Whither retail

Victor Calanog, director of empirical research, Reis Inc.

As published in Scotsman Guide's Commercial Edition, October 2008.

After a relatively stable run from 2004 to '07, neighborhood and community shopping centers saw the largest quarterly deterioration in occupancy in the second quarter of this year. This could indicate that retail is the commercial real estate sector most affected by the current economic turmoil.

Shopping centers' vacancy rates increased from 7.7 percent in the first quarter of this year to 8.2 percent in the second quarter. This follows a vacancy-rate increase in the first quarter that pushed net absorption to negative territory. With vacancy at its highest level since 1995, and asking and effective rents slowing to a crawl, brokers would be wise to tread carefully when they enter these waters.

The general economic malaise has affected consumers in ways that depress the retail sector. Energy, food and transportation prices have increased significantly. With tighter credit conditions and payment difficulties, consumers are cutting back on flexible spending patterns, further slowing retail sales. Holiday-spending patterns also have been weak.

Taking this into account, the International Council of Shopping Centers has estimated a 25-percent increase in store closings this year, the highest number since 2004. High-profile chains such as Linens 'n Things and Mervyns have filed for bankruptcy protection, while others such as Starbucks and Wilsons Leather declared plans for closing stores. Larger retail-property types, such as regional and super-regional malls, have not been spared: Vacancy rates for these properties jumped in the second quarter by 40 basis points to 6.3 percent, their highest level since the first quarter of 2002.

Meanwhile, construction completions have fallen. One to two years ago, estimates had 40 million square feet of neighborhood- and community-retail space coming online this year. With projects delayed or canceled, and given the difficulty of obtaining financing and more-pessimistic views on market demand, our estimate for completions is now 28 million square feet, comparable to annual figures for the previous four years. Newly completed properties also now average 35-percent vacancy when they enter the market, compared to about 25 percent in the past three years.

Weaknesses may continue through next year, with recovery having some lag time behind the general economy.

Consumers have long heard the cliché "Let the buyer beware." The same advice now holds true for brokers specializing in retail properties.

Victor Calanog, director of empirical research at Reis Inc., writes a monthly column on property types for Scotsman Guide. As head of Reis' core economics team, he is responsible for data models, forecasting, valuation and portfolio services for clients in commercial real estate. Reach him at victor.calanog@reis.com. Faruk Ozdemir, senior analyst for retail and team leader for the Quality Control department at Reis, contributed to this article.