Pent-Up Shopping Demand Fuels Surge In Retail Leasing

Mirroring the rebound in other commercial property sectors, leasing and occupancy of U.S. malls and shopping centers continued to improve across the country in fourth-quarter 2010, and CoStar Group economists expect demand to accelerate for the next two years as shoppers open their wallets and the economy adds jobs, leading to renewed demand for retail space.

With the very low amount of new supply of retail space and a strengthening economy, retail vacancy rates are expected to continue to decline through mid-2013.

Absorption of retail space, which has been positive for six consecutive quarters, should continue to be positive through at least mid-2012, CoStar Group forecast this week in its Year-End 2010 Retail Review and Outlook. CoStar Real Estate Strategist Suzanne Mulvee co-presented the retail market report with Real Estate Strategist Kevin White.

"Retail real estate fundamentals have closely followed retail sales, which are now looking quite positive. Retail sales turned positive in 2009 and between early 2009 and today, have eclipsed their pre-recession high," Mulvee said. "We're moving in the right direction from a fundamentals standpoint. Recovery is in motion."

Over the last few months, fears of a double-dip recession have eased and GDP growth, now at around 3%, will continue to be strong through this year and into 2012, White said. Consumer spending, which has improved for the last 18 months, ramped up a strong 4.4% in the fourth quarter, the best since 2006. Retail sales are growing at a healthy 7% clip, levels not seen since the housing boom, White said. Household finances have recovered to a reasonably healthy level, and pent-up demand for consumer durables is solid. Spending on health care and personal care are up 14% while food/beverage spending has increased 5% and general merchandise is up 4%.

But the outlook isn't without risk or potential problems, which could cast a shadow over the longer-term outlook later in CoStar’s forecast during 2013-14, White cautioned. Housing remains locked in a double-dip downturn. State and local government cutbacks will continue to be a drag, especially in state capitals and other metros dominated by government. The federal deficit is expected to hit a record $1.5 trillion this year, leaving a 70% debt-to-GDP ratio that could drive up interest rates.

"We're not expecting consumers to lead this recovery by any means, but we also don't expect them to be the huge drag on the recovery that some of the more pessimistic economists expect them to be," White said. The economy should get a boost from pent-up demand for cars, clothing and electronics.

"American consumers went on a buyer's strike during the recession. Finally, they're loosening up the purse strings and there's a lot of pent up demand that will continue to play out over the next year."

Stepped up leasing activity resulted in 13 million square feet of positive absorption in the fourth quarter nationally -- the sixth straight quarterly improvement - with most individual metros seeing a net gain in leased space, including Houston (3.8 million square feet), Washington, D.C. (3.04 million square feet), Philadelphia (2.87 million SF), Boston (2.28 million) and Long Island, NY, (1.87 million) rounding out the top 5 metros that are concentrated in healthier segments of the economy, including energy, government, and health care and education sectors.

The direct vacancy and availability rates declined again in the fourth quarter and appear to have turned a corner, although they remain well above their five-year averages.

Retail construction, like most other commercial categories, remained stifled, with developers delivering a record low of less than 50 million square feet in 2010. Very new supply is in the pipeline, with starts totaling only 23 million square feet in 2010, including just 3 million square feet in the fourth quarter. That compares with 176 million square feet started during the market peak in 2007.

Very few large centers are under construction and projects have especially plummeted for grocery-anchored centers, which are exposed to the weak housing market, as big-box value retailers like Sam's Club and Costco have competed for the dollars of thrifty shoppers.

"We've not yet at the bottom for deliveries of new construction, we're still probably a year away," Mulvee said.

Quoted rents continue to fall and their recovery will trail improvements in fundamentals. With profits rising quickly, matching their 2006-07 levels, retailers are under less pressure to cut occupancy costs.

All told, CoStar forecasts a strong recovery in the retail sector. Deliveries will rise gradually, hitting 40 million square feet by fourth-quarter 2014. Absorption will peak and vacancies will bottom in the first half of 2012, with a gradual decline in absorption through 2014 paired with a rise in vacancy rates as the supply pipeline reopens.

May Newsletter

1Q Bank Results: Potential for CRE Armageddon Fading

Weakness, Trouble Remain but Healthy Lenders Could Carry CRE Markets to Better Days

Although first quarter results of U.S. bank holding companies across the country are unmistakably downbeat about the short-term outlook for commercial real estate in general, and their portfolios in particular, they also hint at a growing sense that the problems are working themselves out.

For starters, banks generally reported that troubled loan assets were systematically moving through their books. For example, older construction loans on commercial developments and owner-occupied properties were being shifted to term loans, giving borrowers a chance to work through slow cash flow periods.

Banks were also widely reporting that the inflow of new nonperforming commercial real estate loans was beginning to slow down. At the same time, more of the loans already being labeled as non-performing were being shifted to the real estate owned (REO) category. From there, it is likely only a matter of time before those assets would be sold back into the marketplace.

In the performing section of their portfolios, banks reported that a substantial portion of those assets have also already been renewed or restructured.

In its April 2010 Global Financial Stability Report, the International Monetary Fund contained a brighter outlook for bank losses in the near term, as expected write-downs on both the loan and securities books of U.S. banks decreased across the board compared to last fall, said Mark Fitzgerald, senior debt analyst for CoStar Group.

"These improved short-term losses are due primarily to two factors. First, signs of an improving economic environment have decreased loss expectations," Fitzgerald said. "Second, some write-downs have simply been pushed forward, as external factors, including low interest rates, have enabled banks to push off distress into the future."

In part because of that delay, the IMF report forecasts real estate loan charge-offs are still expected to increase in 2010 and may not peak until 2011.

"What are the implications for commercial real estate investors?" Fitzgerald asked, then answered: "The banks supply approximately 50% of all debt capital to the sector, so lending capital could be constrained for some time. However, there is a bright side. If we continue to follow our current path, and distressed assets bleed slowly into the market over time, then healthy lenders may have enough capacity to meet low transaction volumes (especially with depressed pricing). The large banks that have recently reported

healthy earnings (primarily due to their trading and fixed-income operations) are a potential source of capital, and these banks have historically been under allocated to commercial real estate compared to the overall banking sector."

However, Fitzgerald added: "On the other hand, if an external factor pushed more distress into the marketplace (i.e. major interest rate increases, changes in regulator behavior), this could create significant opportunities for opportunistic investors."

What follows are recent comments and reports from specific large and medium-sized bank and bankers regarding current commercial real estate portfolio and market conditions and market outlooks. The statements come from first quarter earnings reports, earnings conference calls and monthly banking condition filings with the U.S. Department of Treasury and are believed to be relatively indicative of what most banks reported.

April Newsletter

Big Willie Going Green

In this economic slow down period, business owners and commercial property owners try to differentiate their particular business and properties from the competition.

One of the most popular and rewarding ways to set a business apart is to embrace the popular trend of going green. This is especially true for commercial property owners. Businesses will also be able to take advantage of the trend by locating their businesses in an Earth-friendly building.

Converting an older building into a green building, using LEED standards, will not only increase the marketability of the commercial space, but also lessen the amount of resources used thereby lowering the utility costs.

The owners of the Sears Tower or should we say the Willis Tower (Big Willie) realize the value or retrofitting a property to be more environmentally friendly. The $350 million dollar renovation will start next spring and will upgrade the building from top to bottom. All 16,000 windows are to be replaced together with mechanical, lighting, and plumbing systems. The total estimated base energy savings is an astonishing 80%. Wind turbines, rooftop gardens and solar hot water panels will all contribute to the savings. When all is said and done Big Willie should achieve a Platinum LEED rating, which is the highest sustainability designation of the U.S. Green Building Councils rating system. It is anticipated that the savings achieved from the lowered utilities bills will be passed through to the tenants.

The LEED green building rating system is a nonprofit coalition of building industry leaders and is designed to promote design and construction practices that increase profitability while reducing the negative environmental impacts and improve occupant health and well-being.

The LEED system gives legitimacy to companies who have pledged to go green and invites a larger customer base as well.

Green companies are likely to do more business with other green companies while still maintaining their “traditional” clientele. In the past it was difficult to track how much going green actually saved. Thanks to new requirements adopted by the U.S Green Building Council in order to achieve a LEED rating utility bills will be monitored (but not made public) to determine exactly what the savings are and how they are achieved.

Chicago Commercial Realty Brokerage (CCRB) offers businesses expert advice on how to find buildings and go green. Having been founded in the clutches of a recession and within the trend of going green, CCRB has the insight and expert staff to help companies differentiate themselves from the rest of the pack by going green.

“By becoming a leader in commercial property environmental conservation, you open many more doors,” said Victor Dunbar, President and Co-Founder of Chicago Commercial Realty Brokerage. “As a property owner you have given yourself a competitive edge by providing tenants with a more energy efficient, updated facility. As a tenant you have lowered your monthly base cost and can provide your services at a more competitive price.”

The commercial property idea of going green is not just a trend but also a permanent mainstay. Companies that are proactive in the quest to become environmentally friendly will be ahead of the curve as this will be the way business is done in the future. Building owners holding out by not taking steps to upgrade and adopt green standards may find themselves with a lot of vacant space in the not to distant future. If Big Willie can be converted into a Platinum designated LEED building the thousands of others can too.

By Jim Dunbar

The Time to Buy is Now

For the most part, the investment community has been holding back on commercial real estate acquisitions, waiting and waiting for the market to hit bottom. But according to a new report by CB Richard Ellis Investors, while the bottom may not be at hand just yet, it’s close enough.

Speculation that the market bottom may be near is not pure speculation, there are three reliable indicators; history is one of them. As CBRE Investors’ points out in its new quarterly report, the cumulative NCREIF Property Index depreciation over the last four quarters totals -19.1 percent (of note, the NPI experienced depreciation of -9.5 percent and -8.7 percent in the fourth quarter of 2008 and the first quarter of 2009, respectively). Comparatively, when observing the major real estate slump of the early 1990s, it took the NPI more than twice as long--an aggregate 10 quarters--to experience the same decline.

“This means that while the pricing downturn in the early 1990s took many years to bottom out, the current downturn is much steeper and, therefore, maybe shorter,” the report notes of the first of the three indicators. “At this point, we don’t know if we’re at the bottom, but it appears we’re pretty close, from the pricing perspective,” Lee Menifee, Global Strategy senior director with CBRE Investors, told CPN. “Over the last two or three months, there’s been a firming of prices on income-producing assets with secure tenants, especially smaller deals.”

In a ddition to the NPI pattern, the past behavior of publicly traded REITs acts as an indicator. U.S. REITs, over the years, have served as a leading indicator of private market pricing reductions and recoveries. REITs began their downward spiral in early 2007, while the NPI began its downfall in mid-2008. “Just as REITs led the private markets in 2007 and 2008,” the report concludes, “it is probable that the recent share price recovery is an early indicator that a trough in private markets is coming soon.”

The third sign that the bottom may be within close reach involves transaction volumes, and the fact that they are so low, there’s only one way to go, and that’s upward. “As cash constrained owners increasingly become unwilling sellers, transaction activity will pick up,” according to the report. “An increase in sales will provide needed pricing information to both buyers and sellers. This transparency will both encourage more sellers to offer properties at realistic prices and provide buyers with the confidence to re-enter the market.”

The credit market continues to20be quite inhospitable, but for those who are in the position to buy, the waiting game should be over. “If you are purely focused on not buying until the market hits bottom, then you are not going to buy until

after the bottom hits,” Menifee said. “The point is to be somewhere close to the bottom; if you’re looking for absolute certainty, you won’t get it.” Some investors do get it. “German retail investors investing in open-ended funds are very active in the U.S. They took a breather in 2007 and shut down, but now they’re looking for secure, income-producing assets.”

Looking ahead, transaction volume is on track to increase, with more coveted acquisition opportunities on the horizon. “More deals will be coming to the market in the next 12 to 18 months as sellers become more realistic,” Menifee explained. “The bid-ask gap is closing, although it is taking longer than everyone expected. But the big rush of capital back into assets is a ways off. There are still significant hurdles to overcome in terms of expectations of rent growth and leasing, but property prices are reflecting that; prices are reflecting that downside.”

So, now really is the time to buy; holding out for rock bottom may very well result in lost opportunities. “There’s been so much focus on the downside, particularly over the last year, and there’s been good reason to be mindful about buying properties,” he said. “But much of the downturn has passed and much of the re-pricing has happened. You can still be in defensive mode, but you can buy properties on that basis. In the market now, there are more attractive opportunities, so you don’t need to be an aggressive buyer to take advantage of those opportunities.”

By: Barbara Murray, Contributing Editor to Commercial Property News