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Community Shopping Center Vacancy at 12-Year High

The national vacancy rate for neighborhood and community shopping centers increased by 20 basis points in the first quarter to 7.7% — the highest level since 1996, according to real estate research firm Reis. Mall vacancy increased 10 basis points in the first quarter to 5.9%. Adding to the bad news, retail absorption of space in the quarter went negative for the first time since the company began tracking the sector in 1980.

“From the perspective of a mall owner, the most significant challenge that could emerge this year is for one of your anchors to go dark,” says Sam Chandan, chief economist at Reis. “That makes it extremely difficult to lease up your inline space.”

Asking rents across retail property types increased a meager 0.4% in the quarter, the smallest rate of increase since the fourth quarter of 2001, while effective rents climbed only 0.1%.

Despite weakening in the first quarter, retail fundamentals are exhibiting measured movements rather than a precipitous fall, Chandan points out. “We have to take it in stride,” he says. “It’s not the kind of drop in occupancy or rent that we observed in the office sector in 2001 and 2002.” Chandan refers to the high tech crash, when the national vacancy rate for office space rocketed upward to 16.9% by the end of 2003 from 8.3% in the end of 2000.

As single-family housing developments proliferated in the housing boom earlier this decade, neighborhood retail centers popped up to serve those new communities, Chandan explains. Not surprisingly, slowing home sales in the adjoining neighborhoods increased the difficulty of leasing those retail spaces, which is why vacancy rates have been creeping upward for the past two years.

The greater worry among retail market observers is a recent increase in vacancy at more seasoned shopping centers in developed areas. Chandan believes drug stores and community retailers that sell medicines and other goods close to the consumer’s home or work are losing business as value-conscious shoppers buy more of those goods at big box stores. “We’re seeing some of those very value-oriented brands post stronger results,” he says. “Some of that is customers buying necessity goods [at big box stores] that would normally be coming from a strip mall.”

Consumers are clearly cutting back on spending; sales at stores open at least one year grew by just 0.3% in the first week of April on a year-over-year basis, the slowest growth in five years, according to the International Council of Shopping Centers.

Retail vacancy rates have climbed 200 basis points since mid-2006 due to a continuing deluge of new supply, says Joshua Scoville, director of strategic research at Property & Portfolio Research Inc. Developers delivered 143.6 million sq. ft. of retail space in 2007 and are on track to pump out another 137 million sq. ft. by the end of this year, according to Boston-based PPR.

Increasing vacancy rates among retail properties are to be expected in a recession driven by reduced consumer spending and a deflating housing market, Scoville says. Of the major property types, retail is suffering the most. “Retail is taking it on the chin this cycle, there’s no question.

A strong correlation between a burgeoning housing industry and expansion of retail real estate in recent years has translated to rising vacancy rates in the wake of the housing correction, according to Hessam Nadji, managing director of research services at Marcus & Millichap. “This is very much in line with what we started to predict as long as 18 months ago when the housing market started to go south,” Nadji says, referring to retail vacancy.

Those vacancies will continue to rise this year as retail tenants retract from expansion plans, Nadji predicts. However, the rising vacancies reported this year and the credit crunch will help to curtail construction starts and slow the delivery of new space in 2009 and 2010. That will help retail absorption improve when the economy begins to recover, probably later this year.

Nadji emphasizes that individual markets vary widely in retail fundamentals. San Francisco, Seattle, Washington, D.C. and New York, among others, are enjoying healthy demand for retail space, while California’s Inland Empire and other markets hit hardest by the deflating housing industry are suffering on the retail front as well. “There are markets that are still amazingly strong in retail.”

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