Retail development in 2014 neared the peak level seen during the last economic expansion, and the frantic pace will continue throughout this year.
“People are under the impression that nothing is being built, but that couldn’t be further from the truth,” says Garrick Brown, vice president of research for the West Region for DTZ. “They’re still caught up in the news of yesterday. But the news today is that there’s a lot of retail development occurring.”
Premium space wanted
Last year, developers delivered 23.7 million sq. ft. of new retail space, according to research from DTZ. That total includes grocery-anchored and power centers, along with malls and outlet centers. It doesn’t include urban retail or single-tenant buildings like banks or drug stores.
In comparison, developers delivered 25.5 million sq. ft. of new retail space in 2005, the peak of the development cycle. From 2004 to 2007, the retail sector averaged about 21 million sq. ft. of new deliveries, Brown says, adding that DTZ is tracking 19.1 million sq. ft. of retail space under construction.
“These levels of construction are as aggressive as what we saw at the last cycle when consumer spending was much more solid,” Brown notes. “I have a feeling that number will go up based on the proposed projects. I wouldn’t be surprised to see that we’ll match last year’s numbers.”
Despite the new construction, Brown doesn’t characterize the current retail landscape as overbuilt. “Instead, I’d describe it as under-demolished,” he says. “The demand for new space has been driven by national retailers looking for premium space. In most markets, there’s virtually no vacancy in the class A space. The vacancy is in class B, and especially class-C space, much of which needs to be torn down.”
Lender focused on risk-management
During this construction cycle, roughly 75 percent of new retail square footage has been pre-leased. The level of pre-leasing has allowed developers to get construction loans.
“Getting a construction loan is a lot easier than you think, especially with pre-leasing,” says Ernest F. DesRochers, senior vice president and managing director of NorthMarq. “Lenders are thinking about one thing—risk management—and pre-leasing reduces risk.”
However, Brown contends that pre-leasing numbers are slowly dropping. “That’s what concerns me,” he admits. “People are feeling a little more confident, so they’re doing projects that are a little more speculative. Yet, the categories that have driven demand for the past couple of years—the dollar stores, for example—are now shrinking.”
Banks are providing the bulk of construction financing today, according to DesRochers. He says they are hyper-focused on risk because they must comply with new regulations including BASEL III, which requires every construction loan to have a minimum of 15 percent cash invested in the loan.
“Because of those requirements, there are governors on lending, and lenders are not as aggressive as they were in the past,” DesRochers says. “They want the deals that won’t go bad … the ones that won’t have risk-based capital charges.”
Interestingly, DesRochers has noted a stratification of lending nationally. “Small banks lend to small developers, big banks to big developers,” he explains. “There are no crossed lines anymore.”