Rising gas prices and the subprime fiasco continue to dominate headlines, alerting the brokerage community to be wary of the near future. The economic turbulence is causing many brokers in the retail industry to expect consumer and business spending to slow considerably moving forward.
Retail sales grew 3.1% during the past 12 months, half the speed recorded over the previous two years. Will this slowdown in demand coupled with a robust year of retail construction lead to a large increase in vacancy and a backlash in retail rent growth? How will this impact investors and the brokerage community?
A more discriminating investor
From a long-term perspective, this is just a bump in the road. Investors and brokers are seeing retail prices and cap rates better reflect property quality, location and tenant credit, a trend that will be more apparent throughout this year.
Over the past year, the gap between buyer and seller expectations has widened, leading to a 20% decline in sales velocity. The return to more normalized conditions, however, is to the benefit of the market's long-term health.
Soaring fuel prices during the past five years amid global political issues and rising oil demand has had little effect on gas consumption in the United States. Money spent at the pump is discretionary income that doesn't go to shopping.
The proportional amount of retail dollars spent on gasoline during the past year exceeds the 15-year average of 7.7%, equating to roughly $74.5 billion that Americans could have spent elsewhere. Reallocating more of the personal budget to the fuel costs will be felt by all.
Pessimistic economists are signaling flares that weakness in the lending environment foreshadows the next recession in the U.S. economy. According to RealtyTrac, which compiles default notices, single-family home foreclosures in the United States are up 12% in the 12 months leading up to March. The majority of payment failures are due to subprime mortgages, which barely represent 5% of the overall residential market.
Trickle effect of subprime fallout
Excessive lending to non-creditworthy borrowers and first-time homeowners with lower incomes has led some subprime mortgage companies to close.
The result will only lessen demand for homes, decreasing housing turnover. A slowdown in transaction velocity in the residential market will hurt sales of home-related goods, such as appliances and furniture. Home improvement stores are expected to be most affected by the cooling housing market because of a decline in cash-out refinancing activity.
Despite the stigma around gas prices and subprime lending, retail sales in 2007 will continue to be driven by the same force as in years past: employment. The March unemployment rate dropped to an impressive low of 4.4%.
Savvy retail sales brokers should focus on the discount segment of the single-tenant market for sales opportunities, since low-income consumers are expected to boost sales at deep-discount stores, including Dollar General and Family Dollar Stores. On the flip side, high-end retailers will feel the slightest of change in buying patterns among their patrons.
Property sales volume takes a hit
Although these macroeconomic problems began to manifest themselves in early 2007, the downturn in the retail property sector occurred in the first half of 2006. Much of the inventory was leftover from the heady climate of 2005 when many owners and investors put less desirable assets on the market in an effort to tighten their portfolios.
Hence, a total of $26 billion in retail property sales, including all multi-tenant and single-tenant transactions, closed during the first six months of 2006, compared with more than $30 billion in the first half of 2005. That change represents a 13% drop.
Currently, investor sentiment is being guided by tenant sustainability. Investment sales brokers should advise existing owners to purchase properties with tenant leases expiring in 15 years or more to attract the highest prices.
A dearth of opportunities still exist for savvy retail brokers to negotiate transactions due to the capital-rich marketplace. More than $20 billion in retail property sales closed in the first quarter, a 76% increase over the first quarter of 2006.
As long as Americans are employed, retail spending will continue. If total retail sales volume in the first quarter indicates the long-term strength of the retail sector, the brokerage community should view the subprime fiasco and rising gas prices as mere blips on the radar screen.
Bernard J. Haddigan is the senior vice president and managing director of Marcus & Millichap's National Retail Group. He can be contacted at [email protected]