Retail Development - Coming Around The Bend?
RETAIL DEVELOPMENT – COMING AROUND THE BEND?
The retail industry welcomed 2014 with cautious optimism, not unlike the sentiment from the previous year. After years of relative stagnation commencing in 2008, experts believe that retail development took a step forward in 2013. Based on some positive news regarding the housing market, the potential for an influx of capital, and more favorable financing opportunities, it appears as if there may be reason to expect continued improvement in retail development this coming year.
One sector of the economy which has a major influence on retail development, and which has been relatively sluggish for the last several years, is housing. The latest data from the National Association of Realtors shows pricing gains in the overwhelming majority of the U.S. markets, with some up 10% or more over the past year. It also appears that sales activity is on the rise, as existing inventories are at near record lows, and new home starts are at their highest levels since before the start of the “Great Recession”. In fact, the UCLA Anderson Forecast anticipates an increase in housing starts to 1.25 million units in 2014 (and 1.44 million units in 2015), up from an estimated 913,000 units this past year. It is commonly understood within the industry that if new housing developments are built, new shopping centers will follow. In addition, the continued resolution of residential foreclosures, the influx of institutional investment and the force of the expanding population may all contribute to a continued uptick in the housing market in 2014 with the retail market to follow.
Another positive sign in retail development is the fact that the development pipeline appears to be filling up, albeit at a modest pace. Evidence suggests that developers and investors are finally starting to come out of pocket to make payments to move projects along. These payments include fees paid to consultants, architects and land use experts, as some retail developers prepare for the commencement of new projects when their permits and approvals are obtained, probably in the next 12 to 24 months.
The availability of financing is another shift in the marketplace that may result in more ground up development, as well as more money being available for re-development and re-structuring of retail assets. Over the past few years, there were few banks willing to make loans secured by real estate projects (and not just retail). However, it appears as if commercial banks and other lending institutions are now looking favorably at real estate again. In addition, many experts predict a continued resurgence in commercial mortgage-backed securities which should result in more money “getting into the game”. According to data from the Urban Land Institute, issuance of CMBS loans was expected to reach $90 billion in 2013 and should climb to $100 billion in 2014. The comparatively weak return from Treasuries has also made real estate a more attractive investment option.
While there are some positive signs, one issue that will likely continue to have an effect on the retail industry, as well as consumers in general, is political unrest in Washington. Squabbling by politicians in our nation’s capital resulted in a government shut down from October 1st to October 16th, the first such cessation in activity since 1995-96. Notwithstanding the Bipartisan Budget Act of 2013, the budget sequestration which began in 2013 is likely to have a lasting effect, as budget cuts begin to impact various segments of the population. Since consumers drive the retail industry, any lack of confidence in our governmental may result in a reluctance of consumers to part with hard earned dollars. In fact, some experts believe that the biggest factor in a resurgence in retail development may be what transpires in Washington in the coming year and beyond.
Of the different types of retail projects, grocery anchored neighborhood centers appear to be most on the rebound, as space in those projects seems to fill up quickest. According to CBRE, the percentage of existing space that landlords of such centers are actively marketing for tenant build-out will decline to 10.6% in the fourth quarter of 2013, down from 12.3% in the third quarter and from 12.7% at the end of 2012. Analysts predict that a relatively low amount of new neighborhood centers will open in 2014, creating additional demand for existing space at those types of projects. In addition, grocery stores remain one of the sectors of retail that have felt less of a sting from e-commerce as people continue to want to shop for their groceries, rather than have them delivered. Only time will tell whether the paradigm shifts for delivery of groceries and other perishables, as companies like Amazon.com begin to experiment with home delivery of these items.
In addition to neighborhood centers, traditional malls appear to be maintaining occupancy rates despite the wobbly economy. Statistics show a current national vacancy rate of 4.8%, compared to 5.8% one year ago. One reason for the relatively strong numbers in the mall category is that mall properties account for the majority of the “trophy assets” in the United States, with retailers willing to pay more in rent to locate themselves in well performing projects with a lot of foot traffic.
As in the last few years, retail developers who are not willing to take the risk on new development will likely remain focused on what some in the industry call the “Five Rs”: renovation, rehabilitation, repositioning, releasing and refinancing. As has been the case in recent years, shopping center owners with existing product that they want to retain are spending money on renovation and rehabilitation. Such work includes common area and building improvements, in addition to upgrades to accommodate the savvy shopper who requires instant access to his or her mobile device. Other shopping center owners may work to reposition their portfolios by shedding under performing assets, while attempting to acquire Type A properties which boast higher rents and require less maintenance.
The ability to re-lease existing product remains an important component of shopping center ownership. As in recent years, there continues to be a significant amount of second generation space hitting the market due to the downsizing of “mid-box” or “junior anchor” tenants like PetSmart and Old Navy. Retail developers with downsizing tenants in their portfolios who are able to re-demise the affected space may find willing takers in some of retail’s growth sectors. For example, so called “fast-fashion” tenants like Forever 21, H&M and Uniqlo are actively growing and scooping up second generation space. Likewise, discount and dollar stores such as Dollar General, Family Dollar and Dollar Tree are also in the market for residual space, often in the 5,000 to 10,000 square foot range. Creative use of existing space is not limited to retail developers however, as some larger tenants have begun leasing showroom space in their stores. For example, Samsung is expected to open “ministores” measuring approximately 500 square feet inside some Best Buy stores this coming year. Microsoft also plans to work with Best Buy to create demo space in its stores. Such subleasing is a way for larger retailers to offset occupancy costs without giving space back to their landlords.
In addition to space created by retailers who are looking to shrink their footprints, there continues to be some second generation space on the market resulting from the closings of retailers like Linens ‘N Things, Circuit City and Borders. Fortunately for retail landlords, specialty grocers like Whole Foods, Trader Joe’s and Sprouts have been willing to absorb some of the vacant space, and that trend is expected to continue in 2014. However, the struggles of some of the “big box” tenants has caused concern among developers who count department stores as their tenants. Indeed, some department stores are relying on deep discounting on some of their merchandise just to remain competitive. Similarly, the venerable department store, Nordstrom, has chosen to focus on the growth of its off-price concept, Nordstrom Rack, rather than opening new full department stores. In addition, one report states that more than half of all Saks stores are now Saks Off 5th stores, which is Saks’ outlet concept, and that 13 of the 15 planned stores for the next two years will reportedly also be of the outlet variety. It will be interesting to see how other department stores, such as Macy’s and J.C. Penney, continue to adapt to a market that appears to favor a smaller footprint.
To fill vacant space, shopping center owners are looking to those categories of tenants that have survived the past six years and are currently looking to expand. Fast food and casual restaurants continue to eat up vacant space, led by quick service tenants like Chipotle, Qdoba Mexican Grill and Five Guys Burgers. As with grocery stores, restaurant tenants remain relatively impervious to on-line competition and, in general, appear to be in an expansion mode. In addition, as home values continue to rise, more and more “Mom and Pop” tenants will be ready to sign leases, coupling increased equity in their homes with lenders who are more willing to grant SBA loans and home equity lines of credit. Finally, to fill the smaller spaces, retail developers continue to look to check cashing operations, shipping stores, spa concepts and hair salons, all depending on the demographics of the area in which the shopping center is located and the existing tenant mix.
As has been the case in the past several years, retail developers (whether re-leasing existing product or leasing new, ground up development) are being forced to deal with the challenges brought about by the Internet and e-commerce. More and more retailers are getting involved with so-called “click-and-collect” shopping, where the customer orders online and then picks up the goods at a store nearby. “Social curation” has become a buzzword in the retail industry, and involves the use by retailers of shopper social data from social sites such as Digg and Reddit. That information allows retailers to better merchandise and stock their stores to cater to desires of their customers, which could ultimately result in more efficient use of space and further downsizing. Other retailers are becoming more and more concerned with a “content rich” shopping experience, and are offering in-store only events and services aimed at bringing customers into the stores and keeping them there. E-commerce and the use of smart phones and tablets by customers are likely here to stay, and both retail developers and retailers alike will need to continue to adapt to the changing marketplace.
When it comes to the world of retail development, the undercurrent of optimism from the beginning of 2013 continues to swell. While ground-up shopping center development may still only be faintly visible on the horizon, a more robust housing market, coupled with stronger consumer spending and more available capital, bodes well for an improved year for retail developers in 2014.
Please click here for the full Retail Perspectives 2014 Forecast.