The retail market

After a long run as the darling of professional investors, shopping A centers find themselves eclipsed by gathering strength in other commercial property sectors as we enter 1996. It is a reminder that cycles are the dominant fact of life in the real estate business.

Ironically, many of the dangers which appeared to threaten the viability of malls five to seven years ago have been successfully averted. The consolidation of department stores, for example, prompted national chains to re-examine their approach to retailing with generally good results. The reinvention of Sears, Roebuck is a case in point. When the Woodward & Lothrop stores came up for sale, Federated and Penney's went toe-to-toe for the acquisition. Clearly the venerable retailing names still have considerable appeal. For the first seven months of 1995, department stores posted a 7.3% year-over-year gain in sales, smartly outperforming other stores. Total sales growth (excluding automobiles) was 5% for the period.

But, the key women's apparel sector has struggled. Clothing sales have been on a treadmill. Shoppers, tired of the sameness at most clothing and shoe stores, are going elsewhere. Through July 1995, women's specialty store sales were down 2.3% from 1994 and shoe stores gained a mere 0.6%. Despite a few laudable exceptions, like The Gap and its off-price offshoot, Old Navy, this sector's poor performance shows in weak sales at most centers.

It is not as though consumers have not been spending. Computers and appliance sales soared 16.9%, after an outstanding 1994.Jewelry store sales were up 8%, sporting goods outlets 7.6%, and furniture stores 6.6%. So the shoppers were out there, with money to spend and credit to burn.

Discounters and power centers are still formidable players, and investors frequently cite concerns about competition from them. But the discounters are having their own troubles. Jamesway, Caldor and Bradlees all found themselves in bankruptcy during 1995. TJ Maxx acquired Marshalls and Filene's Basement was buffeted by negative press. Consolidation appears to be coming to the discounters, as it did to the anchors in the past eight years.

"Outlet megamalls," giant retail facilities ranging from one to two million square feet, are the monsters of value retailing. The megamalls have enormous trade areas, carry branded merchandise and offer shoppers the enclosed ambiance of the regionals. While comparatively few in number, they could quickly become much more common. New projects are targeted for the nation's 20 largest metropolitan areas, employing a formula of 40% discounters,40% outlet facilities and 20% "big box" retailing. Similar to "destination malls" like the Mall of America, the outlet megamalls are not the place for the monthly shopping trip. But they can capture a significant share of consumption at the seasonal peaks.

How are traditional centers fighting back? Aside from remerchandising, improved service is becoming a watchword. The Nordstrom influence is being felt nationwide and malls are learning to optimize the entertainment function, much as they learned to utilize the food court. Multiplex cinemas are now seen as a strategic weapon, not just a place to drop the kids.

Urban retailing is coming back, too, as we projected last year. A half-dozen or more downtowns are seeing a wave of store-openings: Barnes & Noble or Borders superstores; Disney and Warner Bros., Crate & Barrel, the Body Shop and Liz Claiborne are opening facilities along the nation's main shopping streets, taking advantage of center city revivals.

As always, the retailing environment is complicated. This year, investor interest is markedly reduced. Shopping center yields in the NCREIF portfolio were 6.1% as of the Second Quarter 1995, lagging apartment, warehouse and R&D returns. Retail REITs show a 12month total return of only 6.6%. Investor interest is shifting as a result. The formation of regional shopping center REITs a few years ago took a large number of centers into the capital market arena. When a mall of good quality is marketed, there is still ample investor interest. Other centers, if they have sufficiently high current returns, are much sought-after by the REITs. General Growth's successful bid for the $1.8 billion Homart portfolio was a headline deal in 1995. GE Investments, Prudential and Ohio State Teachers also made significant acquisitions. We expect more will follow in 1996.

In the current market, most owners are not eager to sell. Financing is extraordinarily available for those seeking to recapitalize instead of divest. ACLI reports nearly $2 billion of mortgage debt committed in the Second Quarter 1995, at an 8.2% interest rate and a 9% cap rate. For the 12 months ended in June 1995, the life companies issued mortgages totaling $5.5 billion on shopping center assets. Loan-to-value ratios are still a conservative 65%, but owners with equity to tap can easily arrange to raise cash from their assets.

Turning to the markets arrayed on Landauers Retail Matrix, we find these trends well illustrated. is counters are penetrating the Northeast, with Target and WalMart looking for prime sites. Boston is an excellent example of an urban downtown supportive of street retail. The Boston area is expected to outperform the nation in median household income growth through the end of the decade. A pension fund purchase of the $158 million regional center in Taunton illustrates the appeal of the established markets. New York shows poorly on our growth scale again this year, but this may be deceiving. Manhattan is really not a "shopping center" environment. Certainly, Fifth Avenue is booming with locals and tourists alike, and top quality merchants are opening here with increasing frequency."Big box" retailers are preparing to move in force into the other boroughs, near the majority of New York's 7.3 million residents. The New Jersey suburbs look much better, and capture a significant outflow of sales from the city due to sales tax differentials. On Long Island, regionals are holding their own, but the already fierce competition will heat up further in 1996 when a 930,000-square-foot Simon/ Fortunoffs megamall is set to open.

Power centers are flexing their muscles around Philadelphia, especially in suburban King of Prussia. Upscale retailing is also on the rise. Suburban centers around Washington, D.C. are sparking interest. A 105,000-square-foot community center in Fairfax County,Virginia reportedly sold for an aggressive $212 psf in August 1995. Suburban Maryland is also being mentioned as a potential site for a new development on the scale of the Mall of America. But some caution should be observed. The growth rate of the nation's Capital District should slow in the later '90s, with median household income doing no better than the national average over the period. This is not the time for optimistic proJections.

High construction volumes are making Charlotte a more difficult environment for retail analysts and for investors. Selectivity is especially critical here. A recently completed community center, 100% leased, sold for $150 psf not long after GE Investments acquired a shopping center for 72% of the price it commanded in 1991. And, as an illustration of further institutional interest in malls with expansion potential, a 1980's vintage center in the Norfolk metro area sold for $84 million, at an 8.3% cap rate. Atlanta is seeing enormous retail construction volumes, but who could notice this in the midst of the run-up to the Olympics? F.W. Dodge estimates 1996 retail development activity at 8.5 million square feet. Institutional investors are busy both on the buy and the sell side, especially in the Perimeter area. Capitalization rates for midsized facilities are in the 9% - 10% range, and developers are enjoying an excellent opportunity to build and market their projects. There is certainly an oversupply risk as economic growth wanes.

The same risk of excessive development is evident in a number of the Sunbelt's other "hot" markets. Dallas could average 3.5 million square feet of new store space annually through 2000, which will dilute the sales per square foot of all centers if, as expected, household incomes merely track the national average growth rate. Denver finds itself in the same dilemma, and retail vacancies should tick upward. Volatility is no stranger to Phoenix, either. California investors, including public pension funds, are following the population movement into the Valley of the Sun. In 1995 West Coast entities were on the buy side of shopping center transactions in Mesa and Scottsdale. Retail starts are surging once again in and around Phoenix, as demographic trends accelerate. This market can be rapidly oversaturated with stores, yet a megamall is planned. Let buyers heed the lessons of history.

The Midwest looks to be a solid regional performer in the late '90s. Chicago should enjoy high occupancies. Most recent development activity has been well-conceived expansion such as the Woodfield Shopping Center in Schaumberg. The addition of Nordstrom and 50 mall shops brought the size of this center up to 2.7 million square feet, with 288 shops. The Loop's North Michigan Avenue is as attractive as ever, and can be considered the model for the return of urban retailing. And affluent Lincoln Park seems to be the next upscale neighborhood retailing node.

The industrial revival of the '90s has benefited the retail climate in cities like Detroit and St. Louis. Both have healthy suburban markets as we look to 1996 and should see sales per square foot grow at or above the national rate.

On the West Coast, though, there may be bruising competition. Megamalls must be reckoned with in both San Francisco and Seattle. Power centers and big boxes abound, and malls will be hard pressed to justify recent pricing levels, typified by 7.5% to 8.5% cap rates.

In Los Angeles, the Northridge Center is back in business following a major post-earthquake rehabilitation. Many retail deals are being done with an eye to repositioning, especially the conversion of strips and community centers to power centers. If southern California's economic recovery matches the slow pace that Texas experienced in the '80s and the Northeast in the early to mid-'90s, patience may be a much-required virtue for investors here.

Retail property, then, finds itself in an unaccustomed position near the bottom of investor preference. This is not a cause for panic, but part of the expected order of cyclical change. Our concerns are directed toward the fundamental capability of the merchants themselves to provide the quality of goods and services which will return shoppers to malls. We are also wary of the proliferation of retailing forms cannibalizing the consumer's limited pocketbook. As was the case with department store consolidations, we expect these issues to sort themselves out over time, a textbook example of "creative destruction."

If the retail property sector is cooling off, it may just be high time for investors to take a breather.

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