Retail: Will Consumers Keep Spending?

Retail real estate executives say that their business is set for a year of rising rents and stable occupancy rates, after rents fell by 1% and vacancies edged up a half-percentage point in 2002.

Somebody needs to make sure that shoppers know about this plan. As the year draws to a close and retailers brace for a tepid Christmas, there is considerable doubt that consumers will sustain the surprisingly strong levels of buying that propped up the U.S. economy in 2002.

With third-quarter earnings reports came fresh warnings from major retailers about lower expectations for the fourth quarter and next year. Even discount stores, the strongest performers during the past two years, anticipate a slowdown.

“The challenges for next year start right now,” says Michael McCarty, senior vice president of research and corporate communications for Indianapolis-based Simon Property Group Inc. “The upcoming holiday season will be critical in determining retailers' appetite for future growth, especially in 2003.”

Projections for consumer spending in the fourth quarter vary, but the National Retail Federation predicts that spending will rise a sluggish 4% from last year's $201 billion in overall holiday sales.

And even that number could be hard to achieve. After the Conference Board's Consumer Confidence Index plunged to 79.6 in October — its lowest level since 1993 — it rebounded in November to 84.1, but was still below Wall Street expectations.

Encino, Calif.-based Marcus & Millichap, which tracks the top 31 retail markets in the country, predicts that fundamentals will improve in 2003. Rental rates are expected to grow from $19.27 per sq. ft. in 2002 to a projected $19.51 per sq. ft. next year. Rents in 2001 averaged $19.09 per sq. ft.

The firm also predicts vacancy rates to stabilize. Rates are expected to rise to 8.57% by year-end 2002 from 7.93% last year. The firm predicts that vacancy rates will stabilize to 8.58% in 2003.

The number of store completions also will fall next year, helping reduce vacancies, Marcus & Millichap says. After the rapid development of about 90 million sq. ft. in 2000 and 2001, completions are expected to decline to 68 million sq. ft. this year and then to 54 million sq. ft. in 2003.

Credit Watch

If the rebound in consumer confidence can be sustained, a solid, if not spectacular year, may unfold. If not, the picture could be ugly for retailers, says Gene Spiegelman, director of retail services for Cushman & Wakefield. “Some people are saying the first quarter of 2003 could be the worst bankruptcy season in a decade,” Spiegelman says. “A poor holiday season will push retailers over the edge.”

Through the third quarter of 2002, 4,958 stores had closed, compared with 4,966 through September 2001, reports Salomon Smith Barney Inc. Shopping center stores were hit hardest, with closings jumping 17.1% from 2,908 to 3,406. More than 280 of those were the result of Kmart Corp.'s filing for Chapter 11 protection in January. At the time of the filing, the corporation had assets of $17 billion.

Mall shops and anchors have fared better. Mall anchor closings totaled 46 through the third quarter of 2002, down 68.5% from 146 closings as of the same time last year. A total of 1,506 mall shops had been shuttered at the end of the third quarter, down from the 1,912 shop closings as of third-quarter 2001.

But despite the danger signs, retail remains a favored product for lenders. “Retail is still a strong category, either No. 1 or No. 2 on every lender's list,” says Allen O'Brien, managing director at Atlanta-based

Mezzanine financing has become more prevalent because some lenders are doing whatever they can to place money in retail, O'Brien notes. For instance, a lender that may only be willing to provide long-term financing for 70% of the property's value may chip in a short-term, mezzanine loan to cover risks associated with construction.

Most developers have modest expectations for 2003. But next year seems to hold as many questions as answers. “Can we put certain things behind us — the corporate scandals and the situation with Iraq?” Spiegelman asks. “It might just be one of those fluctuating, transitional years.”

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