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.