Although this market showed strength in recent years, look for potential slowdowns in 2007

Sam Chandan, chief economist and senior vice president for research, Reis Inc.

As published in Scotsman Guide's Commercial Edition, January 2007.

U.S. neighborhood and community shopping centers have demonstrated exceptional stability in operating fundamentals and cash-flow performance through the most recent peak and trough in the commercial real estate cycle.

An increase in the number of retail completions scheduled for the coming year, however, coincides with expectations of slower economic growth and less-robust housing markets. These economic trends will place pressure on consumer spending. This may, in turn, impact the demand for retail space and the performance of commercial mortgages collateralized by retail properties.

A brief history

In the most recent recession, the national vacancy rate for the retail sector increased only modestly, from a low of 6.3 percent leading up to the downturn to a peak of 7.3 percent in early 2002. Rents declined during only one quarter.

Other commercial markets didn't fare so well. The national apartment market's vacancy rate more than doubled through the previous cycle. It was even-more pronounced in the office sector, where vacancy climbed from a low of 7.9 percent in late 2000 to a peak of 16.9 percent three years later. In that same three-year period, effective (post-tenant-paid concession) rents for office space tumbled.

The stability of the retail sector through the recession and recovery can be explained, in part, by relatively restrained retail-development activity leading up to the market peak. Measured completions shielded the retail sector from the office market's supply issues.

Strong consumer-spending growth also supported demand for retail space. Between 1999 and 2005, spending on furniture, household goods and clothing increased. Meanwhile, wage and salary growth averaged 4.5 percent.

Robust yearly consumer-spending growth in areas with high demand for retail space has been tied to the housing-price increase that followed the recession. According to the National Association of Realtors, existing home prices increased by 4.7 percent in 2001; prices increased by almost 45 percent from the beginning of the recession through the end of 2005.

There is some disagreement among economists with regard to the extent of the "wealth effect," which dictates that households increase their spending in response to greater perceived wealth from appreciation in their primary asset. But there is no doubt that much of the increase in spending was caused by the withdrawal of home equity in an environment of historically low borrowing costs.

Consumer spending today

By mid-year 2006, the wealth effect and mortgage-equity withdrawal had come under pressure, however. Home prices in the United States -- including for single-family homes, condominiums and co-ops -- recorded their largest year-to-year declines in more than 35 years this past August and September. The median price fell 2.2 percent in each month as compared to a year earlier, according to the National Association of Realtors.

The August and September declines are the first drops in home prices at the national level since 1995. What's more, according to the Bureau of Economic Analysis, the U.S. personal savings turned negative in 2005.

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