The retail market

The hunters have become the hunted. Shopping center owners, ever in search of improved market capture rates, have found their mall properties the subject of intensifying interest by prospectivve purchasers. Aggressive bids for available centers are pushing prices ahead faster than the underlying levels of consumer spending.

Although the U.S. economy generated an impressive year of GDP growth in 1994, consumption was skewed toward big ticket items such as autos and appliances, limiting the dollars available for soft goods expenditures.

Through the first nine months of 1994, retail sales increased at an estimated annual pace of 7.8%, up from 6.3% over the same period in 1993 but below the 9%-to-10% bump many analysts had anticipated. Of more concern to shopping center owners, however, was the year-over-year decline (.4%) in the apparel and accessory category and a comparatively sluggish 5% increase in the general merchandise group.

With pent-up demand for durables now largely satisfied, non-durable sales should advance smartly in 1995. Incomes are still rising, suggesting that consumers should have the extra cash to begin spending more on the soft goods which are the staples of the shopping center industry. Increasing sales should push retail rents up, especially since shopping center construction remains well below historic levels.

As we anticipated in last year's Forecast, the REITs made a huge imprint on the industry in 1994. The infusion of capital and the acquisition imperative sparked a spate of transactions, particularly in strip centers. A review of Landauer's 1994 property sales database indicates that REITs accounted for over a third of the major strip center transactions.

IRRs and cap rates are falling thanks to this new impetus to purchase. Peter Korpacz' investor survey places the target yield for strip centers at 11.9%, down 2.4% from 1993. While supply/demand ratios clearly improved in some segments, we see potential problems if too many development and expansion plans move forward. Strip centers are too easy to build and have too little franchise value to be immune to oversaturation.

Most of the regional mall market remains strong and highly predictable. Investor demand is robust for the top tier properties. Posting consistently good sales-per-square-foot figures, well-located malls have weathered the department store shakeup admirably. They command the highest rents from the best tenants and have used the last few years to make the upgrades and expansions necessary to consolidate their dominance. Highly desirable, they are largely responsible for cap rates dipping below 7%.

However, a portion of the regional mall market remains in trouble. Victims of inferior locations and the smaller pool of quality anchors, these properties will more than likely fall prey to the big discounters in 1995.

Traditional supply/demand analyses on the market and submarket level will be the best instruments for predicting the year ahead. Many malls should be well positioned for healthy gains. New supply will be the big question mark. Capital is available again and some of the newly formed REITs are actively pursuing development deals. But with long lead times and numerous impediments to ground breaking, regional malls are still one of the most stable acquisitions.

The future of the power center is more problematic. On the scene just ten years, power centers have already entered a shakeout period. Competing formats are cannibalizing each other in over-stored markets. While some concentration is considered beneficial to all players, the finite pool of retail dollars obviously cannot support all establishments. Retailers' territorial ambitions are prompting some questionable store openings. More weeding out is expected in 1995, as a handful of dominant players take hold of the top.

The most popular new format is the "supercenter," combining a large full service grocery with a traditional big box discounter. These centers average between 130,000 and 250,000 square feet. K-Mart added 55 Super Ks in 1994, while Wal-Mart opened close to 70 new stores. Super-centers pose the biggest risk to small neighborhood centers anchored by grocery stores.

Landauer's Retail Matrix analyzes economic and real estate trends in 60 metropolitan areas. Both volume and growth measures are essential to determining market quality, but since most areas change their relative size (measured by the Volume axis) very slowly, their position on the Growth axis is the more sensitive indicator of shifts in comparative advantage.

The Texas markets turned in the best performance in our Matrix this year, due largely to the improved economic climate. Employment is swelling in Austin, Dallas and San Antonio. The infusion of income has been a boon to retailers, allowing GAFO sales per square foot in all the Texas cities to exceed the national average. Dallas ranks highest, given its strength in both growth and volume, but Ft. Worth, San Antonio and Austin are also among the top ten.

In Honolulu, restrictions on new supply pushed the five-year GAFO sales per square foot growth to the top of the 60 markets monitored. Store inventory totals are comparatively low, while the city ranks high on the Growth axis thanks to the tremendous wealth still centered on the island. Although a nagging recession has cut into income expansion, Honolulu receives a Market Quality Rating of three and ranks second among the markets reviewed.

Five of the six Florida cities Landauer tracks (Orlando, West Palm Beach, Jacksonville, Ft. Lauderdale and Tampa) scored within the top 20 this year. Although household income (a volume measure) tends to be below the national average in these markets, consistent job gains and a steady stream of tourists allows these markets to perform well in the growth categories. Miami's position on the Matrix improved this year, but it still remains in the bottom tier, ranking 49th. Income levels are comparatively low in Miami and, even though steady immigration is inflating population totals, real GAFO sales have fallen over the past five years.

After lackluster performances, some of the California markets are showing signs of improvement. Income growth projections are strengthening in Los Angeles, San Diego and Anaheim, reflecting forecasters' belief that Southern California's potential for population expansion will elevate consumer wealth in the latter half of the decade.

The primary exception is Riverside-San Bernardino, 21st in this year's rankings. Income projections have also been revised upward in the Inland Empire, but new development appears to be outstripping demand, causing a significant slowdown in GAFO per square foot gains. Riverside-San Bernardino has added 43% to its retail inventory since 1990, the highest among the metropolitan areas.

The Northern California markets continue to struggle. San Jose, Oakland, Sacramento and San Francisco are not expected to enjoy the same boost in immigration the southern cities should receive, and are therefore unlikely to experience similar income gains. Growth restrictions, while beneficial to a point, have a negative impact in some of these highly regulated markets, forcing many interested retailers to look elsewhere for expansion.

Some slippage has occurred in Seattle where income projections have been scaled back to reflect weakness in aerospace. Other hightech industries, led by Microsoft, should continue to generate healthy job gains, but losses at Boeing will be a drag. Nevertheless, Seattle was just edged out of the top ten ranking. We expect conditions to improve.

Among the worst performing markets were several East Coast cities. New York, Hartford, Bridgeport and Boston all fell victim to real declines in GAFO sales over the past five years. Although the recession is officially over in the Northeast, job gains are generally slim. New Jersey is showing the best prospects. Here, regional malls enjoy special dominance as the density of development precludes new competition in highwealth areas. Smaller centers are vulnerable to the onslaught of discounters streaming into the region.

The most important variable will be construction. REITs will be among the prime stimulants, but the eagerness of institutional investors to include retail properties in their portfolios will also be a part of the equation. The danger here is in repeating the mistakes of the 1970s, when too much of a good thing spoiled the party for everyone.

One development trend Landauer does view favorably is the growing interest in urban retail. With ample barriers to overbuilding, renewed interest in downtown development seems to offer promising potential. High incomes, limited competition and a new willingness on the part of municipal economic development officials to work with retailers should result in excellent opportunities for developers patient and sophisticated enough to work the labyrinth of building in an urban core.

Until recently, most retailers shunned downtown and ethnic neighborhood projects with their associated expense and hassle. As long as demand remained strong, suburban locations with their ample acreage and comparatively unfettered zoning requirements were preferred. But now that many metropolitan areas are sufficiently stored, developers are eyeing urban markets as one of the few remaining retail frontiers. Cities simply house too many people with too much income to ignore.

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