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Retail Down, But Not Out

There is deep-seated pessimism in every corner of the retail landscape this year. Chains such as Sharper Image, Goody's Family Clothing and Linens 'n Things are all mired in bankruptcy. Gap has seen same-store sales decline for 15 quarters in a row. Bon-Ton's losses have been mounting.

Meanwhile, Borders Group has cut 20% of its corporate staff and is angling for a merger with rival Barnes & Noble. Home Depot, which has closed 15 stores and cancelled plans to construct 50 more, might not see a substantial recovery for years, experts say.

Many developers and investors in retail can't recall such unsettled market conditions since 9-11. Brokerage Marcus & Millichap reports that of the 32 million sq. ft. of new retail space delivered in the first quarter this year, only 22 million sq. ft. was leased. Still, projects in the best-located sites continue to move ahead, albeit at a more cautious pace.

In certain retail segments, the pace of development has slowed. The Torto Wheaton Research division of CB Richard Ellis predicts that the delivery of neighborhood shopping centers will plummet 30% this year to 22.8 million sq. ft. from the 32.7 million sq. ft. total of 2007, then slip further to 21.1 million sq. ft. in 2009.

Retail rents, which rose 3.2% in 2007 in the neighborhood center sector, are likely to rise just 1.7% this year and then inch up just 1.6% next year. Bernard Haddigan, managing director of Marcus & Millichap's national retail group, predicts property sales transactions this year will be 40% of the volume last year. “It will likely take 24 to 36 months before the market comes back to normal, or something close to it.”

Traditional financing dries up

Much of the fall-off in new development is tied to hamstrung banks and institutions. Eighteen months ago, developers with committed tenants could build with just 10% equity. Today they need 25% equity, and often 35% or more.

The scarcity of debt financing has brought acquisitions to a near standstill in many places. Bankers aren't encouraged by a forecast from Marcus & Millichap that vacancies will rise nearly 1.5% this year, on top of a 1% rise in 2007, to bring the national average to 11.1%. Absorption has turned negative in some segments.

Meanwhile, several REITs are concentrating on redevelopment of existing assets. General Growth Properties, which ranks No. 2 on NREI's list of top shopping center owners with a U.S. portfolio of 180.5 million sq. ft. , added a Nordstrom to its 2.3 million sq. ft. Ala Moana Center in Honolulu in March. For the first time in years, the Chicago-based company has no new malls opening in 2008.

“We've cut $600 million in capital spending over a three-year period, though we're still spending $250 million on remodeling existing malls this year,” explains John Bucksbaum, chairman and CEO. The REIT opened a regional mall in Turkey last year, and will increasingly look overseas for future investment.

Seizing opportunities

Casto, a developer based in Columbus, Ohio, is pushing ahead on select projects, including the 500,000 sq. ft. Albany Park in New Albany, Ohio, that is part of a 300-acre mixed-use project. “The fact is that national chains, which two years ago couldn't open stores fast enough, are continuing to do deals in some places,” says Paul Lukeman, a partner in Casto.

Sandy Sigal, president and CEO of Newmark Merrill Cos. in Woodland Hills, Calif., which owns 43 shopping centers mostly in the West, estimates that “small-tenant leasing activity is down 40%.” Still, he is forging ahead on new centers such as the 100,000 sq. ft. project in Carson, Calif., expected to break ground in late summer.

“That center is 75% pre-leased, so we have enough confidence to proceed,” Sigal says. “The biggest problem we have is that construction costs are up radically. Materials like asphalt and steel and roofing are all sky-high. It's not easy to get rents to cover those costs.”

At Ryan Cos. in Minneapolis, Dan Walsh, vice president of development, says that building starts in fringe areas have evaporated around many metro hubs as retailers are less willing to invest in sparsely populated markets. Developers are going back to landowners asking for lower prices and longer terms on option contracts to buy land for retail, but compromise has often proven elusive.

“This is not a good time to tie up land for development,” Walsh says. “The pipeline of new development is shorter than it has been in years. It will be 2010, I think, before retailers return to their normal growth patterns.”

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