Shopping Center Business

MAY 2015

Shopping Center Business is the leading monthly business magazine for the retail real estate industry.

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196 • SHOPPING CENTER BUSINESS • MAY 2015 Bill Rose With little supply growth, absorption of retail space is increasing. Demand For Space T he accelerating U.S. economy, to- gether with increased hiring and income growth, has lifted con- sumer confidence and supported higher spending. This, in turn, has pulled an in- creasing number of retailers from the side- lines. Anemic supply growth concurrent with a 26 percent rise in absorption netted a 50-basis-point decrease in vacancy to 6.6 percent, the largest decline in 14 years. The level of energy, competition and ra- pidity of change in the retail industry has accelerated as new concepts, expanded distribution channels, and engaged inter- national brands have begun to challenge outdated market strategies and uninspired store formats. Location is the retailer mantra and the scarcity of quality chain retail space has re- sulted in creative redevelopment of select urban storefronts for luxury retailers. Va- cant anchor space in malls and shopping centers has found new larger-format ten- ants such as Forever 21 or Whole Foods Market, while reconfigured in-line and end-cap spaces have drawn high demand from restaurants, fitness centers, specialty grocers and entertainment venues. Repur- posing of otherwise functionally obsolete but well-located buildings for uses such as medical offices or charter schools has also bolstered performance trends. Exceptional investor demand for urban storefront and single-tenant product mir- rors the strength and direction of retailer demand for these property types, which is ultimately shaped by demographic, so- cietal and technology trends. The millen- nial generation has fostered strong growth in casual dining brands such as Chipotle, Panera Bread and Baja Fresh, as well as spinoffs of traditional retailers targeting a younger audience, by locating in core submarkets in urban storefront formats. Single-tenant properties accounted for more than two-thirds of retail absorption and 76 percent of last year's meager com- pletions. The vacancy rate now matches a pre-recession low of 5.8 percent. Al- though recovery in multi-tenant product thus far has lagged that of single-tenant, net absorption increased by 52 percent over the prior year and vacancy fell to 8.0 percent from 8.5 percent. At $18.68 per square foot, the average asking rent for single-tenant properties remains 8.1 percent below peak, while the average for multi-tenant properties, at $16.64, lags peak rents by 12 percent. The modest pace of recovery in the re- tail property sector has so far lagged the other property types, but economic and operational improvement for a broader range of markets and asset types appears to be underway. The prospect of sustainable momentum in operational performance has investors expanding beyond premier markets and top-tier assets and focusing on growth-oriented opportunities. The most active markets continue to be the preferred gateway metros of New York City, Los Angeles and Chicago, but improved space fundamentals in second- ary markets and the notable arbitrage in prices and cap rates has increasingly piqued investor interest in high-growth, expansionary markets such as Dallas/Fort Worth, Atlanta, Miami and Boston, all of which reflect significant upticks in veloc- ity. As investors' confidence and appetite for opportunity has increased, they are assuming more leasing, renovation and development risk in a greater number of secondary and tertiary markets despite recent cap rate compression. Access to capital has increased steadily in the last year, particularly in these smaller metros. As a result, retail mortgage originations grew 16 percent year over year as of fourth quarter 2014. Three trends are forecasted in 2015 within the retail real estate market. The first is consumer spending will rise as the boost in consumption from lower oil prices will create an expansion- ary environment for retail sales, broad- ening performance gains across metro areas. The second is greater liquidity on the lending side, and a healthy spread of 80 basis points between secondary and tertiary markets will chan- nel more acquisitions to tertiary markets as long as the local economy and market demographics support it. In comparison, the spread between the two market tiers narrowed to within 30 basis points at the 2007 peak. The third is tied to stronger wage growth and an increasingly robust sales environment, which will continue to improve space fundamentals. Still-limited new supply will spur creative redevelop- ments of tired shopping centers. Best-in- class space, especially urban storefronts, still takes top honors in pricing and low cap rates. Relative to primary and early- recovery markets, retail assets with higher vacancies and rents still below their peak offer revenue potential to help offset high- er financing costs in a rising interest rate environment. Investors must consider, however, the economic risks of smaller metros as well as the potential for quick ramp-ups in supply, factoring these con- siderations into their investment criteria. Many of the strongest retail markets in the country are within California, which is spurring development of new, high-profile destination centers. In Southern Califor- nia, high-density, mixed-use projects are beginning to pepper the landscape. Build- ers had years to plan and permit during the recession and now have the financial wherewithal to move projects forward. Runway Playa Vista in Los Angeles and Bill Rose

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