Retail

Retail Redux?

In some markets, a good space is hard to find.

By Beth Mattson-Teig |

Retailers that are back in expansion mode are bumping up against a big obstacle — a lack of inventory when it comes to good real estate locations. The limited supply of new retail construction has been a huge help to improving absorption and vacancies. Yet the market has reached a tipping point where good space is hard to find, and many retailers are still reluctant to commit to the higher rents now needed to support new development.

“Tenants have taken their foot off the brake and are very aggressively pursuing deals again,” says Brian Sorrentino, CCIM, director of ROI Commercial Real Estate in Las Vegas. There were 4,490 proposed retail and restaurant store openings in 2014, according to the International Council of Shopping Centers, with dollar stores the most active sector. In addition, the nation’s largest restaurant chains grew their unit count by 2.2 percent, to more than 220,000 locations, according to Technomic’s 2014 report on U.S. restaurant chains.

Deceptive Calm

The broad industry view shows a retail recovery that continues to move forward at a fairly sedate pace. During 2014, the improvement in occupancies at neighborhood and community shopping centers was relatively flat. Vacancies declined just 20 basis points for the year to reach 10.2 percent, according to Reis. Last year, mall vacancies actually rose 10 basis points to reach 8 percent, due in part to a number of Sears store closings during fourth quarter.

However, a deeper dive into individual markets reveals a completely different story. Retailers and restaurants are back in full force looking to open new locations, and they are having an increasingly difficult time landing prime locations amid stiff competition. “There has been very little new space delivered to the market since 2009, and everyone is fighting for the same space,” Sorrentino says. “Good space is very tight, and nobody wants the overbuilt secondary space.” In Las Vegas, for example, there is strong demand from quick service restaurants looking for 2,500-square-foot end-caps with patios, which are locations that are few and far between, he adds.

In Memphis, Tenn., retailers such as Ikea, H&M, and Bass Pro Shops have recently opened new stores or committed to leases. Wireless carriers such as AT&T, Verizon, and T-Mobile are continuing to grow. On the restaurant side, fast casual concepts have been thriving, along with renewed activity from QSRs including Hardee’s, Dairy Queen, and Krystal. Specialty grocers such as Sprouts, Fresh Market, and Whole Foods also have been expanding.

Two big challenges for many tenants are the lack of available quality space and rising rents. Several years of limited new supply coming online coupled with continued expansion by both retail and restaurant tenants is creating a shortage of quality space. “We saw so little development through the great recession, other than build to suits, that robust demand is far outstripping the supply,” says Shawn Massey, CCIM, CRW, CLS, a partner at the Shopping Center Group in Memphis.

Back to the Future

Although the current competitive market is starting to recall the frothy market of 2005–06, when a high level of expansion created intense competition for top retail real estate, today’s market has a key distinction. A decade ago, if the right space didn’t exist, someone built it. Today, that is not the case, at least not yet.

“I think we are going to see new projects coming out of the ground again in the next six months,” says Dave Denton, CCIM, vice president of real estate brokerage at DAR Development in Grand Rapids, Mich. “But the difficult part is the pricing difference between new construction and existing space that is good quality and in good locations.” Buildings costs have increased in recent years, making new space more expensive.

For example, top rates for existing retail space in Grand Rapid’s main retail corridor are between $16 and $22 psf triple net. New construction in the same area would rent for $35 psf or higher. Some national retailers can pay those rents, but smaller shops and franchisees in this market just can’t pay $35 or $45 psf and make money, Denton says.

A second key difference in today’s retail market is the sizable performance gap that exists between class A space and that of class B and C centers. Tenants are gravitating toward quality properties and locations, while secondary and tertiary retail corridors and B and C locations continue to struggle in many markets. “There are landlords that are still in tough situations with large vacancies, but that is not where the active retailers are going to look today,” Denton says.

Midwest Attracts Retailers

Retailers and restaurants are accelerating store growth by expanding in existing markets and entering new markets. Lincoln, Neb., for example, landed on the radar for many national restaurant and retail chains after the city opened the Pinnacle Bank Arena at the edge of downtown in 2013. “When we opened that arena, it really put us on the map nationally, and we started getting a lot of attention,” says Robin Eschliman, CCIM, president of Eschliman Commercial Real Estate in Lincoln. The arena also has sparked ancillary development, including restaurants and two hotels, as well as condos and apartments.

In Lincoln, Chick-fil-A, Dunkin’ Donuts, Slim Chickens, H&M, Marshalls HomeGoods, and Aldi have all opened new stores in 2014 or are set to open stores this year. Many of those brands are new to the market. “We’re like a lot of places. We have a very small amount of class A shopping center space or high quality corners and pad sites for new drive-thru restaurants,” Eschliman says. Most of the vacancies are concentrated in the older class C shopping centers or areas of the city that have less attractive demographics and lower incomes.

However, the increase in retail activity has helped to revive a stalled retail project located in the far southern part of Lincoln that has sat largely empty for several years. The Wilderness Hills shopping center was built in 2009 next to a Kohl’s store that was completed in 2008. Although the nearly 500,000-sf project was ill-timed with the recession, the shopping center is now seeing fresh interest. A Marshalls HomeGoods store and an Aldi grocery store opened there last year, and there is more interest from retailers to lease space in that center, Eschliman notes.

After recently hitting the 1 million mark for population, Grand Rapids also is getting more interest from national retailers new to the market such as Trader Joe’s, Dave & Buster’s, and West Elm. On top of that, existing chains are looking to expand their presence in the metro. “We’re seeing a lot of demand for space, but unfortunately from a broker’s perspective, not enough space,” Denton says. As a result, some of the older and empty space is starting to be repurposed. In Grand Rapids, for example, a vacant Barnes & Noble store was converted to a Dave & Buster’s, while a long vacant Ruby Tuesday’s was razed to make way for a Trader Joe’s.

Rents Move Higher

Clearly, the pendulum is swinging back in favor of the landlord. “Our market has been very active,” says Jorge Rodriguez, CCIM, director of central Florida retail at Colliers International in Orlando. The Greater Orlando area was one of the first Florida markets to recover, in large part because of a record number of visitors to the region in the past few years. Last year, there were some 59 million visitors to Orlando.

Second-generation restaurant space is almost non-existent. Boxes and junior boxes also have been very active in Orlando, and large spaces between 20,000 sf and 40,000 sf are extremely hard to find, Rodriguez says. Those spaces where there are more options are often located in “transitioning” markets where tenants are leaving the market for various reasons, such as a shift in the trade area or more competition from newer centers, he adds.

As the supply of space shrinks, many landlords are offering fewer tenant improvement dollars and pushing rents higher. During 2014, asking and effective rents for neighborhood and community centers increased a modest 1.8 percent and 2.0 percent respectively, roughly the rate of inflation, according to Reis. However, rent increases vary depending on the conditions within specific markets, trade areas, and individual properties.

In hot markets such as Orlando, rents have climbed into the $40s psf for space in new developments, and Rodriguez is currently negotiating a lease for a national fast casual chain where the rent is nearly $50 psf on a newly built location. Even in 2006, during the competitive market prior to the recession, rents were only at about $40 psf, he adds.

As supply of space shrinks, rents are trending higher, particularly for strong locations, agrees Massey in Memphis. “We are starting to see some of the highest rents ever quoted and actually signed in the Memphis market,” he says. For example, Massey has done some deals that are north of $50 psf for new construction — the highest level he has ever seen in his 14-year career.

“Our biggest obstacle with lack of supply is that landlords of the better properties are asking rents that are much higher than the market will bear out in the long term,” Massey says. He doesn’t think the high rents are sustainable over the long term for most tenants. “Many tenants will need to come back to renegotiate their rents to a level that aligns with sales,” he says.

Tenants are finding that they need to be aggressive, move quickly, and even be willing to think outside the box to find space in today’s competitive market. One option is to buy out another tenant’s lease that is looking to close, or contacting a landlord about a space before it is vacant. Maybe that existing retailer is not healthy or is behind on rent, Rodriguez says. “There are ways to get creative in the market to try to get good spots,” he says.

Beth Mattson-Teig is a writer based in Minneapolis.