Clouds Are on the Horizon of the Retail Market

The improved economy has allowed the national retail market to improve steadily over the past several years. The vacancy rate declined from 10.5 percent in 1992 to 8.1 percent in 1995. In addition, effective lease rates increased by 2.9 percent from 1994 through 1995. Because the retail market was not as overbuilt as the office market during the early 1990s, the level of retail construction did not plummet to negligible levels. In fact, from 1990 through 1995, the retail inventory increased by 14 percent. Another factor that has led to the improvement of the retail market is strong absorption from 1992 through 1994, which outpaced new construction by 24 percent during this period. However, several market indicators and developing trends have emerged with the potential to dampen the further improvement of the retail market.

Real disposable income increased by 3 percent during 1994 and 1995. However, the level of real disposable income growth is projected to decrease slightly in 1996. The moderate rate of real disposable income growth is reflected in retail sales growth. Retail sales growth decreased from 6.8 percent in 1994 to 3.5 percent in 1995. This slowdown is projected to continue into 1996. Demand for new retail space on an aggregate basis is closely linked to growth in retail sales. Large increases in retail sales support the addition of new retail space. The retail inventory increased by 2.4 percent in 1995. The sluggish rate of retail sales growth casts doubts as to whether the significant additions to the retail supply can be absorbed fully in 1996.

Another potentially worrisome trend for retailers is the surge in the level of consumer installment credit. Consumer installment credit represents loans to households for financing consumer purchases of goods and services and for refinancing existing consumer debt. Installment debt jumped from $882.2 billion in October 1994 to $1 trillion in October 1995, which represents an increase of 13.9 percent. In fact, installment debt has more than doubled since 1985. The high level of installment debt has two consequences for consumers. First, as consumers start to "max-out" their credit cards, they tend to defer purchases of the discretionary goods in order to pay down their credit lines. Consequently, the level of consumer spending decreases. Second, cash purchases increase. This pay-as-you-go approach increases purchase discipline and slows the purchase of big-ticket items that are traditionally purchased with installment credit.

Because retail concepts evolve rapidly and are quickly copied, there is a great deal of ongoing change in the retail industry. Power centers, which were the darling of the industry a few years ago, have lost much of their luster. Some of the older power centers that were built in the mid-1980s have faltered because major tenants have not renewed their leases or have gone out of business. These tenants have consolidated locations into newer and larger stores that are 100,000 square feet or more. The proliferation of "category killer" retailers competing against each other has created a major shakeout in the industry, especially in consumer electronic and business supply categories. The survivors of this shakeout will emerge as stronger retailers with less competition, which translates into fewer tenants for power centers.

Traditional department stores have countered the category killer threat by improving their level of customer service and merchandise selection. However, the category killers have seriously threatened general merchandise stores, which are unable to match the pricing of the category killers or the service and selection of a department store. General merchandise stores comprise the in-line tenants of super-regional, regional, and community shopping centers. As a consequence, regional and super-regional malls have started to experience a higher level of vacancy because of the quick turnover of general merchandise tenants. Historically, super-regional malls have rarely experienced significant levels of vacant space.

During the early 1990s, neighborhood shopping centers were negatively impacted by consolidations and bankruptcies of grocery and drug store chains. Since this shakeout, grocery and drug store chains have experienced greater stability. This has softened lender reluctance to finance new neighborhood shopping centers that feature strong preleasing. However, the financial woes of junior department stores such as Kmart could potentially have a national impact. As Kmart continues to struggle, the decision to shut down stores could seriously jeopardize some community shopping centers.

On the positive side, electronic retailing, such as video shopping channels, has made only moderate inroads into the retail market. The overall market penetration of electronic retailing remains low because consumers remain reluctant to forgo the personal inspection of soft goods that is impossible with electronic retailing. More-sophisticated distribution systems that will offer delivery of products within hours will offer more serious competition to traditional retailers. However, these distribution channels will not be established until the late 1990s.

In 1994 and 1995, large entertainment centers emerged, combining recreational uses that at one time would have been stand-alone facilities. Entertainment centers that include restaurants, theaters, and video game rooms that appeal to a wide variety of age groups have been introduced in power centers and covered malls. These centers have the potential to take some of the sting out of the loss of a category killer.

Over the past decade, the retail industry has quickly evolved to meet the rapidly changing expectations of the consumer. Triggered by high credit card balances, slowing rates of consumer spending growth present a further challenge to an industry that is already beset by intense competition. Flexibility and adaptability will separate the winners from the losers as the competition for sales and market share continues to heat up.

George Green

George Green is a policy representative/senior economist for investment real estate at the National Association of Realtors in Washington, D.C.