Americans are shoppers; it's embedded in the culture. However, in a recession, shopping habits shift slightly and that change reverberates through the retail investment and commercial real estate industry. As shoppers stock up on the necessities of life at bargain prices, investors look to value-oriented properties that will see them through the tough times.
In light of the recession, the fact that the retail sector performed better in 2001 than in 2000 underlines the core strength of U.S. consumer spending. Even though the declining economy, worsening unemployment, and ever-present fear of terrorist attacks are taking a toll, the outlook is not as bad as some pundits would have us believe.
Healthy Signs In addition to an improving statistical outlook, consumers` recessionary spending habits and the current retail space inventory also support a positive retail forecast.
Retail trends in the current recession likely will mirror consumer behavior during previous ones. Typically, consumers cut back most on durable goods, such as furniture and electronics, resulting in negative growth in those categories. They also reduce their expenditures on soft goods, such as apparel, but at a lower percentage.
In contrast, during tough times, Americans tend to increase spending on food and drink and other local services typically found in grocery-anchored food centers. Their overall tendency is to continue their core buying habits even in a recession. This bodes well both for the retail industry and for the retail space market.
Further good news comes from looking at current supply estimates. The oversupply of retail space prevalent during most of the 1990s peaked in 2000. After hitting a low point in 1993, annual retail completions grew by 9.68 percent per year through 2000. Last year showed only a slight slowing from the 2000 peak, but in 2002, new completions are expected to decline 19 percent from the 2000 peak. Declines are expected to continue, with a 46 percent drop predicted for 2003 and 47 percent in 2004.
These dramatic reductions in expected new retail space inventory, coupled with positive retail sales in 2001 and the anticipated near-term recovery from the recession, are the primary factors that not only insulate most U.S. retail markets from further deterioration but also provide for a projected quick recovery.
Market Outlook As of year-end 2001, the national retail real estate market stood solidly in the contraction phase of the value cycle. All but four of the nation`s top 54 metropolitan statistical areas currently are in this phase, which equates to 96 percent of the total retail stock, up significantly from 75 percent at midyear 2001 and 46 percent at year-end 2000. The remaining four markets -- Columbus, Ohio, Memphis, Tenn., Hartford, Conn., and Las Vegas -- are in the recession phase.
Looking to the short-term future, the proportion of total retail stock in contraction should decline starting this year as the anticipated economic recovery begins and new completions moderate. Total stock in contraction should reach 82 percent in 2002, 42 percent in 2003, and 43 percent in 2004. Markets in recession should increase to 15 percent of total stock in 2002 before dropping to less than 1 percent in 2003 and zero in 2004.
Three of the markets that have the greatest value potential -- Orlando, Fla., Las Vegas, and Atlanta -- currently show double-digit vacancy rates. Still, all three should bounce back in lock step with the anticipated economic recovery. Austin, Texas, and Los Angeles, which are fairing better than the other three markets currently, should show strong gains in occupancy as the economy recovers, helped in part by a major decline in new retail space inventory. Markets with stable value prospects include Oakland, Calif., San Francisco, New York, Boston, and San Diego. Each of these markets will benefit from an improving economy offset by additions to their existing space inventories. Finally, markets with limited value potential include Jacksonville, Fla., Oklahoma City, West Palm Beach, Fla., Riverside, Calif., and New Orleans. All show double-digit vacancy rates yet none is expected to show significant improvement during the next four years.
Implications to Value The value implications for retail real estate are mixed and depend on the property format.
Grocery-anchored strip centers should provide the greatest level of stability in retail sales, occupancy, and rents. Provided that the grocery anchor is one of the top two or three in a market, these centers historically have held up well in recessions. Consequently, these properties have attracted increasing transaction activity in recent months and, along with apartment properties, are a favorite of the institutional investor market.
Power centers, which often are dismissed by investors as overbuilt and subject to the risk of tenant defections to newer and bigger centers, are showing promise in certain circumstances. Those anchored by discount and value-oriented stores -- including Wal-Mart, Target, and Kohl`s -- and various warehouse chains are attracting an increased level of interest from buyers of retail properties. Sites near dominant regional malls provide some of the best locations due to that property types proven market characteristics, which often include above-average household-income growth. Transactions involving these power centers are growing noticeably, which suggests a more mainstream acceptance and likely value increase. By contrast, run-of-the-mill power centers without the popular, sales-busting anchors remain very much out of favor.
Malls, which depend on discretionary purchases of nondurable goods, especially apparel, are facing lower traffic and sales growth than those stores in the value-oriented categories. The dominant malls, many of which also are known as fortress malls, continue to attract institutional investor interest despite stagnant or modestly declining sales during recessions. Protected by leases that span recessionary times and credit tenants whose long-term strategies involve continued mall presence, these top-tier malls either will continue to maintain their values or at worst will suffer minimal, short-term value declines.
Fortunately, modern recessions are short-lived. In recent times, the typical recession lasted only 11 months. Because consumers, as a group, tend to tighten their belts only slightly during a recession, the retail space market is not likely to suffer as much during this current recession as other types of real estate.
The brightest spot in the many-shaded retail picture is the above-average gains in sales by discounters (excluding Kmart), warehouse stores, and other value-oriented retailers. Americans know how to shop, and they know where to find the bargains.
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