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.
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
“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.
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.
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
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.
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.