The Retail Recovery: A Work in Progress
Daniel Edward Rosen Dec. 8, 2011, 1 p.m.
Along the most coveted urban corridors and across core regional malls owned by the Real Estate Investment Trusts, retail property fundamentals improved in the third quarter.
Modest but observable gains in occupancy rates, rents and sales per square foot in these segments of the retail market contrast with broader metrics, however.
Measured across lifestyle and shopping centers, and among properties not benefiting from institutional ownership or management, retail fundamentals have yet to gather momentum.
Even in the case of some large REITs, relatively tepid improvements in occupancy rates and the dilutive impact of lease rollovers have negatively impacted same-store net operating income.
Capital Markets Pause
The retail sector’s mixed fundamentals trends—combined with the winnowing of investor sentiment at the hands of European and domestic political dysfunction—worked to slow transaction activity in the third quarter. While total volume declined, credit markets remained accommodative of very well-qualified investors. Following a summer respite, retail REITs raised over $500 million in secondary equity offerings in September and October, in spite of exaggerated volatility in stock markets. More recently, Simon Property Group sold $1.2 billion in unsecured debt with $500 million at 2.8 percent maturing in January 2017.
Lenders in the secured debt market have also eased their underwriting criteria along some dimensions, taking greater risks in many cases. The average occupancy rate of retail properties securing new financing declined through the first three quarters of 2011. In the first quarter, the average occupancy rate was just under 96 percent; the median, just under 98 percent. Lending was less restrictive in the third quarter, with the mean and median occupancy rates declining to 94 percent and 95 percent.
A reflection of the year-to-date drop in the underlying Treasury rate, the average interest rate on long-dated fixed-rate retail mortgages has declined from 5.8 percent to under 5.3 percent. In spite of measured sales, those who qualify for financing enjoy access to very favorable terms. Lenders also have a wider cushion over Treasuries than they do for apartment or core office.
Divergent Performance Trends
Apart from access to financing, well-positioned operators are finding an increasing number of opportunities to develop or enhance assets. Simon announced last week that it would undertake an expansion of King of Prussia Mall, already the largest mall in the nation by leasable area, linking the suburban Philadelphia center’s two principle sections and adding roughly 40 stores. Simon had increased its ownership share in King of Prussia from 12 percent to 96 percent in late August. The most productive retail venues are inevitably the first to experience a recovery in credit availability and absorption.
At the King of Prussia Mall, which reportedly generates in excess of $850 million in retail sales per year, at least nine brands have opened locations in 2011. LL Bean, a stalwart of the New England wardrobe, is expanding the scope of its brick-and-mortar strategy in a shift from its long-standing catalog business. Canada’s Lululemon Athletica, a relative newcomer, joined LL Bean in locating to King of Prussia.
King of Prussia is undoubtedly among the most coveted retail assets in the country. Even if the trade area’s demographic trends are lackluster, the strength of the mall’s agglomeration allows it to outperform any generic measure of retail space performance. The balance of the mall’s tenant mix is also a factor, weighed as it is to products and services that have exhibited limited substitution into online sales thus far. Not every apparel retailer is outperforming its benchmark, but losses to online competitors have been measured. Legacy booksellers and electronics retailers face a dimmer outlook. The anecdotal evidence is reasonably reflective of the empirical analysis in this regard. Best Buy, which has a U.S. retail footprint of almost 44 million square feet, offers a case in point. In spite of the demise of its major legacy competitor, the electronics retailer saw its second-quarter same-store sales fall by 2.8 percent, the sixth consecutive quarter of decline.
Qualified Rise in Consumer Spending
For a broad class of retailers in more modest environs than King of Prussia, the consumer tide must rise for net absorption to turn positive. The labor market has struggled to develop momentum, both in terms of job creation and compensation. The nominal value of wages and salaries surpassed its first quarter 2008 peak in the second and third quarters of 2011. But in real terms, there is still a ways to go. In the third quarter, for example, nominal-dollar disposable income rose by an annualized 0.2 percent while real income fell by 2.1 percent.
To the benefit of retailers, personal consumption growth has outpaced wage gains as consumers have grown fatigued of restraint and the notion of deleveraging. The difference in income and spending is observable in a declining savings rate, however. From its most recent peak of 6.2 percent in the second quarter of 2009, the savings rate has fallen to a preliminary estimate of 3.8 percent. As a source of new retail spending, the drawdown on the savings rate is rapidly running its course. Stronger job growth and an eventual rise in disposable income are necessary conditions for sustained improvements in consumption.
Absent a rapidly rising jobs tide, it is apparent that gains in consumption have been uneven. Narrowing the analysis to the retail components of consumption, the data show that year-to-date spending through October 2011 was 8.2 percent higher than during the same period last year. The upside has accrued to nonstore retailers, including online sales, which have risen by 12.8 percent over the comparison period.
On account of fluctuating fuel prices, spending on gas has risen by 19.0 percent. Spending on cars is 10.6 percent higher. Brick-and-mortar retailers have seen trends turn positive, but the extent of the improvement has depended on the type of good and online retailers’ penetration into the market. Sales have been practically flat at electronics retailers and home furnishing stores. Apparel retailers have seen spending rise 5.9 percent.
Sam Chandan, Ph.D., is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.