COVER STORY, APRIL/MAY 2009

RETAIL CHANGES WITH MARKET
The retail sector is trying to roll with the market changes.
By Stephanie Mayhew Specht

The retail market in the Northeast has always been robust due to the high density, high incomes and high barriers to entry; however, as the economy continues to struggle its way through the current cycle, the Northeast retail sector is having to make some adjustments. In this issue, Northeast Real Estate Business sat down with three retail experts to talk about the retail climate in their markets.

Manhattan Retail

Manhattan has long been known as a Mecca of sorts for retailers and in the past several years just about every kind of retailer has pushed to put their footprint in the city. However, as the downturn continues to churn around the world, even the Manhattan retail sector is feeling it. Christine Emery, senior managing director of The Lansco Corporation, noted that everything is off in Manhattan.

“I think that altogether, the number I keep hearing from both landlords and tenants is that everybody’s sales are somewhere between 25 and 35 percent off. Except for some of the stronger retailers.”

Stronger retailers in this recession have generally been those more attuned to value. Emery’s firm represents Uniqlo, a Japanese retailer that prides itself on not just a low price point but good quality basics that Emery says that the holder of the credit card, mom and dad, can feel good about purchasing for their tweens and teens.

Although the market is down, there are still strongholds within the city that seem impenetrable to the downturn.

“The corner of 57th and Fifth is always in demand, recession or not. I think the same thing holds true for Soho, which is the other main shopping center of the city. It has a great mix of high-end and low-end,” remarks Emery. “Those submarkets just do not lose their value.”

Those two areas are still high on the list for potential retail investors as well. Emery recently sold a property located at the southwest corner of Prince and Greene streets, and while she says that the buyer got a very small discount, they still in reality paid top dollar for the property simply because of the location.

However, the wear and tear from the current climate and rising vacancy rates are being seen as you travel out from these two main shopping districts. Emery explains that some of the smaller retailers are closing up shop as their leases come to an end rather than renew. In the years past, Manhattan landlords enjoyed sky-high rent growth, but now those kind of numbers are just not feasible for many retailers. For example Emery notes that on Broadway between Lincoln Center and 86th Street rents were reaching $350 to $400 per square foot, certainly more than someone can pay today and stay in business. However, today landlords are offering relief.

“Retailers and landlords are intelligent, so you will see landlords reaching out right now and creating windows of rent relief that will be re-visited later,” Emery says. “Landlords recognize what is going on now and they want to keep their tenants. Those that own real estate in this city are sophisticated and have owned their properties for a while, so they know what these recessions are like, and they are responding.”

Concessions are also coming in to play as landlords try to retain their current tenants and lure in new ones.

“Concessions are more generous. For instance, landlords recognize that it is very hard to put together cash to build a store right now because of the credit markets. If a landlord is in good shape financially, they might contribute to that cost, or if they are not in good shape, they might give a longer free rent period depending on the installation, the tenant and the tenant’s credit,” explains Emery. “Either way, most likely they will reach out.”

Emery does note that you will not see these types of concessions in the premier markets of 57th and Fifth Avenue or the corner of Prince and Broadway, but it is happening in the secondary and tertiary markets.

Overall, Emery believes that the recession has in a way helped bring everyone back to a certain degree of reality in regards to what retailers can afford to pay for rents. While this might not be the best news for landlords is has opened doors for some retailers looking to edge their way into the coveted Manhattan retail market.

“What happens to the Manhattan retail sector in a very deep recession, because rents drop and there is more opportunity, the second-tier retailers, the local guys, come back into the market,” explains Emery. “It gives them a chance to see if they can make it in the city, where obviously the returns are well worth the risk if you can make it.”

Emery also notes that many of the smaller fashion and shoe retailers, as well as wholesale retailers are also looking to break into the Manhattan retail sector.

“It is an opportunity for those types of businesses to see if it works. They can afford to take the risk at these new rental numbers,” she says. “Landlords may structure a 5-year lease at a discounted rent with an option to renew at 75 percent of market after 5 years. I think so many landlords, having been through this in the 1980s, know what to do.”

While many of the bigger ticket items are hurting in Manhattan retail, Emery believes that if a retailer has found the right style, the right customer and the right price point, it can and will survive.

Connecticut Retail 

In Connecticut, Matt Halprin of New England Retail Properties remarks that the retail sector there is not much different from anywhere else in the United States. Connecticut has always been in demand because of the higher per capita income in the state, especially Fairfield County, which is so closely tied to New York City. However, the troubles being felt on Wall Street along with what is going on with the global and national economies are having a definite ripple effect on the state’s economy as job losses increase. And as that ripple is being felt, retailers are hurting and some are closing up shop. When asked about retail vacancy rates, Halprin’s reply is simple, but stark.

“I would not even be able to give you a statistic, there are retailers closing up every day.”

However, although some national retailers have retracted and altered their plans for expansion in the state, Halprin says that they are still staying busy at New England Retail Properties. The majority of the current leasing activity is being done by value-oriented retailers that are taking advantages of lower rents and the consumers hungry for a deal. Halprin notes that retailers such as Family Dollar, Dollar Tree, Big Lots, Aldi Supermarkets and Price Right Supermarkets are all making moves in the state. In addition, pharmacies, although they have greatly slowed their expansion in comparison to a few years prior, are still cherry picking locations.

“We just took over a 225,000-square-foot value oriented center in Waterbury, and the rents are as low as I have ever offered before,” Halprin remarks.

Brokers like Halprin are also thinking outside the box to fill vacancies, turning to more service oriented retailers such as medical facilities, off premises dialysis centers and MRI centers.  

“We just did a 7,000-square-foot medical deal for three doctors taking over an old tire store,” says Halprin.

Many of the national restaurant chains are struggling in the current climate as well.

“The national chains may not have been affected in Connecticut specifically by the sales volumes, but they have been affected nationally, and those restaurants that we have here go along with them,” says Halprin. “We used to do a restaurant deal every 3 weeks and now we are doing one every 4 or 5 weeks.”

Some chains have adjusted however and a few smaller concept chains, such as Five Guys Burgers and Fries and Jake’s Hamburgers are even still looking to expand in Connecticut.

As far as rental rates go, it is no longer about Class A, B or C type properties, Halprin notes that rental rates are varying greatly from center to center. He recently received a call from a prospective tenant wanting to open up a small appliance store. When Halprin asked him about lease parameters, he said, “How short of a lease can I get and how cheap can I get the rent?”

“Everyone knows that there are vacancies, so they figure that there is no more market rent, it is what the landlord will lease it for,” he explains. “However, some landlords are hampered by their commitment to their lender as to what their pro-forma rent needs to be, but basically, from a financial point of view, if the landlord has no debt, he can make whatever kind of deal he wants.”

Although in the end, it does not matter what the rent is if there is no one qualified to lease it. Overall, rents are down roughly 20 percent and concessions are going hand-in-hand with just about every transaction. For example, Halprin explains that today, landlords would rather give a concession for TI than pay for a retailer to do a build-out simply because they just don’t know how long a retailer will stay in business in this kind of a market.

“They would rather give a concession for TI and let the retailer spend their own money to build out the space. And maybe instead of a 5-year lease, they would do a 6-year lease for the first year at half rent,” he says. “We have a couple deals like that going on right now.”

As retailers retract and financing becomes more difficult to come by, retail development has slowed as well. In the past, areas of Connecticut like Fairfield County were coveted places to develop because of the incomes and the overall lack of land, but now that has changed.

“There are some projects being discussed along the shoreline, but without tenants they can’t develop them,” says Halprin. “There has been discussion of mixed-use developments in Norwalk and Stamford and Bridgeport, but the mixed-use requires retail and the residential is down, so it may happen, but it is out there maybe 3 to 5 years at best.”

Halprin adds, “They are all on a slow down. We are involved with some big-box developments with the traditional national tenants — Target, Wal-Mart, Home Depot and Lowe’s — and several deals have been pushed back to 2010 to as long as 2013.”

While some retailers are on quiet hold, many are rethinking their game plan all together, revamping expansion plans and looking at developing more efficient prototypes.

In terms of investment sales, it has slowed, but buyers are still interested, although Halprin notes that investors are looking for deals.

“There are those that have cash that want to buy value and they are waiting for the market to get more depressed,” he explains. “We have not seen the commercial properties get foreclosed on by the lenders yet because the lenders have enough of their own problems and do not want to be forced into taking properties on their books. Therefore, many lenders are trying to work with owners and developers as much as they can.”

And while the Connecticut retail sector has not seen properties coming to the market with distressed prices, values have dropped.

“As the tenants leave the market and the income streams drop, coupled with the shorter-term renegotiated leases, the value of the properties drops,” Halprin says.

Similar to other markets around the world, many sellers are not being realistic in their pricing, believing that they should still get what they could have gotten 3 years ago. Halprin recently closed a deal on a shopping center for a 1031 exchange buyer. The deal was closed with a 7 to 8 percent discount from the original September 2008 price. 

“The seller was cooperative in realizing that the value he had negotiated in September 2008 wasn’t there now. They were willing to lower the price to close quickly,” says Halprin.

In addition, if a fair deal can be made between a buyer and seller, the question of tenancy is still a major issue. Halprin remarks that in today’s climate many tenants are considered risky and it is tough to know who is a good credit tenant anymore. Looking to the future, Halprin notes that the state of the retail sector down the road will depend mainly on growth.

“The biggest issue in Connecticut is industry jobs and growth,” he says. “Hartford is the insurance capital in the world and many of the major insurance companies are based here, and at one time were growing at 8 to 10 percent a year. But now with no growth and no jobs there is no retail growth.”

Philadelphia Retail

The city of Philadelphia always seems to stay fairly balanced, never experiencing the dramatic highs and lows that other markets tend to — a factor that can be a blessing at a time like this. According to Brad Nathanson, associate vice president of Investments and director of the National Retail Group in Marcus & Millichap’s Philadelphia office, the retail sector has managed to sustain a healthy balance given the city’s absorption rate on new retail that has been built within the last 3 years.

However, that is not to say that Philadelphia is not feeling some ill affects. Nathanson does note that the city has suffered some job loss and the demand for retail space in Philadelphia has been dampened and is selective at best. 

“The only demand that is arising is for Class A space that is anchored by strong dominant grocers,” he says. “Rents for that space now command the same rents unanchored strips were commanding at the height of the market, hence the flight to quality for tenants.”

Thus, vacancy rates have begun to rise. Natahnson expects that retail vacancy rates will rise to around 9 percent this year.

“There were quite a bit of medium boxes that went with the tri-state market and with the lack of new retailers looking for space, they will probably pull from other centers within those markets, hence the rise in vacancy,” he says.

As vacancy rates increase, owners are feeling the downward pressure on rental rates. While many retailers are clamoring for reduced rents and more concessions, many owners are just trying to keep their heads above water and make a return on their investment. For example, Nathanson notes that in the last 5 years, many un-anchored strip centers were built within the Delaware Valley at inflated land/construction costs. Thus, in order to make a return, developers would need to achieve rental rates in the $22 to $25 per square foot range. But with the rise in utility costs, lack of positive store sales, and the inability of franchised and mom/pop tenants to get max leverage SBA loans due to decreased net worth, Nathanson laments that it is going to be difficult to sustain stabilization within those centers.

Projected market rents for smaller un-anchored space will be in the $17 per square foot range, and for anchored small-shop space rents will be about $19 per square foot.  Landlords of medium-box space were at one time pulling in $14 to $17 per square foot for attractive space within dominant centers, but that number is expected to now range from $8 to $11 per square foot. And Nathanson says that landlords will at least be spending $35 to $50 per square foot in tenant improvement allowances to achieve those rents.

“We are seeing more and more landlords offer 6 months to a free year of rent to attract those businesses into their centers,” he says.

The squeeze on vacancy rates is not just due to retailers putting expansion plans on hold or the lack of new retailers entering the market, but part of the problem is the exit of some once stellar brand names. Some such names include Circuit City, Linen & Things, Tweeter, Steve & Barrys, Office Depot, Value City, Oscar Huber Furniture, Lane Furniture, Starbucks and Ritz Camera.

Natahnson also notes that we might see some national brands such as Rite Aid, Whole Foods, Charming Shoppes, Michaels, AC Moore, Pier 1 Imports, Kmart, Blockbuster, and local Bon-Ton Stores begin to consolidate stores.

“I think the bigger issue facing the Philadelphia retail market is that we expect more retailers this year to leave the market than enter our market overall,” he says.

Some retailers are still expanding though, and like in other markets, it is mostly more service and value oriented retailers such as auto parts stores, dollar stores, lower end grocery stores, convenience stores and gas stations, medium-box discount clothing stores and regional anchor grocers. Nathanson says some specific retailers that he has seen making some moves include Autozone, Advance Auto Parts, CVS/pharmacy, Family Dollar, Dollar General, Dollar Tree, Aldi, Save-A-Lot, Wawa, Turkey Hill, Sheetz, Ross, Marshalls, TJ Maxx, Homegoods, Giant and Shoprite

As retailers leave the market or slow their expansions, and since credit is still a major issue, retail development has slowed in Philadelphia as well. Nathanson also points out that land values have not come down in conjunction with the slow down either.

Worthington, a major mixed-use development in Malvern, Pennsylvania.

However, some major developments are still underway and are expected to come out of the ground this year and next. Worthington, a 100-acre, 2.4 million-square-foot mixed-use development in Malvern, and Providence Towne Center, a 725,000-square-foot hybrid center set on 80 acres in Collegeville, are slated for completion this year. And the Village at Valley Forge a 131.9-acre mixed-use project at the old Valley Forge Golf Course next to the King of Prussia Mall is underway as well. 

“I believe that all three of those projects are going to affect the retail market within Conshohocken and King of Prussia as there is approximately 2 million square feet getting added where your dominant anchor is Wegmans,” notes Nathanson. 

The general balance of the Philadelphia market mentioned above has also helped keep the investment sales market intact. According to Nahtanson, because of the city’s dense population coupled with prime sites, a lengthy approval process and the lack of available land there is still a great demand for product. In addition, the Philadelphia market can still support the absorption needed to keep the market strong.

And while cap rates overall have been fairly consistent in comparison to regions such as the Midwest and Southeast where over-building surpassed population growth, Nathanson does point out that cap rates have increased for some product types. The biggest jump in cap rates was for larger anchor centers with grocers and soft goods as the dominant retailers. A jump, he notes, that took many developers by surprise.

“Those cap rates moved about 100 to 150 bps in our markets to a range of 7.50 to 8.25. The dominant single tenant properties like Walgreens and bank ground leases have moved as well up 50 to 75 bps to 6.75 percent to 7.25 percent,” he says.

Overall, despite any bumps in the road, investors, developers and retailers alike are still bullish on the city. Submarkets such as Gloucester County New Jersey and the Route 422 Corridor in Montgomery County are just two prime areas that have undergone heavy expansions of housing and employment. And according to Nathanson, that should still be the case during and after the downturn because of excess land that is still available, and dominant retail centers that were built in those markets with the likes of Target and Wegmans, and should entice in even more secondary retailers.

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