightly higher forecast rent growth helped it to edge out San Diego (No. 3). Orange County's strong demographics continue to produce healthy retail sales and maintain a tight market vacancy, currently just 5 percent. In San Diego, a robust level of retail sales, vacancy in the low 4 percent range and solid demographic trends combine to attract both retailers and investors.
Boston's (No. 4) high personal income and relatively low vacancy allowed it to overcome low scores for household and employment growth. The demographic strength of the market has kept consumer spending healthy and allowed retail sales to increase. While shopping centers registered a 50 basis point increase in vacancy in the past year, much of it that vacancy can be attributed to the high-priced Central Boston submarket. Most submarkets posted a decrease in vacancy, with South Shore being the tightest at 2.7 percent.
Fort Lauderdale, Fla.'s small development pipeline and strong household growth helped it secure a No. 5 ranking. The number of households grew by 1.7 percent in 2002. Retail sales have suffered little from the economic downturn; sales were up 4.1 percent last year, with growth of 3.8 percent forecast for 2003.
Rounding out the Top 10, San Francisco (No. 6) benefited from the highest personal income, as well as low completions and vacancy. Los Angeles (No. 7) earned high marks for rent growth, low vacancy and a relatively low inventory of retail space. West Palm Beach, Fla. (No. 8) is behind only San Francisco and San Jose, Calif., in personal income, while also scoring high marks for household and employment growth.
Despite posting the lowest personal income among our 38 markets, Riverside-San Bernardino, Calif., still managed to crack the top 10, at No. 9, by virtue of its high household growth and low stock of retail properties. Sacramento, Calif., whose high rankings in household and rent growth offset low rankings in completions and personal income, earned the No. 10 spot in the rankings.
Improvement for some; challenges for others
Fourteen markets improved their rankings from the 2002 NRI, while 22 markets fell. Among those gaining ground were Las Vegas (up 10 places), Los Angeles (up eight places), Phoenix (up six places) and Atlanta (up six places). Las Vegas improved its lot by posting the highest expected employment and household growth rates among our 38 markets for 2003. Developers are counting on these expectations, as Las Vegas has the largest retail construction pipeline (as a percentage of inventory) in place among all the markets surveyed.
Despite a relatively flat economy during the past few months, Los Angeles' low vacancy rate will help it maintain solid rent growth, and its employment outlook calls for at least a moderate recovery after the job losses it suffered in 2002. Both the Phoenix and Atlanta markets are expected to experience relatively little improvement in their retail fundamentals. The markets rose in the index, however, thanks to a turnaround in their job numbers and because a number of higher ranked markets facing declining fundamentals fell.
The markets that experienced a double-digit drop in their rankings — Minneapolis-St. Paul, Denver and Seattle — are all expected to witness a significant short-term degradation in supply and demand fundamentals. Minneapolis-St. Paul's job pool will grow in 2003 after a flat year in 2002, but the growth will be anemic by recent historical standards.
Denver retailers will struggle as layoffs at telecom companies and other high-tech firms continue for the third straight year. Seattle, home to Microsoft and many of Boeing's operations, will be challenged by a sluggish high-tech sector and an aerospace industry that is still struggling to cope with the collapse in air travel after 9/11.
Despite these short-term challenges, there are plenty of opportunities to be had in the lower-ranked markets. Investors with a keen eye for value and a thorough understanding of the local market will be in a position to earn outsized returns once these markets rebound.
Who Bernard J. Haddigan
National director of Marcus & Millichap's National Retail Group