ICSC REPORT: Marcus & Millichap Weighs In On National Retail Trends

Bernard Haddigan, managing director for Marcus & Millichap's National Retail Group

Marcus & Millichap held its popular Retail Trends forecast earlier this week at the International Council of Shopping Centers (ICSC) Spring Convention in Las Vegas. Always one of the most well-attended events at ICSC, M&M each year convenes a panel of some of the industry's foremost executives to present and comment on its retail market forecast and national market overview.

This year's panel included Andrew Scott, CEO of Centro Properties Group; Brad Hutensky, president and principal of The Hutensky Group; Steven Maun, president and partner at RED Development; Donald Wright, senior vice president of real estate for Safeway; Bernard Haddigan, managing director for Marcus & Millichap's National Retail Group; and Hessam Nadji, managing director of research services for M&M.

Haddigan, who led the panel, provided CoStar with a one-on-one review of the presentation, which he said drew a record crowd of 1,400 to 1,500 people in attendance.

In an overview of the economic factors affecting the retail industry, Marcus & Millichap made note of the ongoing problems plaguing the housing market. New home sales are down 24% and existing home sales 12% from a year ago. Retail sales have been on a downturn over the past year, in-line with numbers recorded in 2002 and investment in businesses is also down over the last year. However, the state of U.S. employment remains strong and has been on the rise since 2003.

Inflation pressure has been decreasing over the past few months, moving in the "right" direction Marcus & Millichap said, but still called the level "too high for Fed comfort," resulting in relatively flat Fed funds rate over the past year. Haddigan told CoStar, "Inflation is not completely in control, we don't expect to see decreases in discount rates. Instead that they will remain flat or a slight uptick will occur." The Marcus & Millichap presentation made note of an "economic downshift" already underway; job growth is predicted to slow, but overall GDP is predicted to rise in the coming months.

The company forecasts a decrease in retail property deliveries in 2008, keeping overall vacancy rates from increasing too severely; and reported that obsolescence (of older shopping centers) is a big factor in this dynamic.

"There is a lot of aging retail out there, some is lower density or it may not be the optimal use of the property. In such cases, we're seeing a lot of capital going into tear-downs and redevelopments," Haddigan said. "For our buyers, we always evaluate the property's highest and best use, and especially in infill deals, we're seeing these properties considered from a redevelopment perspective. Population growth is leading to a return to the urban core of a market."

According to Marcus & Millichap, the retail industry's 2007 construction pipeline is comprised of 43% big box retail, and mixed-use development has surpassed the construction of regional and super-regional centers. Haddigan touched on this trend, "Mixed use is a concept that has accelerated significantly over the last few years and we expect this to continue. Developers are creating communities that people like to be a part of, dynamic 'Live, Work, Play' communities."

Addressing retail rental rate trends and vacancy, M&M found that retail rental rates have been on the rise for the past decade and that the average effective rent per-square-foot is expected to hit $18 this year, followed by moderation in 2008. The firm also reported the total U.S. retail vacancy rate has increased slightly over 2006, nearing 10%.

In retail capital markets, Marcus & Millichap sourced CoStar COMPs in finding that the price-per-square-foot (psf) of multi-tenant retail has consistently risen since 2002 while the price psf of single-tenant retail remained stable. Currently, multi-tenant retail hovers around $170psf and single-tenant retail hovers around $235psf. The firm said to expect retail investment sales volume to hit $70 billion this year, an approximate 13% increase over last year. The firm reiterated that retail investment remains a profitable investment, as retail real estate returns continue to be competitive with returns on the S&P 500.

Reporting on the health of retail real estate in what it defines as first and second-tier markets, Marcus & Millichap found Seattle, San Francisco and Las Vegas to be the most improved in terms of retail vacancy over last year; while Miami, Charlotte and Riverside/San Bernadino experienced the most significant increase in vacancy during the same time period.

"There is just too much construction in the pipeline in some of these markets," commented Haddigan. "It's affecting markets like Florida where there has been a lot of spec building. As we expect deliveries to slow, vacancy should catch up in these markets."

Markets Marcus & Millichap found to have the lowest overall retail vacancy are Oakland, Las Vegas and San Francisco, while markets with the highest vacancy rates are Indianapolis, Dallas/Fort Worth and Columbus.

In addition, the company listed the top ten markets that it says are prime for retail investment based on a proprietary supply/demand index: New York City, Fort Lauderdale, Phoenix, Oakland, Seattle, San Diego, Orange County, San Francisco, Washington D.C. and San Jose. Tier-one markets experiencing the most population and job growth were listed as Austin, Las Vegas, Riverside/San Bernadino, San Antonio and West Palm Beach; while top second-tier markets it predicts will experience the most growth over the next five years include Modesto, CA; Charleston, SC; Sarasota, FL; Raleigh, NC; and Scranton, PA.

Following the market overview, the panelists weighed in with their observations. And while we do not have space to include their views in this report, Haddigan did share the following insight he learned through Aussie Andrew Scott, who said that, under a recent change in Australia's tax laws, real estate firms are having to contribute 9% to 10% of their earnings to one of the country's programs. That has caused a significant amount of money to exit the country and seek a home in other countries, especially U.S. real estate. "They're here to buy portfolios. Their strategy is to invest their cash and they have record amounts to invest," Haddigan explained.

Scott's Centro is a perfect example of this trend. The company's recent deals include last summer's $3.2 billion buy of Boston retail REIT Heritage Property Trust, and more recently, the $6.2 billion acquisition of New Plan Excel Realty Trust and Galileo Shopping America Trust's portfolio of 140 U.S. retail centers for an undisclosed amount.

The Marcus & Millichap ICSC panel concluded with a presentation of the 10 major trends affecting the retail industry and retail real estate by extension:

1. Economy to slow, but expected to avoid a recession.
2. Retail absorption and rent growth to ease after several years of above-trend growth.
3. Slower growth should reduce inflation pressure, giving the Fed more flexibility - Interest rates range-bound.
4. CMBS spreads, rising investor concerns to lead to tighter underwriting.
5. Broad-based cap rate compression giving way to fundamentals and value creation.
6. Sellers should be mindful of price expectations based on "financial engineering" vs. real market pricing.
7. Buyers waiting for a major price correction will miss the market.
8. Value-add component, focus on local, trade area profile and property operations most critical.
9. Long-term capital flows, replacement cost, still a major favorable force.
10. Caution: Housing, Capital Markets are the wild cards in any forecast.

Expounding on the trends, Haddigan commented, "Because there's been such an abundance of capital recently and lenders make their money by lending, we've seen many loan structures we haven't seen before. Interest-only is a good example. Over the last 18 months, buyers could put 10% down and instead of the effect of a traditional amortized loan, we would see the interest-only option creating an illusion of cash flow," said Haddigan. "In the long run, there's risk on those deals; if you don't have rental growth, etc. that could lead to problems. Buyers still need to look at the fundamentals; buy a deal that makes sense based on sustainability and growth in NOI that can support the debt service."



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