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In a Dreary Climate, Discount Retailers Bear Good News

Amid the chorus of negative economic news from the past week – including a bleak jobs report and continued talk of recession – a few glimmers of hope shone through, particularly in some surprisingly strong retail sales reports. But as consumers redirect their shopping dollars to more value-oriented retailers, chain stores will continue to feel the pinch.

Sales at some of the country’s top value-oriented retailers were stronger than expected in February, beating most analysts’ forecasts. Wal-Mart Stores, Target Corp., Costco Wholesale Corp. and Ross Stores all reported higher-than expected sales growth. Another sign of the times – deep discounter Big Lots raised its 2008 profit forecast.

Looking ahead, the International Council of Shopping Centers is forecasting improved sales for March as a result of spring break and Easter shopping. Also, Congress’ recent passage of an economic stimulus package will put dollars into U.S. consumers’ pockets starting in the summer.

Still, several pockets of retailing, chiefly department stores, continue to struggle. Weaker profits at Sears will likely see it close stores and sell off some of its real estate assets in the future. Sears’ fourth-quarter 2007 (ended Feb. 2) saw net income fall 47% and same-store sales drop 4.5% across its 3,400 U.S. and 380 Canadian stores. JCPenney, Nordstrom and Gap Inc. also saw sales fall in February.

One of the chief harbingers of gloom is the lingering residential subprime mortgage mess, which threatens to stifle general economic progress for the foreseeable future and continues to overwhelm the more scarce positive news. For example, last Friday JPMorgan Chase & Co. issued a report, co-authored by analyst Christopher Flanagan, stating Wall Street banks could face a “systematic margin call” that could wipe out some $325 billion of capital, all thanks to aggressive subprime mortgage lending gone bad.

The same day, March 7, the U.S. Department of Labor reported that nonfarm payrolls fell by an unexpected 63,000 in February, which marks the second straight monthly decline in job growth. It was also the largest drop in payrolls in five years.

Rightly or wrongly, the JPMorgan report proclaimed, “The weak February employment report points to an economy in recession.”

CB Richard Ellis’ new chief economist, Ray Torto, a veteran industry watcher, has a different view on the future of the office and industrial markets, at least. His theory centers around the notion that “economic rent,” – defined as average rent multiplied by the market occupancy rate – will be essentially flat for 2008 in the nation’s office and industrial sectors.

Torto argues that while the leasing market will slow compared to both 2006 and 2007, it will not mirror conditions which occurred in 2001 when office economic rents dropped by 9.6% and industrial economic rents declined by 4.4%.

In fact, Torto says many U.S. markets are poised for growth. “While national forecasts call for a rise in vacancy rates in 2008 and a small rise, on average, in rents, there are markets that will do quite well in 2008 compared with the nation.”

According to Torto, the best office markets will be Charlotte, Raleigh, Pittsburgh (Penn.), Dallas and Indianapolis. The top industrial markets will be Indianapolis, San Jose, Akron, New York and Pittsburgh.

“Real estate is an investor’s market – not a trader’s market – and for long-term investors, opportunities will arise from others’ mispricing or misfortune,” says Torto.

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