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The Good, The Bad, The Empty: Sales Metrics Show Wide Gap Between Performing, Laggard Shopping Centers

Vast Majority of Total Retail Vacancy Confined to Dead or Relatively Isolated Shopping Centers
February 11, 2014
In contrast to generally strengthening sales in other U.S. retail property sectors, the shopping mall segment showed relatively weak performance as 2013 ended, a byproduct of lingering sales declines by embattled traditional anchors JCPenney and Sears.

First, the good news. Neighborhood centers and power centers saw sharply higher sales volume per square foot in the fourth quarter compared to 2006 -- the last year the U.S. retail market could be called truly healthy, noted Suzanne Mulvee, director of retail research for CoStar, who along with real estate economist Ryan McCullough recently presented Costar's recent Fourth-Quarter 2013 Retail Review and Outlook.

Many strong retailers have lifted their profits to record highs, stocked up on cash and invested in technology to streamline operations against a backdrop of slow-but-steady demand growth. The U.S. retail real estate market absorbed 16 million square feet of net space in the fourth quarter of 2013, and the U.S. retail vacancy rate fell 10 basis points to 6.5%.

The total supply of empty retail space has fallen significantly since peaking at over 400 million square feet in 2010.

However, while the space availability picture for retailers is slowly tightening, a CoStar analysis of the composition of total vacant retail space reveals that much of the unused space is located in older, less desirable or isolated properties that few if any credit tenants would consider.

With location and occupancy factors taken into account, less than 22% of the 370 million square feet listed as vacant at the end of 2013 can be described as fully competitive and vital retail space, according to CoStar data, meaning the available options for most high quality tenants are much less than the overall vacancy would indicate.

According to CoStar's McCullough, national high-credit retail tenants prefer to locate stores within specific productive clusters or nodes of complementary retail to help draw traffic. Such property clusters, when supported by sufficiently strong demographics, performed better during the downturn and recovered faster than similar retail properties in isolated locations. For the same reason, national tenants also shy away from locating within centers with chronically high vacancies.

Removing the nearly 60% of centers that are relatively isolated -- defined as those with less than 500,000 square feet of surrounding retail located within a half mile radius -- along with the dead or dying shopping centers with vacancies of 40% or higher, leaves just 78 million square feet of highly competitive space across the country, McCullough said.

The vacancy rate in those clusters of productive space is just 3.5%, significantly below the national average, and comparable to the average 3.3% retail vacancy rate of the 2006-2007 period.

"With the good space in higher demand, you’re going to see a lot more competition, and we expect to see rental rates accelerate from here," McCullough said. "While the vacancy rate is coming down overall, there are certainly winners and losers," even within the same submarket.

Mall Millieu

The gap between top-performing and lower-quality mall properties was evident in recent fourth-quarter results and management discussions of large publicly traded mall operators such as Simon Property Group (NYSE: SPG), General Growth Properties (NYSE: GGP), Macerich (NYSE: MAC) and CBL.

GGP reported that Class B mall sales were flat on a year over year basis while its Class A mall properties posted healthy sales growth. Macerich said it continues to sell off less productive malls and cull its existing portfolio.

The gap is apparent in most markets. For example, the average mall vacancy rate in Memphis was 13% at the end of 2013. However, much of that empty space is in non-competitive properties. Vacancies for competitive space typically range between 2%-4%. In Memphis, the quality space has a vacancy rate of just over 4%, comparable to Seattle, where the overall vacancy rate is well below 8%.

Citi analyst Michael Bilerman, discussing CBL's fourth-quarter earnings, sees risk in further department store closings and declining mall sales, and longer-term secular risk in retailer demand for space in CBL's lower quality malls.

Mall owners and investors alike are closing watching the fortunes of the largest national chains, with Sears/KMart and JC Penney topping the lists. Sears has announced 8.3 million square feet of store closings, while JCPenney recently announced 33 additional store closings.

Other retail chains, including Fashion Bug, Blockbuster, Big Lots, Albertsons, Radio Shack, Sweetbay and Bloomingdale's are also rolling up significant amounts of space. However, offsetting those closures are announcements by 27 retailers and service providers that will open new stores, opening an estimated 63 million square feet, led by a diverse array of tenants ranging from AutoZone, Kohl's and Subway to discounters such as Dollar General, Family Dollar and Costco.

"We’re encouraged that the number of store openings is going to continue to far outpace store closings," Mulvee said. "This isn’t going to save the really bad retail centers; they should and will go away.

However, rising demand, combined with sales per square foot already at a level sufficient to drive rent growth, will result in continued improvement to shopping center fundamentals this year, Mulvee added.

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