Suddenly, development doesn't seem like quite the safe bet that it did at the beginning of the year for retail REITs.

As the downturn in the housing market spills into other industries, development yields are declining, from the high double digits at the beginning of 2007 to less than 10 percent in the past three months, says David Lynn, managing director for research and strategy with New York City-based ING Clarion.

A combination of factors is conspiring against building from the ground up. Consumers are pulling back. This in turn is altering retailers' expectations. Many are scaling back on formerly grandiose expansion plans, while existing store closings are also up. These factors are lowering demand for both existing and proposed shopping center space. That means that developments that looked like they would lease up quickly six months ago may take a lot more work to fill today. The net result: declining development yields.

On the consumption front, weary consumers are spending less, which has led to anemic same-store sales growth of 2.3 percent year to date, compared to 3.6 percent in 2006, according to ICSC. In September, same-store sales grew a measly 1.7 percent.

This shift in the development climate comes at a time when many REITs are sitting on huge development portfolios. Regency Centers Corp., based in Jacksonville, Fla., has $929 million of new projects under construction, according to Charlottesville, Va.-based SNL Financial. Houston-based Weingarten Realty Investors is working on $373 million of retail properties, while Indianapolis-based Kite Realty Group Trust has plans for new projects worth at least $200 million. Regional mall REITs, such as General Growth Properties, Simon Property Group and Taubman Centers, meanwhile, have pipelines worth billions of dollars each.

As it stands, even if developers pull back on centers with planned opening dates in 2008 or 2009, tens of millions of square feet of new space is coming on-line right now. Overall, there will be 188.2 million square feet of retail space delivered this year, according to CoStar — the largest amount in at least the past 25 years. At the same time, Colliers International forecasts that the national retail vacancy rate will rise 0.3 percentage points to 7.4 percent for the 12-month period between December 2006 and December 2007. That's in line with the statistics compiled by REIS, Inc.

All these factors have conspired to drive down development yields. At the same time, credit markets have become more conservative and that's changing the investment climate. Cap rates reached a low of 6.9 percent in 2006, according to Real Capital Analytics, down from 7.4 percent in 2005. Now cap rates are on the rise — anywhere from 50 to 100 points above their lows, according to estimates from brokers and investors. As a result, many REITs may change tack and look for more acquisition opportunities while slowing development activity.

That could reverse the dynamic that has been at play for the past couple of years. During the early stages of retail real estate's bull run, which began in earnest in 2002, REITs were achieving growth targets by snatching up mall and shopping center portfolios left and right. Overall, REITs typically accounted for more than 40 percent of all retail acquisitions. In the past two years, the share has dropped to approximately 20 percent.

For a development to be economically feasible, a builder needs yields of at least 7 percent to 8 percent. In the past couple of yeas, yields far exceeded those thresholds. Now, many developers face projections hitting right up against those numbers. This change in market fundamentals has taken its toll on privately held developers, who have less liquidity than the REITs. REITs typically partner with cash-flush institutional investors to increase yields but they are now scrutinizing their pipelines.