Opportunities await retail property investors as market slowly recovers Featured

6:29am EDT December 7, 2010

There’s been surprising

growth in the real estate, retail sales and retail investment markets as of

late. But does this mean long-term recovery is in the cards for the region as a

whole?

Smart Business spoke with

John M. Leonard, first vice president and regional manager of the Atlanta

office of Marcus & Millichap Real

Estate Investment Services, to learn more.

In light of the holiday

season and the steadily improving commercial real estate market, what are your

predictions for retail sales and the retail investment market?

Nationwide, core retail sales

fell steeply between mid-2008 and mid-2009 but have since staged a recovery to

pre-recession levels, with further gains anticipated through the holidays.

While sales have surpassed previous peak levels, nearly one-third of the

recovered gains have come from e-commerce. Since the trough in monthly retail

sales in December 2008, online retail sales climbed nearly $5.6 billion at the

expense of many traditional retailers. Drugstores, grocery stores, and

restaurants and bars also account for outsized shares of the increase, while

clothing stores, building supply dealers and furniture retailers posted the

weakest gains.

Having reached a high of 10.3

percent nationwide in the first quarter of 2010, U.S. retail vacancies are

starting to decline, albeit modestly. They currently stand at 10.2 percent.

Effective rents are starting to firm as well. The drop in vacancy is expected

to accelerate over the next 18 months, and effective-rent growth will occur as

early as spring 2011. Per-square-foot pricing would follow a similar pattern.

One concern, however, is whether the retail recovery this time will be as rapid

and prolonged as previous recoveries. The lack of any significant job and

income growth suggest that this time, it may be a slower recovery.

How have growth in

e-commerce and the fallout from the recession impacted consumers and retailers?

The recession has given way

to a structural shift in shopping behavior that could change the retail landscape

for years to come. As job losses mounted and budgets tightened, consumers

became more price-conscious, and many discovered lower-price alternatives, such

as discount chains and online stores. As the economic recovery gains momentum,

consumers may have little incentive to revert to previous shopping habits.

While major discount chains will continue to expand, more mom-and-pop

retailers, which have already lost sizable market share, will be pushed to the

edge. Marginal chains and those that fail to offer a competitive advantage to

brick-and-mortar powerhouses or Internet-based services, such as movie rental

chains or music stores, will also face steep challenges.

How will this holiday

season impact retailers and retail building owners?

Forecasts call for a 2.5

percent to 3.0 percent gain in holiday spending this year, up from a modest

increase in 2009 and a decline in 2008. Strengthening consumption trends

advanced GDP growth to 2.5 percent in the third quarter, a positive trend for

retailers. Optimistic consumer surveys support improved holiday retail sales;

however, web-based shopping was expected to account for a significant share of

the increase. Black Friday also competed with Cyber Monday for top gains this

year, and the outcome could be an important signal for retailer trends as the

economy strengthens. 

Shifting shopping habits and

a choppy start to the recovery have given way to changes in the retail

landscape. This year, major national retailers have increased their pop-up

store counts significantly, with Toys R Us now operating 600 temporary

locations, up from 90 stores in 2009. The addition of national chains to the

pop-up store roster has considerably expanded this retail niche, which was once

dominated by bare-bones operations selling seasonal wares. Retailers are taking

advantage of opportunities to pick up space in desirable shopping centers and

malls that may have been cost-prohibitive just a few years ago. Though pop-up

stores will not drive a recovery in property operations alone, they should help

pad NOIs through this holiday season and may ultimately lead to some

longer-term leases.

This holiday season will be

better than the last few, but it will likely take several more quarters for

consumers to entirely shake off the effects of the recession. During the third

quarter, retail vacancy retreated 10 basis points to 10.2 percent, the first

decline recorded since mid-2005. Nonetheless, the vacancy rate remains near its

highest level in approximately 18 years and will likely fluctuate in the near

term as employment growth returns slowly. While the retail sector should post

improvements in late 2011 as economic growth accelerates, meaningful gains in

occupancy and rents remain unlikely until 2012.

In addition to this

positive short-term news, which specific segments of the retail property sector

are expected to perform well in 2011?

Single-tenant net-leased

properties with national-credit retailers will remain the most sought-after

deals as high-net worth individuals and well-funded REITs compete for

acquisitions. Unimpressive returns offered by alternative investments and

ongoing stock market uncertainty continue to heighten private buyers’ appetite

for low-risk, corporate-backed assets. Cap rates for these deals have already compressed

50 basis points this year. Yields will tighten further in 2011 but should

stabilize by midyear as returns approach pre-recession levels. Lower cap rates

and a shortage of high-quality assets listed will expand acquisition targets

for many buyers, and properties leased to well-known franchisees will garner

more attention and clear the market faster. Cap rates for these assets will

average 50 basis points to 150 basis points above those for best-in-class

investment-grade deals, depending on the financial strength of the guarantor.

Looking ahead, new accounting

standards proposed by the Financial Accounting Standards Board could impact the

single-tenant sector significantly by requiring lease liabilities to be

accounted for on corporate balance sheets. FASB is expected to issue a draft of

their proposed rules by early 2011.There will be a comment period, and then

FASB is expected to issue their final rules in late 2011, for an effective date

of 2012 or 2013.  If approved, the

standards would likely influence businesses’ decisions to buy or lease real

estate.

John M. Leonard is a first

vice president and regional manager of the Atlanta office of Marcus &

Millichap Real Estate Investment Services. Contact him at john.leonard@marcusmillichap.com

or (678) 808-2700.