Hoping for a quick turnaround in the retail real estate sector? Don’t bet on it. That’s, at least, the opinion of more than 700 commercial real estate experts surveyed for the Urban Land Institute’s and PricewaterhouseCoopers’ annual Emerging Trends in Real Estate report.
“We’ve all got to pray for retail,” said Jonathan Miller, a consultant with Urban Land Institute and the report’s principal author during a Tuesday presentation of the report’s findings. “It’s had a great run. But it’s in for a tough time. … Class-B and -C malls will lose stores as chains consolidate into better malls. It’s going to be ugly.”
In judging prospects for property types in 2009, respondents ranked retail only above for-sale housing. On a scale of 1 to 9 with 9 being excellent and 1 being abysmal, retail came in with a 4.26 rating as an investment option and a 3.95 rating as a development option. Among 11 sub-sectors, regional malls ranked last (3.89 investment, 3.11 development), power centers ranked tenth (4.06 investment, 3.50 development) and neighborhood and community centers ranked sixth (4.67 investment, 4.08 development).
Respondents expect power center cap rates to rise 66 basis points from July 2008 (6.91 percent) to December 2009 (7.57 percent), regional mall cap rates to rise 59 basis points during the same time period (6.19 percent to 6.77 percent) and neighborhood and community center cap rates to rise 52 basis points (7.01 percent to 7.54 percent).
Across the board, the report found that experts expect the commercial real estate industry to experience a rough—and lengthy—correction. “ If our report appears bleak, it is because the people we spoke to were uniformly concerned and uniformly worried about the economy, the liquidity crisis and the impact on the real estate business,” said Stephen Blank, one of the principal researchers and advisers with the Urban Land Institute on the report.
The downturn could rival what the industry experienced in the early 1990s even though most sectors avoided overbuilding—the fatal flaw that exacerbated the previous downturn. In all, experts expect the sector to bottom in 2009, bounce along the bottom in 2010 and only begin to recover in 2011. That comes as a jarring revision to previous estimates that said the worst stretch for commercial real estate would be the first six months in 2008—in other words, already behind us.
“Commercial real estate just starting to correct,” Miller said. “It’s the last sector that is going to have problems.” The issue that Blank and Miller pointed to is the fact that while the credit crisis may be easing, the real recession, which could be the longest in the U.S. since the 1970s, has yet to take its toll on commercial real estate. “Commercial real estate is a lagging indicator,” Miller said.
As layoffs pile up, office space needs to shrink. It also means people have less disposable income to spend at shopping centers or to use for travel. “It’s a vicious cycle,” Miller said.
For a turnaround to take place, the report’s authors pointed to a few key things that need to take place. Private markets need to correct and investors need to absorb losses. Debt capital needs to begin flowing again. Regulators need to restore confidence to markets and the economy must begin to improve and jobs need to be created.
As for specifics, experts expect real estate value losses to average 15 to 20 percent from their mid-2007 peaks. Cap rates will rise 150 to 200 basis points off 2006 lows. For lesser quality assets, the adjustments will be even greater. “People have set aside the idea that there was a ‘secular’ change in risk/reward metrics,” said Blank.
The top markets for retail—the cities where experts say it makes sense to buy or hold assets rather than sell—are Washington, D.C., Seattle, New York, San Francisco and Houston.