As the U.S. Economy Goes, So Goes Retail

When we look at the performance of the retail sector of the building sales market, we generally look at how the retail rental market is doing to gain some insight into what can be expected on the sales side.

blitt bob knakal As the U.S. Economy Goes, So Goes Retail

Robert Knakal

To a large degree, the health of this sector is dependent upon consumer sentiment and, subsequently, consumer spending. Essentially, the better people feel, the more they spend.

And the more they spend, the better this sector performs. It can be said that the retail market is a microcosm of the broader economy, and with good reason: 70 percent of America’s output, or gross domestic product, is based upon consumption, so as the U.S. economy goes, so goes retail.

The best gauge of consumer sentiment is the Thomson Reuters / University of Michigan index, which has been around since the late 1970s. The index’s all-time high was in 2000 at about 111, and its all-time low was in 1980 at a level of about 52.

During the recession in the early 1980s the index was at about 62, during the recession in the early 1990s it was about 55, and during the recession in the early 2000s it was at 82. During our most recent recession, sentiment bottomed out at about 57.

Recently the index has been very volatile while trending upward, and during November Americans became more hopeful about the economic outlook as sentiment on the index rose to 64.2 from 60.9 in October. This level reflected a five-month high but was somewhat muted by the fact that most respondents to the survey still retained a relatively gloomy view of personal finances.

Despite the persistence of relatively low consumer sentiment resulting from negative views of the government’s economic policy, concerns about the economic health of the European Union and high unemployment (notwithstanding Friday’s jobs report), consumer spending has been consistent with economist’s censuses of continued modest growth in real consumption. These consumer spending trends have been more bullish than consumer sentiment would dictate and this positive trend has seeped into the retail market, particularly in the Manhattan submarket.

The market for retail investment properties in New York City has seen volatile swings that have moved in concert with economic conditions since the downturn began in 2008. The retail market here generally tends to outperform most U.S. markets as New York City is considered to be significantly under-retailed, which creates tremendous demand for the relatively limited retail space that exists.

Across the country, most major cities have approximately 22 square feet of retail space for every resident. In New York, there is approximately 7 square feet of retail space per each New Yorker, resulting in a significantly undersupplied marketplace. This scarcity exists because even if a new 50-story building is constructed, there is only one ground floor for prime retail use.This scarce supply of space exerts upward pressure on retail rents and creates significant investor demand for this space.

Citywide, the dollar volume of retail property sales was very strong through the first 10 months of 2011. Through October, retail property sales transactions added up to $1.325 billion. If annualized, this sector will produce approximately $1.6 billion for the year, which would represent about a 78 percent increase over the $900 million that occurred in 2010. This figure also would be more than triple the $450 million that the market saw in 2009.

As is always Massey Knakal’s practice, we examine the total number of properties sold more closely than the dollar volume due to the city’s propensity to have several very large transactions that can skew dollar volume metrics.

Citywide, the volume of retail property sales, on a number-of-buildings-sold basis, is increasing significantly from the low point experienced three years ago. During 2009, there were 127 retail buildings and retail condominiums sold. This figure increased to 160 in 2010, and through October 2011, we have already exceeded that amount with 170 sales. On an annualized basis, the retail sales market is on pace for 204 sales this year, which would reflect a 28 percent increase over 2010 totals.

Surprisingly, a tremendous amount of this activity has come in the Queens and Brooklyn submarkets, where we have seen retail property demand increasing. Not surprisingly, within the Manhattan submarket we have seen the most retail properties sold even though this submarket contains the fewest total properties within all submarkets. Thus far in 2011, Manhattan has had 72 retail properties sold with a total dollar volume of more than $1.1 billion. This high number is mainly due to the phenomenon of so much condominium construction leading to, sometimes, several retail condominiums being sold by the sponsor of a single building.

The value of these properties has also taken a roller-coaster ride since 2007. During the peak years of 2006 and 2007, we were selling retail properties and retail condominiums routinely at 5 percent cap rates, regardless of the quality, credit or nature of the tenant. During the low point in the market in 2009 and 2010, capitalization rates on retail had hit a high of 7.44 percent.

Today, cap rates are compressing sharply once again and it is difficult, in the Manhattan market anyway, to find a cap rate on income-producing retail above 6 percent. Clearly, the historically low interest-rate environment is helping to exert downward pressure on yield and will continue to do so if rate remain at these levels.

The retail market, like all other sectors, was hit extremely hard during the downturn based on plunging consumer sentiment and lackluster consumer spending. During the past several quarters, we have seen healthy increases in consumer confidence and consumer spending that, in New York City particularly, has helped fuel excellent activity in this market segment.

Although these trends are generally positive, volatility month to month has created growth well below trend and this is expected into the foreseeable future until the employment picture gets noticeably brighter.

Robert Knakal is the chairman and founding partner of Massey Knakal Realty Services and in his career has brokered the sale of more than 1,175 properties having a market value in excess of $7.8 billion.

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