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Rising Occupancy Should Bring Growth In Retail Rents By Year-End

Near-Term Outlook For Retail Real Estate Remains Positive Despite First-Quarter Pause In Net Absorption
May 11, 2011
Falling vacancy rates and rising demand for retail real estate should finally bring about meaningful rent growth for landlords in most U.S. retail markets by the end of 2011, according to CoStar Group economists.

Growth in employment and moderately rising demand fueled by greater numbers of shoppers and little new supply of retail development on the horizon should set the stage for a significant drop in vacancy rates, which CoStar expects to fall as low as 5% by late 2014.

Bolstered occupancy will in turn lead to growth in rental rates, which have been in decline since the recession. By the end of this year, rents should turn positive across the U.S. and from there rise fairly rapidly, peaking at about 6% growth annually by 2014, CoStar Group forecast recently in its First Quarter 2011 Retail Review and Outlook. CoStar Real Estate Strategist Suzanne Mulvee co-presented the retail market report with Real Estate Strategist Kevin White and Real Estate Economist Ryan McCullough.

The near-term outlook is promising for retail properties, but longer term, starting in 2013, uncertainties such as employment growth, rising oil prices, delivery of new supply and mounting pressure to generate continued high levels of retail sales could challenge the strength of the recovery, CoStar analysts noted.

"While it is the negligible new supply that is allowing retail real estate to turn the corner, the future depends on job and wage growth levels," said Chris Macke, senior real estate strategist for CoStar Group.

Retail sales have already returned to 2007 levels, with year-over-year growth in the 6% range for the last couple quarters -- well above the historical range of 4.5% to 5%. Spending should remain strong if jobs and economic growth stays on track, Mulvee said.

Though appliances, electronics and other big-ticket purchases are still down, spending on health care and personal care is up over 13%, with increases also reported in online sales, food and beverage, general merchandise, clothing and sporting goods spending. The level of sales per square foot of retail space has also moved well above pre-recession levels -- evidence that retailers are doing better and may eventually need more space, providing a platform for rent growth, Mulvee said.

Leasing volume has also picked up robustly, with CoStar projecting more than 53 million square feet of retail space leased in the first quarter. While it’s not yet translating into large net absorption gains -- just 9 million square feet of absorption nationwide in the first quarter, the lowest since fourth-quarter 2009 -- the heightened activity and diminished supply kept the national vacancy steady in the first quarter at 7.2%.

Fast-recovering, high-barrier Northeast corridor markets are seeing the most demand, with Washington, D.C. posting an absorption increase of 1.5%, followed by Houston (1.2%), Boston, (1.1%), Philadelphia (1%) and Detroit and Minneapolis, (each 0.8%.) Markets hard hit by oversupply and housing issues like Tampa, Phoenix and Atlanta continued to show flat absorption in the first quarter.

Demand remains weak for power centers, where construction of new supply was quite heavy for several years starting in 2005. Construction in all retail sectors is at a standstill and debt market constraints will continue to limit building, though a few projects delayed by the recession are starting to come back.

With little new space available, vacancy rates are finally cresting. Underscoring the breadth of the occupancy recovery, as much as 60% of the 1,000 retail submarkets tracked by CoStar showed declining vacancy rates in the first quarter, with the strongest declines in Northeast and Texas markets like Houston, Detroit, Denver, Boston and Philadelphia.

Housing-bust markets like Phoenix and the Inland Empire still are seeing vacancies well above their historical average. Among product types, lifestyle centers and to a lesser degree malls are seeing vacancy rates tick down.

While the situation is expected to reverse quickly as existing supply gets leased up, overall rents are still edging downward year over year across the retail spectrum. Similarly to occupancy and absorption, rents are improving at different rates in different markets and product types, McCullough said. Rental rates for lifestyle centers and community shopping centers are still seeing downward pressure, while malls and power centers are seeing quoted rents stabilize and even move up slight over the last couple of quarters, McCullough said.

Markets that depend on strong population growth to drive retail sales such as the Inland Empire, CA are seeing largest year over year rent losses. Rents fell 8.4% in the Inland Empire, followed by Phoenix (-7%), Tampa (-7.5%) and Denver (-9%). Markets with sustained growth like Texas and perennially under-retailed markets like New York and Los Angeles saw the least erosion.

The nation’s overall growth rate of around 3% annually "isn’t spectacular" and not as strong as the early recoveries in previous recoveries, but it’s enough to generate jobs and gradually bring down the unemployment rate and create renewed positive absorption and a "pretty meaningful recovery" in commercial real estate, White said.

"We expect it will gather momentum over the course of this year and into 2012," White said.

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