Retail Property Sector Defies Expectations

Last Updated: February 10, 2012 05:01pm ET

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“Retailers in need of reinvention
will continue to downsize or
close stores that fail to meet
operational hurdles," says Rose.

(Mark Your Calendars: RealShare REAL ESTATE 2012, March 22nd in Los Angeles).

ENCINO, CA-Retail properties performed remarkably well and have a strong potential for an upside surprise despite setbacks to the US economy in the second half of 2011, GlobeSt.com has exclusively learned from a National Retail Report. The report, released by Marcus & Millichap, says that space absorption improved for the ninth consecutive quarter, while construction starts fell to their lowest levels in 20 years.

The report also adds that an anticipated rise in net absorption to 77 million square feet will surpass the 32 million square feet of new supply, tightening the US vacancy rate to 9.2% by year’s end.

“The retail sector’s strong performance defied pundits’ expectations,” says Hessam Nadji, managing director, research and advisory services for the firm. “Retail assets overcame a mid-year plunge, as well as a slide in consumer confidence and a modest contraction in per-capita disposable income.”

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Ultimately, Nadji says, core retail sales increased 6.5% by year’s end, with holiday sales growing by 3.8% over 2010. “Private-sector hiring totaled 1.8 million in 2011, with the addition of 466,000 jobs in 4Q,” he says. “Consumers are still under tremendous pressure, but have shown significant resilience amid the financial-market turmoil and recession talk of the past five to six months.”

All 44 markets tracked in the report’s National Retail Index are forecast to post job growth, vacancy declines and effective rent growth in 2012, with San Francisco, San Jose and Seattle ranking at the top of the index. Technology, tourism and strong outlooks for job and population gains will tighten space fundamentals in the five markets that led advancements with seven-spot gains in the national retail index this year, says the report. These include San Jose (#2) and Seattle (#3) with links to technology, strong incomes and low vacancy; Phoenix (#28) and Portland (#6), which advanced on high-tech manufacturing and retail sales; and Miami’s (#14) big decline in vacancy, aided by tourism and low supply.

“Fortress malls, luxury retail stores and well-located grocery-anchored shopping centers in gateway markets, parallel with wholesale clubs and off-price outlets have outperformed the sector,” says Bill Rose, national director of the firm’s national retail group. “Retailers in need of reinvention will continue to downsize or close stores that fail to meet operational hurdles. Limited expansion plans by other retailers must demonstrate substantial value in both market share and profitability to remain viable,” continues Rose.

Retail investment sales increased 32% from 2010 to nearly $61 billion, sparking a 40-basis-point-decline in cap rates to 7.9% on average, says the report. The biggest gains occurred in the $10-million to $20-million property segment, with transaction velocity increasing 98% on a year-over-year basis. Gateway investment markets of New York, Los Angeles, Chicago, Washington, DC, South Florida and Boston dominated sales activity, according to the NRR.

“Accommodative monetary policy will restrain interest rates for the coming year,” says William E. Hughes, senior vice president and managing director of Marcus & Millichap Capital Corp. Furthermore, global investors seeking safety in the midst of ongoing debt crises abroad will migrate to US government debt, which should keep yields low in the mid-term, he says. “CMBS retail loans totaling $1.5 billion will mature in 2012, but many may fail to refinance in the current lending environment because 81% have LTVs exceeding acceptable levels.”

According to Hughes, “Lending for lower-quality, but not distressed assets will ease until economic performance proves out in the first half of the year. While loan assumptions and seller financing will moderate, they will be enough to fill the financing gap.”

Rose adds that “Favorable risk-adjusted returns will be rewarded to those who invest in major mid-American ‘NFL cities,’ while cap rate compression will continue in major coastal MSAs…Clearly, there is no scarcity of liquidity, and real estate fundamentals will continue to spur increased investment sales and finance transactions.”

For more thought leadership from Marcus & Millichap Real Estate Investment Services, check out "StreetSmart," a blog by Hessam Nadji, the firm's managing director of research and advisory services. The blog provides Thought Leadership positions on a variety of commercial real estate-related issues. Click here to watch Nadji on CNBC's "Realty Check" program talking about multifamily and the housing crash. For more information on the Thought Leadership program, contact Scott Thompson at sthompson@alm.com.

Categories: West, Retail, Marcus & Millichap, Los Angeles

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Retail Property Sector Defies Expectations