Retail fundamentals continue to skid along the bottom

Victor Calanog, vice president of research and economics, Reis Inc.

As published in Scotsman Guide's Commercial Edition, January 2012.

Figures from this past third quarter show retail fundamentals have yet to demonstrate consistent signs of improvement. Neighborhood and community-center vacancies remained moored at 11 percent, unchanged from the second quarter. This is a level unseen since 1991, and it is only 10 basis points shy of the all-time record high of 11.1 percent, which the sector hit in 1990.

National asking and effective rents also remained unchanged in the third quarter; at $16.49 per square foot, effective rents are now back to levels last observed in mid-2005, an indication of how much ground retail properties have lost since fundamentals began deteriorating in early 2008.

Larger property types, such as shopping malls, did not remain unscathed. National vacancies rose to 9.4 percent this past third quarter, the highest level on record since Reis began tracking this property type in 2000. Asking rents rose slightly, but mall rents have eroded back to levels last observed in early 2006.

By contrast, other commercial property types are at least showing signs of a fledgling recovery. Office vacancies have ticked downwards slightly, from 17.6 percent at the end of 2010 to 17.4 percent this past third quarter. Office rents also have increased for four straight quarters, albeit at a tepid pace. Apartment fundamentals are roaring back vigorously, with vacancies dropping by 100 basis points in 2011 alone, down to 5.6 percent in the third quarter.

Why is retail ailing? First, recession has wreaked havoc on the demand side of the equation. For the first time in almost 20 years, American consumers pulled back on spending. Although the recession ended more than two years ago, caution continues to pervade spending habits. Retail sales may be creeping back up, but this has yet to translate into increased demand for retail space.

On the supply side, while office and apartment construction pulled back between 2004 and 2008, retail-inventory growth continued at a fairly healthy pace of around 1.6 percent per year — until the bottom fell out in 2009. As such, aggregate demand remains slow, office and apartment properties do not have to contend with the kind of supply glut that bedevils retail properties today.

Not all retail properties are suffering. Power-center vacancies have been declining slightly for about a year and grocery-anchored shopping-center vacancies fell to 7.6 percent in the third quarter. Malls that can charge rents at the top 75th percentile of their specific metros also are boasting vacancies well below the national average.

Retail properties are still ailing, however. It doesn’t help that forecasts of gross-domestic-product (GDP) growth in 2012 have been cut from around 3.5 percent to 1.7 percent, given Europe’s turmoil and the lackluster economic performance for most of 2011 in the U.S. Investors and lenders must set expectations carefully for how retail properties will perform in the near term.

Victor Calanog, vice president of research and economics at Reis Inc., writes a monthly column on property types for Scotsman Guide. He and his team of economists are responsible for data models, forecasting, valuation and portfolio services for clients in commercial real estate. Reach him at victor.calanog@reis.com.

Ryan Severino, senior economist for Reis, contributed to this article.