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Retail Outlook: Cautious Optimism as Tipping Point In Shopping Center Rents Expected In 2012

Absorption Continues to Limp Along, But Recovery In Retail Property Fundamentals Starting to Broaden Across the Country
February 8, 2012
Retail property rents are expected to begin to rise later this year as demand for store space in shopping centers and malls slowly soaks up available space and, combined with the dearth of new space under development, finally tips the supply and demand balance.

Improvements in market fundamentals are starting to spread into secondary markets and smaller shopping centers typically occupied by Mom-and-Pop businesses, according to CoStar’s 2011 Retail Review & Outlook, presented by Senior Real Estate Strategist Suzanne Mulvee and Real Estate Economist Ryan McCullough.

Despite the overall positive signs, market economists remain cautious in the face of the muted overall demand for retail space.

"Our retail outlook is guarded. We’ve seen a decent recovery to date, but not as great as everyone would like," Mulvee said. "Because of the lack of new construction, we’re encouraged by the trend continuing a slow, steady recovery of fundamentals."

While asking rents continued to decline in the fourth quarter, the pace of decline slowed to 1% or less in most markets and should begin to rise again in 2012, McCullough said. Concessions are declining in many areas and selected retail centers are already seeing a slight improvement in effective rents, especially those in high-density and more affluent metros, he added.

"What’s different is that we expect this will be the year that rents come back," Mulvee said. "And as rents start to come back, the (leasing) volume will come back and all of a sudden, it’s going to start to feel better across the sector and across the industry."

U.S. retail logged about 14 million square feet of positive absorption in the fourth quarter -- a decent number but still about half the average quarterly absorption from 2006 to 2008, according to CoStar data.

The retail sector recorded about 49 million square feet of absorption for 2011, down slightly from 2010’s 53 million square feet.


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"While absorption has remained positive for the last several quarters, demand levels remain very low while growth is supply remains slowest we’ve seen in long time," McCullough said.

Fundamentals should continue to tighten regardless of potentially economic landmines like a financial meltdown in Europe or rising energy prices because there’s virtually no growth in supply, McCullough said.

The level of sales per occupied square foot of retail space, an important leading indicator of demand, shows that consumer dollars are flowing through shopping centers that survived the recession at a rate exceeding the peak of the last cycle -- numbers which should encourage aggressive expansion by retailers, driving up demand this year, McCullough said.

The growing efficiency of retail space per square foot, combined with the lack of strong absorption, shows that weaker players are not yet done consolidating, even as healthier retailers get stronger, Mulvee said.

"Better centers are certainly seeing higher productivity from their tenants, which will eventually translate into better rents. But the overall retail sector continues to limp along," she said.

As has been the trend for several quarters, power centers and malls occupied by national retailers with better access to capital and credit are seeing the strongest demand. However, CoStar has also noticed an uptick in the leasing of spaces 5,000 square feet and under by the smaller tenants that fill strip centers and community shopping centers.

Improvements in these retail centers should accelerate in 2012, another indication that Mom-and-Pop stores as well as national franchise retailers are seeing improved business conditions, Mulvee said.

Still, the retail space remains divided among the haves and have-nots due to ongoing consolidation among national retailers. While the number of centers with high occupancy has remained the same over the last couple of years, the number of distressed centers with low occupancy has rapidly increased.

"The good centers are doing quite well and have been able to hold onto tenants, but the bad centers have lost tenants and haven’t had much success in filling vacancies," McCullough said.

Unfortunately, that means investors interested in value-add plays may find it very difficult to reposition those occupancy challenged centers without more grassroots tenant demand, Mulvee added.

That said, demand is starting to expand beyond the coveted high-barrier-to-entry coastal markets into the higher growth Sun Belt metros such as Denver and Houston, showing that retailers are getting a more aggressive in their expansion and willing to accept more occupancy risks in certain cases. Most metros, however, continue to see vacancies above their historical averages, despite record low levels of new development.

Liquidity is gradually returning to the investment sales market for retail properties, with a 30% increase in sales volume in 2011 from a year ago. Recent repeat sales tracked by CoStar show a bottoming of values across most property types, Mulvee said. Capitalization rates are slowly starting to fall, though not as quickly as other property types.

Private investors such as Blackrock and Cole Capital have joined REITs in making acquisitions, and investment activity will accelerate as the economy improves and the investors’ appetite for risk improves.

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