Retail

New Digs?

Retailers consider the costs of new construction.

Developers that have been chomping at the bit to break ground on new retail projects are beginning to see a glimmer of hope as retailers accelerate expansion plans.

By all accounts, retail development has remained fairly anemic in the past five years. Retail construction at the peak of the market in 2005 and 2006 reached nearly 245 million square feet each year. Development over the past five years has been a fraction of that pace with annual construction below 50 million sf. New completions totaled 41.5 million sf last year, according to Marcus & Millichap. “So, we are still way off pace by historical standards,” says Bill Rose, national director of the National Retail Group and the Net Leased Properties Group for Marcus & Millichap in Calabasas, Calif.

Although retail construction has been slow to return as the market has worked to absorb excess space, the pipeline of projects is growing. Marcus & Millichap predicts that retail completions will creep higher to 56 million sf this year, while vacancies are expected to improve a further 70 basis points to reach 6.5 percent by year-end. Retailers and restaurants are starting to expand again, and they do have an appetite for newly built space as they continue to seek out new markets.

“What we have seen, since allegedly coming out of the recession, is modest growth and optimism,” says George C. Larsen, CCIM, a partner at Larsen Baker Development, Brokerage & Management in Tucson, Ariz. Retail development has been ongoing even throughout the recession, but that new construction has been very selective. Construction returned to Tucson in 2011, yet that activity has been driven entirely by single-user retail or restaurant expansion.

Retailers such as Walmart, Conn’s, and Guitar Center, along with the drugstores and dollar stores, have been adding new outlets. For example, Larsen Baker is currently developing a new 40,000-square-foot store for Conn’s, which will occupy the building on a 10-year triple net lease. Restaurants such as Smashburger, Culver’s, and Freddy’s Frozen Custard & Steakburgers have built new stores in the Tucson area over the past few years.

What is noticeably absent in Tucson, and in most markets around the country, is speculative retail development. Even sizable pre-leased shopping center projects are scarce. “It is fairly difficult to get anyone other than restaurants to step up to the rents that are needed for new construction,” Larsen says.

Single-Use Activity

Although outlet centers have enjoyed a building boom in recent years, much of the retail development occurring around the country has been fueled by single-use retail projects ranging from Walgreens and Family Dollar to Walmart and Chick-fil-A. According to a ChainLinks Retail Advisors report published last fall, restaurants and retailers were planning to open an estimated 38,000 new stores in the U.S. over the next 12 months. Restaurants accounted for a sizable amount of that growth with 44 percent or about 16,720 new stores.

“We have actually seen a pretty big resurgence in new retailers coming into the marketplace,” says Ira Korn, CCIM, a managing director and partner at Coldwell Banker Commercial Meridian in Rochester, N.Y. Field & Stream recently announced its plans to open a new store in Rochester and a new Costco is underway, marking the retailer’s first store in Upstate New York. In addition, the North Face and L.L. Bean have both opened within the last 18 months.

“We’re also seeing the growth of a lot of quick-service restaurants,” Korn says. Over the last 12 months, Dairy Queen, Sonic, and Corner Cafe among other quick-service restaurants have entered the market.

Rochester is situated in Upstate New York along with Buffalo and Syracuse. So, oftentimes retailers will put one store in Rochester first to see if it works and then expand west to Buffalo or east to Syracuse. Retailers also like the city’s stable economy. “There is still a lot of vacancy in the regional centers, especially the smaller ones,” Korn says. The market will have to absorb that vacancy before it sees any significant shopping center development. “I would say that we are at least three years out on that type of development,” he adds.

Retailers remain very cautious and thoughtful in their approach to new stores. They are looking to fill in their existing footprint with new locations that have strong demographics. As such, retail developers that are pushing forward with projects are sticking close to a sure thing — population densities.

“You need a site that is in demand,” says Chris Moe, CCIM, a partner at H.J. Development in Wayzata, Minn. The firm has a retail portfolio of about 1.2 million sf in the Twin Cities. Developers can’t go too far out to an outer ring suburb and be able to attract tenants. “As soon as you get out of those top-tier trade areas, there is not going to be any new development for a while, because tenants are not willing to pay the higher rents that you need to justify ground-up development,” Moe says.

Bringing in mixed-use components such as clinics or dentist offices also has helped to anchor new retail projects. H.J. Development currently is working on Woodbury Plaza, a 15-acre mixed-use development in suburban Minneapolis-St. Paul. The first phase of the project will feature an 18,000-sf medical office building, a 6,000-sf free-standing credit union, and two 7,000-sf multitenant retail buildings.

Still Following Rooftops

The current pipeline of retail projects runs the gamut from New York and Miami to Fayetteville, N.C., and Boise, Idaho. So how are those markets and submarkets attracting that growth? Certainly, urban in-fill projects have been a hot ticket as retailers look to get a foothold in markets with strong demographics. The old adage about retailers following rooftops continues to be a key factor for expansion decisions. Retailers are targeting population and household growth, and they are attracted to markets with stable and growing economies.

Fayetteville is one market that has several large retail projects that are either already under construction or proposed. “Over the past 18 months, there has been a very noticeable pick-up in the demand for retail space and the interest from developers in building in this market,” says Patrick Murray, CCIM, CLS, owner and broker in charge at Grant-Murray Real Estate in Fayetteville.

Fayetteville is home to Fort Bragg, which is one of the largest military installations in the world. Over the past several years Fort Bragg grew as a result of the Base Realignment and Closure Commission, which created a lot of new demand for office and industrial space in the region. The office market cooled along with sequestration. However, the retail growth in the past year has been tremendous in comparison to the past, notes Murray. The increased population and growth in higher-income families that moved here because of BRAC has helped the city’s retail and restaurant sector flourish, he adds.

For example, CBL & Associates Properties recently completed a nearly 50,000-sf expansion at its 1 million-sf Cross Creek Mall. Across the street, the new owners of Marketfair Mall are transforming the former enclosed mall to a higher-end outdoor lifestyle center. “It is drawing nationwide attention from a lot of retailers,” says Murray, who is the leasing agent on the project. Anchors include Carmike Theaters, Gander Mountain, and H.H. Gregg, and the redevelopment is scheduled for completion in October.

Boise also has seen a spike in its retail development with notable projects such as Eighth and Main, which opened this year and brought more than 29,000 sf of retail to the downtown area.Ruth’s Chris Steak House opened in the new building in February and will be followed shortly by local concepts. CenterCal Properties also recently completed phase two of The Village at Meridian, a 500,000-sf retail entertainment development. The south phase, which opened last October, features lifestyle tenants new to market such as Charming Charlie, Yard House, and the Kona Grill.

One of the reasons that the Boise market is getting more attention from retailers now is that the MSA population has surpassed 600,000. “It does put us on the radar a little bit for size,” says LeAnn M. Hume, CCIM, CLS, managing director and retail and investment specialist at Cushman & Wakefield/Commerce in Boise. Boise also has had its first Whole Foods and Trader Joe’s open in the marketplace. “That catches the attention of other retailers and gives them an indication that it might be time to start looking at Boise,” she adds.

Such pockets of opportunities exist around the country. Another promising sign is that vacancies continue to improve in many metros. For example, cities such as San Francisco, Pittsburgh, Salt Lake City, and Honolulu are some of the tightest markets, with retail vacancies dipping below 6 percent. As space becomes more difficult to find, particularly in newer class A properties, retail construction will gradually creep higher. However, there are no signs that activity will accelerate more rapidly in the next 18 months.

A number of factors need to align to expand the development pipeline. The biggest factor may be time. “Vacancy will continue to improve and rents will rise in those core MSAs that are enjoying job growth,” says Rose of Marcus & Millichap. The return of more widespread development will depend on the economy, stronger retailer demand, and available financing. “We have to continue to monitor job growth, which is becoming favorable,” he adds. “We have to continue to market to capital markets. If capital markets don’t support new construction in certain markets, then we are not going to see significant new construction.” Lastly, more robust development will weigh heavily on the retailer, particularly the department stores and big-box retailers that have the ability to anchor significant mall and shopping center projects, he says.

Beth Mattson-Teig is a business writer in Minneapolis.

Stumbling Blocks

by Beth Mattson-Teig

Although the retail sector is beginning to recover, the sector still faces daunting challenges that are impeding the return of new construction.

Some of the factors squeezing the development pipeline include excess space that continues to hang on the market, lackluster rent growth, and more-stringent financing requirements.

Owners have been working to backfill empty space. Yet there continues to be dueling forces in the industry with the moderate demand for new space at odds with continued store closings. Major announcements in first quarter included Radio Shack’s plan to shutter 1,100 stores and Staples’ intent to close 225 stores. Although vacancies among neighborhood and community centers declined slightly to 10.4 percent at the end of 2013, they remain elevated compared to 2008 levels when vacancies were at 8.9 percent, according to Reis.

One of the challenges is that construction costs have risen in the last couple of years, while rents have increased very little over the past few years. In fact, effective rates for neighborhood and community centers that averaged $16.83 at the end of 2013 are just 8 cents above 2009 levels, according to Reis. So, it is a challenge for developers to get the rents to cover the higher construction costs and still make a reasonable return. “Our development pipeline is fairly active right now, but only because there has been some tenant requests for space,” says George C. Larsen, CCIM, a partner at Larsen Baker Development, Brokerage & Management in Tucson, Ariz. “We feel that many tenants find it difficult for them to make money at the rents it requires, because new construction is expensive,” Larsen says.

In Tucson, for example, it is difficult to do new construction without collecting rent above $20 per square foot per year net. “That is hard for a lot of merchants to pay,” Larsen says. In addition, tenants can go down the road and find an existing, 10-year-old shopping center that they can get for $12 psf, he adds. National restaurant chains and service businesses such as spas and yoga studios have proved willing to pay top rents. But, apparel retailers and local restaurant operators still have a very difficult time justifying those higher rents based on current sales, he adds.

“In terms of new junior box development, we need the tenants that occupy that category to come to terms with the economics of new construction and the rent required to make the deals pencil for developers,” says Chris Moe, CCIM, a partner at H.J. Development in Wayzata, Minn. “The days of desperate landlords are over and the deals they struck cannot be duplicated in a new-construction scenario.” In addition, that same group needs to gain a better understanding of the impact that kick-out clauses, co-tenancy requirements, and caps on common area maintenance charges have on a developer’s ability to obtain financing for a project, he adds.

Obtaining construction financing is another challenge. Lenders are typically looking for pre-leasing commitments for retail projects of about 75 percent. “The financing is such that you still have to have significant pre-leasing to get a project out of the ground if you are using bank debt,” says Moe.

Beth Mattson-Teig

Beth Mattson-Teig is a business writer based in Minneapolis.

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