Q3 Us Retail Real Estate Report

News: National

October 28, 2009 Written by Sasha M Pardy ([email protected])

Q3 Retail Real Estate Report: Better but Not Out of the Woods Yet CoStar Retail Webinar Provides Insight into National Retail Real Estate Trends in Third Quarter CoStar Group subscribers who attended this week's webinar led by Jay Spivey, CoStar Group's Senior Director of Research & Analytics, were provided with the latest insights on the state of the nation's retail commercial real estate industry covering economic drivers, statistics and trends regarding the retail property leasing, development, and sales markets. Spivey also shared CoStar's forecast for what retail real estate has in store next year and beyond as the nation is expected to climb out of this recession. RETAIL REAL ESTATE LEASING MARKET LEASING ACTIVITY Spotlighting results from CoStar's recently released Third Quarter 2009 National Retail Report, Spivey showed that quarterly retail leasing activity has improved for two consecutive quarters (24.3M SF in the third quarter building on the 23.6M SF of retail leasing activity in the second quarter and 23.1M SF of retail leasing activity in the first quarter.) NET ABSORPTION The steady leasing activity seen this past quarter was enough to slightly offset the number of stores that closed or opted not to renew leases this year. Year-to-date net absorption was a positive 4 million square feet at the close of third quarter, a significant improvement from the negative 11 million square feet of year-to-date absorption at the close of second quarter. Spivey attributed the positive retail absorption to the 14 million square feet of positive absorption recorded at new shopping centers delivered during the quarter, as well as landlords' motivation to keep tenants in their stores and "keep their shopping centers from going dark, even at a loss." However, Spivey pointed out that by his estimate, between 2.5 million and 5 million square feet of this absorption is attributed to seasonal tenants signing temporary leases -- Halloween stores in particular -- nearly all these tenants will shut their doors in November. Analyzing net absorption by property type, Spivey noted that general freestanding retail buildings (+5.3M SF), power centers (+3.0M SF) and lifestyle centers (+1.1M SF) have all shown positive net absorption so far in 2009. Net absorption at outlet centers and super regional malls has been flat, while net absorption at regional malls (-800,000 SF), community centers (-1.1M SF), strip centers (-1.4M SF) and neighborhood centers (-2.3M SF) remained negative, although much improved over last quarter. CoStar, together with PPR, forecasts "negative economic absorption to continue for two to three more quarters, followed by fairly robust positive absorption into 2011 and beyond," said Spivey. "> For a look at how the nation's retail markets performed in terms of net absorption, click here. CONSTRUCTION / DELIVERIES While some have assumed that overbuilding has been a key driver of the retail real estate industry's issues in this recession, Spivey showed that is not the case. "On average, the retail sector has added about 1.4% [% square footage of total existing retail space] to its inventory each year since the '50s," said Spivey, showing that the exceptions have been cycles of excess development during 1969 to1975, 1977 to 1980, 1984 to 1991, and 1999 to 2002. In addition, Copyright (c) 2009 CoStar Realty Information, Inc. All rights reserved.

CONTINUED: Q3 Retail Real Estate Report: Better but Not Out of the Woods Yet

Spivey noted that the current level of retail property under construction in every market across the country, except Washington D.C., is below this 1.4% historical average as well. "The retail market has not been overbuilt in this most recent cycle. CoStar forecasts there will be about only a .8% increase in retail inventory during 2009, which would be the lowest (amount of new space built) ever, so new deliveries are not a part of the problem this time around," said Spivey. "> For a look at the retail construction picture across the nation's markets, click here. VACANCY The overall third quarter national average retail vacancy rate for the third quarter was 7.6%, up slightly over last quarter and up from a low of 6% at the end of 2007. Despite the relatively modest 7.6% vacancy rate, Spivey noted the large gap that currently exists between vacancy and retail space availability. Two years ago, the availability rate was about 75 basis points higher than the vacancy rate. Since that time, the gap has widened to 220 basis points, with the third quarter availability rate coming in at 9.8%. Spivey also noted that vacancy at the nation's shopping centers is much higher, which is where dark space is much more visible to the general public. Specifically, general freestanding retail buildings have a low vacancy of 5.5% and vacancy by shopping center type generally increases as centers get smaller, said Spivey. Within the shopping center category, Spivey showed that strip (11.8%), neighborhood (10.4%) and community (10.3%) centers have the highest vacancy rates, followed by lifestyle centers (8.4%), power centers (8%), regional malls (7.9%), outlet centers (5.7%) and super regional malls (3.8%). The only category showing an improvement in vacancy over the previous quarter was outlet centers; for more on that, click here. CoStar, together with PPR, forecasts that the national average retail vacancy rate will rise to higher than 8% in the first quarter of 2010 and following that, is expected to eventually return to pre-recession levels in early 2012. "> For a look at retail vacancy on a regional market basis, click here. RENTAL RATES At the end of third quarter, the national average retail rental rate (based on quoted asking rental rates, triple net) closed at $16.94 per square foot. While retail rental rates have been on a decline since second quarter 2008, Spivey put this in perspective, showing that on an inflation-adjusted basis, "real rents" are still up about 3% from 2006 levels. CoStar, together with PPR, forecasts that meaningful retail rental rate growth is not excpected to return until 2011. Spivey explained that while we may see some improvement in the face retail rental rate over the next few quarters, inflation-adjusted rents would likely continue to show negative year-over-year change until mid-2011. Just as the decline in rental rates lagged negative absorption and increased vacancy, which has had downward pressure on retail property net operating income, Spivey explained that any improvement in NOI would follow after rental rate gains return; expected in 2012. "> For a look at retail rental rate trends in regional markets, click here. RETAIL PROPERTY SALES MARKET "The retail property sales market has been hit much harder than the leasing market," said Spivey. CAPITALIZATION RATES The national average retail cap rate hit a low of 6.1% in mid-2006 and since, it has risen to reach 7.8%, which hasn't been seen since early 2004. Spivey said the ultra-low 2006 cap rates weren't sustainable Copyright (c) 2009 CoStar Realty Information, Inc. All rights reserved.

CONTINUED: Q3 Retail Real Estate Report: Better but Not Out of the Woods Yet

because "buyers were no longer willing to accept just-above Treasury rates of return for a commercial real estate asset." CoStar found that today's retail cap rate of 7.8% is still below the historical average of 8.2%, and expects the rate to eventually return to the 10% caps that were the norm in the mid-'90s. PRICING "Given investors appetite for risk, retail property sale prices are down significantly," said Spivey. He added that as long as cap rates are rising, sale prices will have to go down until net income improves significantly. On an inflation-adjusted basis, the average price per square foot a shopping center sold for increased relatively steadily from 1995 until hitting a high of about $230 per square foot in 2008, which represented a generous 9% return per year on a compounded annualized basis. Since that high, the average price has dropped significantly, although Spivey noted there have been too few transactions across all shopping center to make a definitive assessment. The pricing change amongst general freestanding retail buildings sold has been less dramatic, said Spivey, showing that on an inflation adjusted basis, the average price such properties sold for increased at an annualized rate of return of about 7.75% since 1995, hitting a high of about $275 per square foot at the end of 2007 -- since, that figure has declined to about $180 per square foot. Looking at the country's 20 largest retail markets, Spivey showed that only two -- Westchester / So. Connecticut and Washington D.C. -- have seen an increase in the average retail sale price per square foot over the last year. The markets that have seen the biggest drop during this time are South Florida (49%), Detroit (-39.8%), Inland Empire (-39.5%), Boston (-36.9%) and Chicago (-34.5%). In general, said Spivey, "the larger markets appear to be getting hit less hard than the rest of the country in terms of price declines." SALES TRANSACTION ACTIVITY and VOLUME During 2007, CoStar recorded between 2,000 and 2,100 retail property transactions each quarter. Since, that rate of transactions has dropped by about half, with barely more than 1,000 transactions recorded in the latest quarter. Looking at total retail square footage sold, the drop in activity is more drastic -- down about 74% from its peak. On a dollar volume basis, the number is sobering -- down 79% from the highs. With the lack of available credit in the marketplace and the halt of CMBS activity, Spivey explained that the bigger deals -- typically institutional Class A shopping center sales -- have been hit the hardest. Transaction activity involving sales of $5 million or less have held up a little better. Looking at the number of transactions, during 2007, we saw between 1,700 and 1,800 general retail building transaction per quarter -- in the latest quarter, activity was down to about 950 transactions. Comparatively, activity is down by about 83% on transactions of $20 million or higher. Looking at retail sales transaction activity so far in 2009 across the nation's 20 largest markets, Spivey showed that most markets have seen between a 40% and 75% decline in sales activity over the same period in 2008. Among these, Tampa, Dallas, South Florida, Westchester, and Houston have seen the biggest drop offs in activity. On a transaction volume basis for the 20 largest markets so far in 2009, Spivey showed Los Angeles, Chicago, Atlanta, Long Island and Northern New Jersey at the top -- all recording transaction volume between $638 million and $863 million during this period. In a new statistical analysis backing up the drop off in sales $20 million or larger, Spivey tracked the average price of an average retail sale dating back to 1995. With the historical average being $1.9 million, a peak of about $3.5 million was hit in late 2005, hovered around $3 million in late 2007 and since has dropped to the current average of about $1.5 million. TIME ON MARKET The average time a retail property spends on the market for sale continues to hamper pricing and volume. "More and more properties are being withdrawn from the market," said Spivey, showing that in the latest quarter, owners pulled about $9.5 billion in retail sale listings off the market, which compares to a preCopyright (c) 2009 CoStar Realty Information, Inc. All rights reserved.

CONTINUED: Q3 Retail Real Estate Report: Better but Not Out of the Woods Yet

recession norm of about $6.5 billion pulled off the market quarterly. For those properties that aren't pulled off the market, Spivey showed the direct correlation between the sale price/asking price ratio declining the longer a retail property spends on the market. Since 2006, the average days a retail property spends on the market for sale has increased from about 200 days to 280 days and during that time the sale price/asking price ratio has declined from about 91% to 85%. (Editor's Note: To keep up on happenings and trends in retail real estate, subscribe to CoStar's Retail News Roundup, a weekly column covering retailer expansions and new concepts, store closings, bankruptcies, cutbacks, acquisition, mergers, sales. new shopping centers, personnel changes, and sustainability. Follow this link for access to back issues of the roundup. In addition to appearing every week in the national news and retail news sections of our web site, you may also receive the Retail News Roundup for free via email by requesting to be added to the distribution list by contacting senior editor, Sasha Pardy at [email protected] Also, click here to subscribe to CoStar's dedicated Retail RSS Feed.

Copyright (c) 2009 CoStar Realty Information, Inc. All rights reserved.