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Retail Rent Growth Finally Takes Root Across U.S. Metros

Absorption, Vacancy Benchmarks Continue to Drift Sideways As Retailers Shake Out Closed Stores
May 15, 2013
Following a recent string of relentlessly unexciting market trends in retail real estate over the past several quarters comes this distinctly positive news for retail property owners -- quoted asking rents have finally turned upward across all retail property types in the U.S. for the first time since 2008.

"This is a symbolic victory," said CoStar real estate economist Ryan McCullough, who co-presented the First-Quarter 2013 Retail Review and Outlook with Suzanne Mulvee, director of U.S. research, retail for Property and Portfolio Research (PPR), CoStar's analytics and economic forecasting company.

This reversal of bad fortune for landlords, which started with rental rate increases in higher-end institutional retail and a few scattered metros of several quarters ago, is the culmination of 2 ½ years of steady fundamentals recovery in retail, he said.

"We’re finally to the point where the average asset is showing steady rent growth again," McCullough said.

Mulvee made note that the 70% of U.S. retail markets that reported positive rent growth during the first quarter represents "a true turning point for the market" into a broad-based recovery.

Without getting too carried away, it should be clearly noted that plenty of challenges remain for owners, tenants and retailers. Rents aren't going to shoot upward and fundamentals are continuing to improve slowly or move sideways.

Muted absorption appears to be the new normal, with a light 17 million square feet in net absorption for the first quarter, down slightly from a year ago, as retailers continue to shed stores and consolidate into stronger shopping centers. Leading year-over-year demand growth are western markets such as Dallas-Fort Worth, Phoenix, Denver, Salt Lake City and San Diego.

With little new construction, vacancies continue to edge downward, with progress still slowed by about 19 million square feet of store closures tracked by CoStar - space shed by such chains as Fashion Bug and Big Lots, as well as hangover from already downsized retailers like Barnes & Noble and Blockbuster.

CoStar expects construction to pick up a bit in 2013 as shifting population opens new pockets of wealth. The first developments to come back have been outlet centers, with six centers under construction across the U.S. and another dozen in the planning stages - and some shopping centers being converted to outlet space.

Power centers and malls are at the lower end of the vacancy spectrum at about 5.9%, while neighborhood centers are starting to rebound, with total store openings exceeding closings by a fairly wide margin.

Demand for malls and especially power centers by category killer retailers such as Best Buy and Staples remains under attack by e-commerce, including the advent of Amazon.com's same-day delivery, Mulvee said. When new construction ramps up again, stronger retailers will gravitate toward the newer centers -- and power centers are like to go dark as a result, McCullough said, adding, "In 10 years, we may be saying the same thing about dead power centers as we do today about dead malls."

The broadening scope of the recovery was reflected in the sentiments of webinar attendees surveyed by CoStar following the retail market presentation:

Lisa Diehl of Diehl and Partners, LLC, of Edina, MN, said the climate for retail investment is strong in the Minneapolis market.

"We had our issues during the downturn, but we're recovering. Everyone I speak with is busier than they were last year, and have done better through May than they did in the entirety of last year. That's a positive sign of activity picking up," Diehl said.

That said, prospects are still playing it safe, she added.

"Landlords are trying to push the rents higher if they can get it. There's still some uncertainly, but things are improving," Diehl said.

John E. Crump, director with HFF in Los Angeles and an investment sales broker mainly focused on California, Arizona and Nevada markets, picked up especially on Phoenix’s relative outperformance on job growth. He found the discussion of the return of the wealth effect and positive rent growth for the first time nationally since 2008 to be of particular note.

"In the California, Nevada and Arizona markets, we are seeing much fewer distressed sales and more stabilized assets," Crump said. "There is a notable lack of product versus supply, and coupled with the ample available low price debt, pricing is at or near peak for coastal areas and improving in the Inland Empire, Las Vegas and Arizona - areas clobbered by the housing downturn."

Almost all property types are performing well with grocery/drug and top-tier malls in highest demand, and other property types following suit improved pricing.

"We foresee continued strength in the next three quarters as investor demand greatly exceeds available supply," Crump said.

"While we have room to grow, I like the favorable and consistent 'North Easterly' trends we are seeing," said Brian Capo, associate with the Marcus & Millichap office in Orlando, FL, another housing-bust market. "Lots or tenants are expanding into Florida, and this will help curb our retail vacancies."

On the investment front, the single-tenant net lease market in properties with national credit tenants is simply "white hot," with numbers surpassing even the mid-2000s boom, according to Capo.

"When a true triple-net deal is put on the market, it does not last long," Capo said. "Investors are aggressive, and meeting the seller's price points. Capitalization rate have compressed rapidly over the last 60 days, in some cases by 50 basis points, he added.

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