Low Level of Retail Construction Starting to Crimp Net …

With Development Largely Restricted to Outlet Centers and Mixed-Use Infill Projects in CBDs, Many Retailers Left With Fewer Viable Options to Expand

The U.S. retail real estate vacancy rate drifted down another 10 basis points to 6.1% in the second quarter -- the 12th consecutive quarter of vacancy decline. The retail vacancy rate has already dropped below pre-recession lows in major metros like Boston, New York, and Denver, and demand remains solid despite continued store closings by Sears, Kmart, The Gap, Office Depot, Staples, Macys and even grocer A&P.

As tight as the market feels with the national vacancy rate just 10 basis points shy of its previous cyclical low in 2007, CoStar senior real estate economist Ryan McCullough argues that its even tighter today than at the height of the boom eight years ago.

Today, only 60 million square feet of new retail space is under construction, compared with 150 million square feet that was under construction in 2007 when developers were building or expanding power centers, malls and shopping centers in pursuit of population growth in the suburban fringes.

"You really have far fewer options if youre a retail tenant in todays market, and thats really starting to wear on the demand numbers," said McCullough, who joined Suzanne Mulvee, director of U.S. Retail Research for CoStar Portfolio Strategy, in presenting CoStar's Midyear 2015 Retail Market Review and Forecast. "Whats holding back a lot of tenants today is the scarcity of available supply in good locations with strong demographics."

Tenants absorbed about 32 million square feet at mid-year 2015, compared to 37 million square feet in first half of 2014. The declining absorption numbers in recent quarters are a logical consequence of the lack of available space, rather than declining tenant demand, McCullough said. Until more new supply enters the market, demand is likely to be reflected in terms of higher rent growth rates, he added. Despite the limited supply of available space, the market is still experiencing a bit of opportunistic leasing and store openings by retailers like Wal-Mart, Dollar General and Dicks Sporting Goods, which can be productive in somewhat less attractive locations. McCullough expects such activity will likely dominate retail expansion until new shopping center supply ramps up.

Meanwhile, store closures continue to provide an alternative source of space as stores are eventually shuttered and the space returned to the market.

Office Depot, confronting an 8% same-store sales decline in the second quarter, said Tuesday it would accelerate its store closure plan. The Boca Raton, FL-based retailer now expects to close 175 stores this year and at least 60 in 2016, for a total reduction of 400 stores by the end of next year.

One new twist in the store closure trend is a recent Chapter 11 bankruptcy filing by grocery chain Great Atlantic & Pacific Tea Company (A&P) which is selling or closing all 300 stores in six Mid-Atlantic States.

However, A&Ps strong store portfolio has an average of $2.5 billion in buying power based on demographics within a three-mile trade area. In contrast, Stop & Shops more than 100 stores have $1.5 billion in buying power, while Shoprites 70 stores come in at $1.8 billion.

"Its no wonder than nearly three-quarter of A&Ps planned closures have already been grabbed by Shoprite and Stop and Shop," Mulvee said, referring to the chains plan to sell 120 stores to the rivals for $600 million.

Development is focused around mixed-use single-tenant projects in urban centers, unlike previous construction cycles where retail expanded into suburban markets. Supply constrained markets like Honolulu, New York City and Miami are seeing the strongest levels of new supply.

"This is the type of space that retailers are demanding, so its worthwhile for developers to push through entitlement issues into traditionally difficult markets," McCullough said.

Conversely, markets like Phoenix, Austin and the Inland Empire that dominated the last construction cycle are seeing a fraction of the activity this time around, Mulvee added.

"Part of the reason deliveries are so limited today is because there is a mismatch currently between where its easier to build retail space and where people and their incomes are concentrating," Mulvee said.

Rent growth continues to hold at about 3% annually, mild compared to last cycle, although denser urban areas seeing rent growth of upwards of 7%, while suburban markets where vacancy overhang remains are seeing little rent growth.

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Low Level of Retail Construction Starting to Crimp Net ...