COVER STORY, MAY 2010

OPTIMISM & OPPORTUNITIES IN RETAIL

Signs of Recovery in Philadelphia MSA Retail
By Brandon Famous

The retail market within the Philadelphia MSA has weathered these tough economic times remarkably well. Historically, this city and its surrounds do not experience the significant economic swings like many other major cities. As such, the vacancy rates did not increase as much as was anticipated, and rents have been relatively unaffected. From a deal-making perspective, there have been some real opportunities for retailers to capitalize on spaces left behind by players such as Linens ’n Things, Circuit City and a host of car dealerships.

While most retailers would still prefer new development to second-generation space, they are taking a hard look at existing mid-size boxes as a cost savings measure. Due to the recent increase in bankruptcies and store closures, the number of alternatives available to many retailers has increased dramatically. There continues to be strong demand for restaurant space. There is little demand for Class C retail space and lifestyle center offerings. Fortunately, there are still a number of retailers actively engaged in the market. Examples include Kohl’s, Dick’s Sporting Goods, Walmart, Best Buy, Staples, Five Below, Chipotle and a plethora of cell phone stores, among others. In addition, strong local and regional retailers are finding this market to be advantageous. Owners are more open to the possibility of leasing space to this type of tenant, as the demand from the nationals has eased.

Circuit City's and Linens ‘n Things’ closings have had a big impact. In the past, Circuit City would be the only competition for Best Buy. With Circuit City vacated, the likes of hhgregg, Ultimate Electronics and 6th Avenue Electronics have taken Circuit City’s place. They have entered the market, and taken over vacant Circuit City boxes (or others) at significantly lower rental rates with the exception of the strongest retail trade areas.

Generally speaking, the better-positioned real estate has seen less than a 10 percent decrease in rents, on average, while other market rents have dropped by 25 percent or more. While owners have not been forced to markedly drop their rents, creative dealmaking is becoming a more accepted practice.

The sale of Tilghman Square in December of 2009 is representative of the obstacles owners faced in selling a property in the last year. Although Tilghman kept an occupancy rate of more than 95 percent throughout the economic downturn, lenders downgraded its value because of a short-term lease of one of the center’s anchors. With liquidity in the marketplace scarce, procuring financing for a property in the $20 million price range with some credit risk posed substantial challenges. The buyer sought an alternative to traditional permanent financing using a credit line instead. Assuming that they would receive better permanent financing terms at a later date, the buyer took the risk of purchasing the asset with short-term money. It will take this same type of calculated risk taking and out-of-the-box thinking to get deals done in the coming months.

In the next 6 to 12 months, there seems to be an impetus to deploy capital. Most of the equity money has been on the sidelines waiting to purchase “distressed assets.” However, with the dearth of retail properties being offered at “fire sale” prices, especially in the Northeast, many of the distressed asset funds and/or institutional buyers have encountered difficulty in deploying capital so as to meet the return thresholds required by investors. There has been a flight to quality. Now, even traditional value-add/opportunity buyers are seeking stabilized, grocery-anchored shopping centers. Demand for grocery-anchored centers, already favored among retail buyers, has increased over the last several months. At the depth of the recession, cap rates for quality properties were in the 8.5 to 9.5 percent range. With the increased demand for grocery-anchored centers, as well as the substantial equity waiting to get off of the sidelines, these assets may see a downward pressure on cap rates below 8 percent and possibly into the low to mid-7 percent cap range.

The first phase of Tristate Ventures’ Upland Square opened in 2009 in Pottstown, Pennsylvania.

There is little active construction, but it isn’t completely at a standstill. Tristate Ventures LP developed the 688,000-square-foot Upland Square in Pottstown, Pennsylvania. Anchors include Target, Giant, Best Buy, Staples, TJ Maxx, Bed Bath & Beyond, and Petco. The first phase opened in July 2009. O’Neill Properties is developing Uptown Worthington, a 745,000-square-foot center in Malvern, Pennsylvania, to be anchored by Wegmans, Target, Muvico and LL Bean. Wegmans and Target will open in fall 2010. Brandolini Companies is developing the 740,000-square-foot Providence Town Center in Collegeville, Pennsylvania. Anchors include Wegmans, Best Buy, LA Fitness, Dick’s Sporting Goods, Michaels and PetSmart. The first phase opened in 2009. Pineville Properties is developing the 509,000-square-foot Airport Center in Allentown, Pennsylvania. Anchors include Sam’s Club, Target and Staples. The first phase opened in 2009 and the second phase will open later this year. Realen Properties is developing Village at Valley Square, a 425,000-square-foot project in King of Prussia, Pennsylvania. Wegmans will anchor the center.

Retailers new to the market — or expected to open their first stores in the market soon — include 6th Avenue Electronics, Anthony’s Coal Fire Pizza, Barneys New York Co-op, Brick House Tavern, Buffalo Wild Wings, Chipotle, Christmas Tree Shoppes, Clearwire, Elevation Burger, hhgregg, Hobby Lobby, PC Richards, and Ultimate Electronics.

Looking ahead, Fameco is already seeing signs of recovery — from retailers who have reopened discussions about expansion plans, to an increasingly active big-box environment, to restaurants clamoring for space, and from new concepts ready to roll out to landlords discussing ground-up development opportunities. We expect a full recovery in 2011, but we do not expect the retail environment to mirror the same rapid growth as was experienced over the past 5 years.

—Brandon Famous is founder and CEO of Plymouth Meeting, Pennsylvania-based Fameco Real Estate, LP.

Promising Signs Emerge in Boston Retail Market Despite Short-Term Challenges
By Robert Horvath and Todd Tremblay

Workforce reductions continue to drag on the Boston retail market, although hiring will likely resume by year’s end. Losses in the financial and construction sectors have most challenged a rebound in consumer confidence. Nevertheless, retail spending has begun to rise, due in part to hiring among the metro’s education and health services employers. Additionally, employment trends have started to normalize in the trade, transportation, utilities, professional and business services sectors, which should further stimulate spending and lead to milder declines in retail property fundamentals than last year. Retailers such as Five Guys, Sonic, and several national and regional banks have capitalized on depressed rents and moved into previously cost-prohibitive Boston submarkets in recent months. While tenant shuffling will persist through the near term, rent decreases will ease this year as space needs grow in core and affluent areas. Rent gains should not be expected at the market level until 2011, although improving vacancy rates in the Central Boston and South Bristol County submarkets will likely expedite a turnaround in rents in these areas. Outside of these submarkets, reduced construction levels will help decrease competition for tenants.

In terms of fundamentals, vacancy has increased and rents have shown some declines. Receding space demand drove up metro-wide vacancy 20 basis points over the past 6 months, with the average rate ending the first quarter at 7.3 percent. Vacancy climbed 50 basis points in the preceding two quarters. In the West submarket, elevated household incomes have kept vacancy low at 5.7 percent as of the first quarter. Limited construction activity and steady demand should improve the rate to 5.4 percent or below this year. Inventory growth and soft demand will contribute to raising the retail vacancy rate 60 basis points to 7.8 percent in 2010. Last year, vacancy pushed 100 basis points higher. In the past year, asking rents have slipped 1.1 percent to $20.97 per square foot, while effective rents have fallen 4.1 percent to $18.79 per square foot. Asking rents decreased 1.6 percent in the prior 12-month span, and effective rents retreated 2 percent. Metro-wide, concessions average 10.4 percent of asking rents, up 280 basis points annually. Owners have most relied on the use of incentives in the South Shore/North Plymouth County submarket over the past year; concessions in the area have surged 330 basis points in that time to 13 percent of asking rents. Rent and occupancy declines underpinned a 4.9 percent decrease in revenues during the year ending in the first quarter. Revenues receded 3 percent in the previous 12 months.

Despite slowing sales activity, investors continue to put a premium on New England single-tenant assets. In the past year, the median price has appreciated 5 percent to $228 per square foot, after gaining 8 percent one year earlier. So far in 2010, cap rates for top national-credit tenants have stabilized and in some cases have compressed 10 to 20 basis points, with assets trading in the mid-6 to mid-7 percent range. The spread for non-credit deals has widened with average yields clearing the market between 9 and 10 percent. Although exchange activity is beginning to pick up regionally and nationally, the bulk of the buying pool continues to be well-capitalized private buyers looking to take advantage of the market conditions. Institutions and private equity are beginning to re-enter the market. The inventories of new construction single-tenant net-lease retail assets will continue to remain low in New England in 2010, as the current pipeline continues to clear the market and future permitting and development remains stagnant. The lack of single-tenant net-leased retail assets in New England will continue to create a highly competitive buying environment for private investors and institutions.

 — Robert Horvath and Todd Tremblay are senior associates and retail investment specialists in the Boston office of Marcus & Millichap Real Estate Investment Services.

Retail on the Uptick in NYC
By Steven Baker

Spring may have just arrived, but the deep freeze that took hold of the retail real estate market in the last 2 years has been thawing since the calendar switched to 2010. The job losses, unprecedented tightness in the credit market and fear that defined the recession have been replaced by a flurry of activity in the first quarter of 2010 that suggests landlords and tenants alike are beginning to see the light at the end of the tunnel for the retail market.

From our vantage point, all of the main mass market shopping corridors are doing fine. Tourist outlets like Broadway between Canal and Houston Streets in SoHo are holding, as are the markets driven by NYU and Columbia University students. In areas like Herald Square, Fifth Avenue and Times Square, profitable deals are being made. Just look at Forever 21 in Times Square, Aeropostale leasing the former MTV studio space at 1515 Broadway and Bowlmor taking space in the former New York Times building. Duane Reade has signed a good number of deals, and chains like Lululemon, Financier, Urban Outfitters and Fairway are actively seeking space or are rumored to have signed leases in key areas.

In addition to these national tenants moving from the sidelines back to the playing field, we see a flock of international tenants coming on the scene. With the exchange rate currently in their favor, European companies like AllSaints, Topshop, Uniqlo and Desigual are taking space in those aforementioned areas, where availabilities are becoming few and far between. New brands add new flavor to New York’s already busy shopping corridors and will provide the excitement necessary to bring shoppers — and their wallets — into the stores.

A new crop of tenants is also making its way into some of the secondary and tertiary markets. Landlords have begun to consider local businesses and mom-and-pop shops for spaces along Third Avenue and other areas where rents are improving, but still down from the highs of 2008. Cafés, gourmet markets, nail salons, wine shops and cell phone merchants are willing to fill some of the smaller spaces in landlords’ portfolios. Discount stores and fast-casual eateries are also emerging victorious in this current retail landscape.

Of course, both the landlords and tenants have had to make some concessions to bring small businesses into areas that at one point had been out of their reach, but deals are being made when they make sense. Leveling the playing field for the local guys is setting the stage for the next great era in retailing. And that’s a good thing for New York City and beyond.

The local guys understand the New York market and are more willing to ride out its ebbs and flows. They are able to get a foothold in the market now before rents edge closer to their previous levels and, because of the opportunities for expansion in this market, may end up going national. Let’s not forget that all of today’s mighty chains started with one store. As the real estate outlook improves, the only place for us to go is up and those of us who support these new-to-market players might one day be standing on the shoulders of giants.

— Steven Baker is an executive vice president with New York City-based Winick Realty Group.

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