Scotsman Guide > Commercial > February 2015 > Department

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Commercial Department: Property TypeCast: February 2015

 

Property TypeCast

Despite an improving economy, retail property fundamentals remain in a rut. Neighborhood and community shopping center vacancy was unchanged at 10.3 percent this past third quarter. The national vacancy rate has declined just 80 basis points over a three-year period, and hasn’t declined more than 10 basis points in any one quarter. This sluggish pace of vacancy compression emphasizes how slowly the retail market has been recovering.Neighborhood and Community Center: Net Absorption and Vacancy; Shopping Center Effective-Rent Growth. Source: Reis Inc.

The trajectory of the vacancy rate shows resiliency, however, because job and income growth have been lackluster in the past several years. The pace of improvement may be slow, but the sector is not retrenching. In fact, the recent economic improvement portends a more robust recovery in the future.

Weak demand remains the main culprit behind the sector’s sluggishness. Net absorption totaled 2.7 million square feet in this past third quarter, a 1.8 percent decline from the previous quarter. This brings the total of 2014’s first three quarters to 6.1 million square feet, a far cry from the 8.2 million square feet absorbed in 2013’s first three quarters. The lack of demand has mostly been driven by a combination of a slow recovery in retail sales and competition from e-commerce. Bankruptcies and store closures continue to trouble property owners across the country, as well.

Construction of new retail space is stuck at historical lows. Just 1.4 million square feet of space came online in this past third quarter, roughly on par with almost every quarter for the past several years. With weak demand and still-elevated vacancy, there is little impetus for developers to break ground on new projects.

Asking and effective rents increased 0.4 percent and 0.5 percent, respectively, in this past third quarter. Quarterly rent growth has been stuck in a range between 0.4 percent and 0.5 percent for five consecutive quarters. In the 12 months ending this past third quarter, asking and effective rents grew 1.7 percent and 1.9 percent, respectively. Year-over-year growth has been slowly increasing over time, but is still only marginally above the rates from late 2013.

Regional malls

Mall vacancies were flat at 7.9 percent for the third-consecutive quarter. Malls began their recovery sooner than neighborhood and community centers, but have stalled faster. Worryingly, vacancy has stalled above levels that are reflective of a healthy market environment. The majority of the vacancy compression has come from low-hanging fruit — the best spaces in the best malls have already been leased.

Class-A malls have few vacant spaces remaining. What remains is more challenging space, predominantly in somewhat inferior malls, which cater to consumers who struggle economically. Any further vacancy compression will need to arise from these inferior malls, which is a challenge for the overall mall subsector. Moreover, the ongoing store closures will only put upward pressure on vacancy. In the medium term, with the recovery ongoing and the labor markets continuing to heal, this should offset the deleterious impact of store closures and put downward pressure on vacancy. The recovery should be slower from this point forward, however.

Outlook

The recoveries in the economy and labor market have shifted into a higher gear, which portends good things for the retail sector. A tightening labor market puts more people to work, which creates more discretionary income to spend in retail centers. It also results in competition for talent, which ultimately causes income growth to accelerate. Although the labor market is not yet in that position, a return to full employment is on the horizon. In the near term, improvement will be modest. Annual rent growth was expected to reach 2 percent by year-end 2014 before accelerating into the high 2 percent range by year-end 2015. Vacancy compression will continue to be slow. Given higher job growth and overall economic improvements, retail net absorption will begin to climb. Toward the end of this decade, we anticipate a far tighter labor market, vacancy hundreds of basis points below today’s levels, and rent growth more than double the current rate.


 

Victor Calanog is chief economist and senior vice president for research at Reis Inc. (www.reis.com). He 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. Brad Doremus, senior analyst for Reis’ economics department, contributed to this article. Reach him at brad.doremus@reis.com.

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