Retail Real Estate's Outlook

Newsweek has a doozie of an article up right now predicting major doom and gloom for retail real estate. ( Hat tip to Real Estate Bloggers for pointing it out.) The Wall Street Journal this week also ran a piece with some dire predictions. ( If you click to the article through Google News you can read the whole thing even if you don't have a WSJ online subscription

Here's a clip from the Newsweek piece:

Malls aren't turning into haunted houses just yet, but they may be on their way, thanks to the recent wholesale shuttering of national retail chains. (This column's long-standing guiding principle has been that when a naturally observed event happens three times in relatively short time-frame, it's a trend. Like, for example, egregious right-wing hacks getting richly undeserved columns in large-circulation print publications.)

First came CompUSA, the electronics retailer that managed to make Carlos Slim Helu, one of the world's wealthiest man, a little less wealthy. Helu spent more than $800 million to buy the computer and electronics chain in 2000. But after years of losses, the Mexican billionaire threw in the towel on the brick-and-mortar business. Last month, CompUSAannounced it would shut down its remaining 103 stores. The week after Christmas, Macy's, whose 850 department stores frequently anchor malls, announced it would close nine large stores in Indiana, Texas, and Ohio.

This is random analysis, to say the least.

For one, there actually have been more than three retailers to announce closings of late. We've posted a lot of new stories about those announcements to the blog. In fact, Ethan Allen just today announced plans to shut 12 stores. The selection at Newsweek doesn't even include one of the bigger blows--Bombay Co's plans to liquidate and shut all 330 of its stores.

But that's besides the point. Retailers shut stores and some have troubles even in the best of times. Certainly, retailers ratcheting up store closings is a problem. But what's been announced so far is well within the norms of recent years.

According to Merrill Lynch and ICSC, here are the number of first quarter store closings since 2002:

Year Closings
2007 1,916
2006 2,082
2005 999
2004 2,864
2003 2,069
2002 3,339

Stores closings in themselves aren't a problem, especially if other chains are expanding. Here there may be a real concern since if the majority of retailers are struggling, which seems to be the prediction for 2008, then expansion plans will be slowed. Still, the starting point is a situation where vacancies--though increasing--are still near all-time lows. To really cause problems vacancies would have to spike considerably. As it stands, owners may have problems ratcheting rents up as much as they have in recent years, but for rents to actually fall would take a big drop in the occupancy rates at retail properties.

That's not to say there aren't concerns. This year promises to be a challenging one and there's no question retail real estate will be off its peak years. Much of our December issue assessed at how the problems in the capital markets were making things a bit more uncertain for the sector than they have been and that the industry would need to adjust its expectations accordingly. Investment sales volume will certainly be lower in 2008. Development will slow. But it seems highly unlikely that we'll see ghost malls, as is posited in the Newsweek piece.

Further, there are real reasons to believe that mortgages on commercial real estate won't see the same kind of catastrophic defaults and delinquencies as there are on the residential side.

Also, the situation with Centro isn't pleasant. But the problem isn't Centro's operations. It's that it had too much short-term debt and it's been impossible for the firm to refinance in current market conditions. In the end, it looks like the company will be sold and I imagine its properties will continue to perform fine.

A concern raised in the Wall Street Journal piece raises the prospect that the retail real estate sector may be overbuilt.

Retail real estate is more closely tied to the housing market than other commercial-property types. As a result, retail landlords feasted in recent years on rapidly expanding tenants and easy financing as carefree shoppers spent their home equity with abandon. Some 145 million square feet of new shopping-center, mall and other retail space was built in the top 54 markets last year, with another 123 million square feet in the pipeline this year, according to Property & Portfolio Research. In comparison, the annual average between 2000 and 2006 was 118 million square feet.

What's interesting about that is looking at the stats from various data providers actually illustrates very different assessments of the situation. PPR's data indicates a peak. Data from CoStar also shows a 25-year peak. The firm estimates 188.2 million square feet of deliveries in 2007--33 million square feet greater than the previous peak reached in 1988. Reis Inc., however, has much, much different data. The firm says completions in 2007 were only about half the delivery levels reached in the 1980s.

I'm not exactly sure what to make of that, but I do think it would affect your outlook massively if you thought the development cycle was at a peak or not. If you think 2007 was the biggest year for retail development ever, then you're going to be more concerned about overbuilding than if you think the industry had been much more restrained about its growth.

Another important factor, I think, is that most observers don't realize that retail sales and retail rents have no direct correlation. Most retailers pay fixed rents, only kicking in a percentage of sales if they have really, really good years. Further, most retailers are signing long-term leases–5 years or more. While it's certainly not great to have dark stores, the rent, in some cases, will still be coming in.

Overall, while the sector faces challenges, from our view it's far from a doom and gloom scenario.

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