When Will Housing Recover To Reinvigorate Retail Development?

Source: CCN Retail Perspectives

Spring 2009

It goes without saying – retail is directly dependent on housing, and new retail development is largely dependent on new housing. This was confirmed by the meltdown in the subprime credit markets, which precipitated an unprecedented implosion in the number of potential homebuyers. That drop in demand resulted in a virtual halt in residential construction (multi-family as well as single-family, although single-family has arguably been harder hit), and a similar cessation in new retail construction swiftly followed, since retailers were no longer able to justify entering new markets, because anticipated population growth clearly will not occur in the expected time frames.

The southwestern portion of the country (California, Arizona & Nevada) arguably (and unenviably) leads the nation in the slowdown in both new home construction and new retail development (although Florida is also experiencing significant problems). California may be the hardest hit due to its huge inventory of new, under construction and proposed housing, primarily in the Inland Empire (concentrated in San Bernardino and Riverside counties) and the Central Valley (chiefly along Highway 99, in and around the larger cities, such as Sacramento). Those new residential developments were forging ahead in reliance on a massive projected population increase in California over the next 20 years, continued availability of cheap credit, and the state’s seemingly unending economic growth (particularly trade with Pacific Rim nations). Without those large new housing developments, and with the steep drop in home sales and sharply reduced consumer confidence, retailers have scaled back their expansion plans, leading shopping center developers to likewise scale back new construction.

The effect of the collapse of the new housing market on new retail development has been exacerbated by the dramatic rise in the number of residential foreclosures. Such foreclosures make available existing homes for first time buyers, as well as homeowners looking to trade up, at much lower prices than has been the case for a number of years. The result is a further depression in home values, sometimes below the cost of constructing a new home, making it uneconomical to undertake new home construction, and further delaying the recovery of new retail construction.

Therefore, recovery of the new retail development industry is intricately and intimately linked with recovery of the new housing markets. Unfortunately, when those markets will bounce back is unclear, because so long as the credit crunch persists, there will be no new housing due to there being no demand for new homes, and thus no new retail development. With the capital markets continuing to flounder, there appears to be no way to accurately predict how to fix the credit crisis or when it will end.

The Obama administration has put forth various programs to aid the housing industry. For example, the housing stimulus bill passed in July 2008 (the Housing and Economic Recovery Act of 2008, portions of which would have ended July 31, 2009) was extended in February 2009 (by the American Recovery and Reinvestment Act of 2009) and expanded so that first time home buyers can receive a tax credit of $8,000 (up from $7,500) if they purchase a home between January 1 and December 31, 2009; more importantly, the tax credit no longer needs to be repaid. In addition, the February legislation extended to December 31, 2009 the increases in FHA, Freddie Mac and Fannie Mae loan limits (to $217,050 for FHA and $417,000 for Fannie Mae & Freddie Mac or, if greater, 125% of the 2008 local area median home price, but not to exceed $729,750).

Other tools in the administration’s arsenal include loan refinancing and restructuring, which could go a long way towards ameliorating the foreclosure problem. One such program involves getting lenders to write down principal balances to 90% of the then current appraised value in exchange for an FHA-insured loan in that amount, but the program also requires a 1.5% annual insurance fee to the FHA and gives the FHA participation rights in any profit on sale or refinance, so its usefulness may not be as great as hoped. While writing down mortgages may not be particularly desirable for lenders, in many cases it would seem preferable to the alternative of taking the property back and possibly getting even less in a foreclosure sale, or having to hold onto the property and become a landlord until the home can be sold for a reasonable amount.

Another loan program just enacted makes available $75 Billion to incentivize lenders to reduce interest payments, and in some cases temporarily reduce principal, such that payments will not exceed 31% of the borrower's income; however, the principal has to be repaid when the home is sold or refinanced, the amount of the loan that is eligible is capped at $729,750, and the loan must have been taken out before January 1, 2009. Unfortunately, this program is likely only available to homeowners who are still working, since there has to be some reasonable expectation that the homeowner can continue to make payments under the modified loan.

Yet another attempt by the Obama administration to assist the housing market is neighborhood stabilization, a program that provides $6 Billion for cities to purchase homes in bulk and then manage, repair and resell properties. The goal here is to help cities exercise more control in neighborhoods that have been decimated by foreclosures, before the effect of abandonment spreads to the other homes not foreclosed upon.

Other measures may yet be enacted – for example, the House of Representatives recently passed a bill that would allow bankruptcy judges to “cram down” the principal on mortgages in Chapter 13 bankruptcies. Although this still needs to be approved by the Senate, where it is expected to face stiff opposition, the fact that there is support for such a measure could prove to be an incentive for lenders to work with homeowners and possibly prevent even larger losses.

It is still too early to tell when such measures will have an impact or how much of an impact they will have, but when combined with other stimulus packages (including other income tax benefits, efforts to relieve banks of toxic assets, and long overdue investment in the national infrastructure), they should eventually result in increased demand for new housing, which will then spur new retail development. Recent data suggests that some of the measures are having a positive effect – for example, sales of existing homes (which increases the demand for new housing by removing an alternative to homebuyers) in February 2009 were up 5.1% over January 2009, the largest monthly increase in 5 ½ years, housing starts were up 22.2% in the U.S. for February 2009, breaking a 9 month string of decreases, and housing permits being issued also increased substantially, beating estimates. While none of these alone indicates that the worst is over (and the early indicators are that there will be some retrenchment), together they provide a bright spot in what has been an otherwise dismal 18 months, leading some commentators to predict that, if such trends continue, the housing slump could well end in late 2009, although an end in 2010 still seems to be the greater consensus.

The backlog of recently constructed but unoccupied housing, along with housing under construction and permitted (and perhaps even entitled) that will probably be completed at some time (since the investment in development and infrastructure is probably too great to abandon), should allow retail developers to adjust to the new realities. However, retail developers will eventually need to learn to work not only in the traditional suburban context with 1-story buildings and surface parking, but also in a denser urban context, including accepting multi-level store buildings and parking structures, as cities require more mixed uses and intensive residential uses.

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