WEDNESDAY, NOVEMBER 18, 2009
by Andy HochbergChicagoThe retail industry has hit one of its most difficult periods in years, perhaps more so than any other sector of the commercial real estate industry.
The primary forces putting the industry in this position are a combination of retail industry and consumer issues. These include an oversupply of product, the state of consumer balance sheets and the lack of venture capital investing in new retail concepts.
From 2004 through 2007, retail development in Chicago was unprecedented, averaging 6.25 million square feet per year according to a report by Mid America. It led to an oversupply of retail space throughout the area. Yet unlike previous cycles, when absorption kept pace with construction, the industry has suffered from a lack of new retail concepts for the market. In the mid 1990s many new concepts were launched under brands such as Builders Square, Home Depot, Phar-Mor, PetSmart, Petco, Omni, Cub Foods and others.
While certain concepts failed, there was a steady stream of new retailers back-filling old spaces with expansion activity. Today, though, there are a lack of ideas and concepts worth funding. Venture capital dollars will remain on the sidelines until there are fresh ideas to captivate investors.
Is it a serious situation? Yes. But the good news is the pace of retail decline has slowed. The quantity of product being developed has been cut dramatically. While retail leasing activity is not absorbing substantial amounts of space, absorption levels aren't getting any worse, in part due to a reduction in the level of new construction.
The good news is there should be acquisition opportunities for buyers with the capital resources to close transactions. The greatest opportunities come from banks and other financial institutions that never intended to be owners of real estate, and undercapitalized developers who do not have the money to operate a property over the long term.
Construction activity will remain at a standstill for the foreseeable future, creating a great opportunity to absorb existing space. Unfortunately, there is plenty of space to absorb without another center being built. We also will see rental rate declines. Most tenants want, and many actually need, relief; yet landlords are concerned with opening the floodgates.
So what will it take to break the logjam? It all comes down to security and savings. People need to feel secure, in the mortgage industry, in the home buying/homebuilding industry, in their jobs and their own personal financial growth. Currently, the American public is focusing more on savings, and on building a nest egg. Once that happens a sense of security and confidence can return to the market.
The overall situation is forcing a return to the fundamentals. On the real estate investment side, net operating income (NOI) will be the key to future value creation, not cap rate compression. NOI translates to yield, and people will chase yield; yield relative to risk is what is important.
From all vantage points, the retail market is in difficult shape. It represents a three to five year restructuring that will have its fair share of winners and losers. The losers are and will be those who ignored fundamentals or simply experienced bad luck and now find themselves with notes that exceed the value of their property. The winners are those who can take advantage of current conditions and either maintain operations at a well-leased, high-quality asset, or create value by turning around an underperforming asset.
Andy Hochberg is the managing principal for Next Realty.More Articles
