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Leasing and Sales are on the Upswing, but Concerns Remain in Retail Sector

After four years of moribund growth, the volume of new development in the retail real estate sector will likely remain minimal. But that’s a good thing, as far as brokers and investment specialists are concerned.

Heads of the leading mall REITs don’t expect new regional malls to be built in the next three to five years—in a mature market, there isn’t a need for them. Shopping centers development might pick up, due to demand for new stores from expanding grocers and drug chains, but will not reach 2005 to 2007 levels.

“Very little will be built anywhere,” says Michael P. Glimcher, CEO of the Columbus, Ohio-based Glimcher Realty Trust. “All of our peers are focused on redevelopment.”

In fact, U.S. retail real estate owners have been shedding space over the past year—both Simon Property Group and General Growth Properties, two of the largest retail REITs in the country, cut their portfolios down by millions of square feet in the past 12 months. They want to focus on their core assets, as do most other retail landlords.

That’s good news because in the absence of new projects, retail tenants and investors have been forced to utilize older properties that may have remained vacant otherwise. Almost all of the big boxes that littered the market after the bankruptcies of Circuit City, Linens ’n Things, Borders and others, are now gone. Grocery chains, movie theaters and restaurants have been opening new locations. Even apparel retailers have begun to talk about new store openings rather than closings and rent concessions, says Thomas W. Gilmore, Madison Marquette’s executive vice president.

“Leasing is going surprisingly well,” he notes. “We started [to see] a pickup in quality of deals last summer. This year, we’re ahead in our leasing pace overall.”

Vacancy at smaller shopping centers fell 10 basis points in the first quarter of 2012, to 10.9 percent, according to research firm Reis Inc. This marked the first vacancy decline in that category since the second quarter of 2005. Regional malls vacancies fell 20 basis points, to 9.0 percent.

Asking rents at shopping centers rose by 0.1 percent, and at malls at 0.2 percent, which might seem infinitesimal, but retail real estate owners and managers may be forgiven for cheering when most of the conversations they’ve had with tenants lately have focused on rent discounts.

“We are more bullish than two years ago,” says Andy Graiser, AG Realty Partners’ co-president in Melville, N.Y.

The picture on the investment sales front is more muddied. There is no question that investors’ appetite for retail assets is strong and moving beyond core properties in prime markets to suburban centers and centers in secondary and tertiary markets (largely a function of there not being enough core product to satisfy investor demand).

In the net lease world, Walgreens is viewed as the most desirable investment vehicle. But according to Nicholas Coo, senior managing director with Irvine, Calif.-based Faris Lee Investments, even Rite Aids are trading lately, despite the chain’s less-than-stellar credit rating.

In April, retail properties sales hit $2.4 billion, according to Real Capital Analytics—up 34 percent over April 2011, representing the strongest uptick of all commercial real estate classes. Year-to-date, retail investment sales volume totals $15.1 billion, up 81 percent from a year ago.

Nationally, cap rates on retail transactions now average 7.3 percent, a 30 basis points decrease from 2011 levels. When it comes to the most highly prized assets, cap rates are even lower. In the first quarter, mall trades in the Seattle area averaged cap rates of 5.3 percent. Retail properties in Manhattan now close at approximately 4.6 percent.

Prices continue rising, but many investment specialists suspect the swing back is due not to healthy improvements in fundamentals, but to availability of cheap debt—which drove the market to the brink of collapse in 2007/2008.

“The CMBS market is clearly back. There are a lot of capital providers and they are providing very cheap loans,” says Joe Dykstra, executive vice president with Westwood Financial Corp. in Los Angeles. “And the cap rates are very low. We think the investment market is overheated.”

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