COVER STORY, SEPTEMBER 2007

STRONG & STEADY IN PHILLY AND NEW JERSEY
Experts believe that the Philadelphia and New Jersey retail markets show strong activity.
Stephanie Mayhew

Barneys CO-OP is taking advantage of prime downtown Philadelphia retail space with a new store in 10 Rittenhouse Square.

Despite some obstacles, the retail markets in Philadelphia and New Jersey continue  to show strong activity and steady growth. Northeast Real Estate Business sat down with a few experts in the retail market to discuss the current activity in these two viable Northeast markets.

New Jersey

Low vacancy rates, moderate rent growth and a limited supply of competition lend to a strong retail sector for New Jersey in 2007. Known for its robust demographics and its close proximity to New York City, northern New Jersey has long enjoyed a vibrant retail market, especially along the Hudson waterfront area across from Manhattan. Central New Jersey has also long held its own in the retail arena and now southern New Jersey is experiencing a growing retail market as the residential population continues to move south in search of more affordable housing options for their dollar. Retail developers in turn are following suit.

Mark E. Taylor, the senior director of the National Retail Group for the Taylor-Zang Retail Group of Marcus & Millichap, and Christopher A. Munley, a sales associate of the Taylor-Zang Group, note that southern New Jersey has become the next hot bed of retail activity in the state. “It is well known that Cherry Hill, Mt. Laurel and Morristown have all of the retail in the world, but if you head south into the Vineland and Millville area and Salem, Gloucester and Cumberland counties, there is definitely a push for retail as the population moves in that direction,” says Taylor.

Robert L. Samtmann Jr., of Equity Retail Brokers, echoes Taylor’s remarks, noting that “A strong number of retail projects are being driven by residential growth, specifically along the Route 322 corridor, which is becoming more of a commuter artery for housing developments in Logan, Woolwich and Harrison Townships.” However, retail developers are not just simply following rooftops. The suburban areas of southern New Jersey contain larger tracts of land at cheaper prices than denser northern New Jersey, allowing developers to build the larger power and lifestyle centers that consumers are demanding. “The movement is not into secondary and tertiary markets per se, but into suburban areas where there is more acreage for developers to build on,” Munley remarks.

However, James Aug, senior vice president of CB Richard Ellis in Hoboken, New Jersey, explains that many developers are still looking to the downtown areas for retail development because of quality transportation access and more infrastructure investments in the downtown areas themselves. Mixed-use developments are springing up in urban areas in New Jersey, bringing with them sought after retail components.

Some residents of New Jersey, often those pushed out of the astronomical New York City housing market, are choosing to take up residence in new multifamily developments with retail components or in true mixed-use developments within metropolitan areas in order to avoid long commutes from the suburbs and to live in a work, live, play environment. “Downtown developments in Montclair, Eglewood, South Orange, Hoboken and Fort Lee will continue to be a driving force for retail in northern New Jersey,” says Aug. “In general, though, the New Jersey market will outperform many other markets due to high incomes and density.”

Lifestyle centers and power centers may be the new buzz words in the retail sector, but according to Taylor, there is not one type of retail development that is more popular than another in the New Jersey market, and the kind of development constructed comes down to several different factors. “The type of retail development in New Jersey depends on the geography of the location, the amount of square footage the developer is able to build on and what the township or the county or the jurisdiction involved wants,” says Taylor. “It is also indicative of which tenants want to be in which market.”

Munley concurs, noting that the demographics of an area can also affect what type of retail development will be successful as well as the type of tenants that center will be able to retain. “If you are in a small town, even if the center has a strong position on a corner with a light, it really still depends on demographics as far as bringing in a national retailer,” remarks Munley. “Centers need an anchor such as a drug store or a bank as a pad site to gain exposure and really grab those type of tenants.“ Munley.

However, there are always exceptions. “Drug stores are trying to go everywhere in every income bracket on a freestanding pad, and fast food retailers and banks can go almost anywhere as well,” says Taylor.

In New Jersey, the national retailers are a hot commodity for any new or existing retail development. Samtmann explains that reliable household names such as Target, Wal-Mart, The Home Depot, Lowe’s Home Improvement Warehouse, Kohl’s, Best Buy, and Circuit City are strong anchors for any project, adding a certain sense of reliability and gravity to any center. “When we see these stores in a market, we know there is existing population density, or that the density is on the horizon and that other national tenants will follow them into a project or a market,” says Samtmann. “Even when these anchors experience ‘blips’ in sales as an organization, they remain strong, successful tenants that can boost the overall success of a project.”

Samtmann believes that “Main Street” town center concepts will become a viable trend for future New Jersey retail; however, he is quick to note that this type of retail development can come with its own set of challenges. “Many town leaders want a new shopping ‘village,’ but the concept can present obstacles for stores that often must alter their design prototypes to fit township edicts,” he says. “Also, developers are being challenged by high construction costs, which result in high rental rates, and leases for many of the ‘Main Street’ tenants are burdened with co-tenancy clauses that may reduce rents or cancel contracts if occupancy drops,” he says. In order for this concept to truly catch on in the New Jersey retail sector, Samtmann says that the industry will be looking to see whether proposed Main Street projects get built and leased, and whether the tenants in existing projects are making sales.

However, despite some major retail development in certain areas of New Jersey, developers still face strong barriers to entry throughout New Jersey due to stringent building and zoning regulations and community opposition to new development. Taylor remarks that a number of retail proposals are still moving forward, but says, “It has been tough to get the ‘go ahead’ from community officials to allow the developers to build.”

Community apprehension has not been the only hindrance for retail development in New Jersey — the lending community and Wall Street are adding another roadblock to potential retail projects. Lynn A. De Marco, managing director of Staubach Capital Markets, notes that due to the current issues and events on Wall Street, lenders have become more conservative across the board. “The shift is a response to concerns with ‘other’ types of securitized debt, in particular sub-prime residential lending,” she says. “The pushback by buyers of the bond issues secured by riskier credit has created a backlog of debt waiting to be taken out of inventory. Some terms that investors have relied on — no or little reserves, interest-only periods and high-leverage proceeds — seem to be a thing of the past.”

As De Marco notes, the state of the housing market has a direct correlation on existing retail and future retail development. And in the Northeast, much like the rest of the United States, the housing market is straining to bounce back. “The continuing trouble in the housing market is rippling over into the retail market,” says Taylor. “Many of the lenders had huge stakes in the sub-prime mortgage market and they lost a lot of money, which has caused them to tighten up on their lending habits for the commercial property even though we are not dealing with the sub-prime housing market.”

Taylor notes that the current turmoil in the market has caused some lenders to stop putting up loans all together. Samtmann agrees, remarking that the current interest rate volatility has put the most notable pressure on freestanding, triple-net, 1031-type properties. However, he says, “Larger parcels of land and properties more suitable for institutional investors and pension funds are less affected by the impact of interest rates and tend to sell more competitively.” Perhaps this is another reason why retail development has moved south in search of larger land sites.

The issues plaguing the lending community and Wall Street have also spilled over into the investment sales market. According to De Marco, the first half of 2007 showed an increase in investment sales volume in New Jersey over 2006 and sales for the trailing 12-month period (ending June 2007) was higher than the previous period. However, she noted that the annual sales volume, $750 million, is consistent with volumes in the 12 months ending June 2004 and June 2005. “There are plenty of willing buyers seeking New Jersey retail, but the capitalization of deals is changing pursuant to the recent disruption in the debt markets,” she says.

Taylor remarks that there continues to be a demand for investment product, but, he says, “The difficulty with investment sales right now does not have to do with the product or the sellers and buyers, it has to do with interest rates. Interest rates have spiked up sharply in the commercial business; therefore, making it more difficult to make a purchase.”

De Marco echoes Taylor, saying, “The recent volatility in the credit markets has created a pause as investors look for more favorable signals from Wall Street.” De Marco adds that because of the current climate, two types of deals will fare better than others. One type of deal that investors are favoring is one with assumable debt since it provides buyers with returns that are measurable and predictable in underwriting. The second type of deal, which is strongly preferred by the low-leverage/no-leverage institutional plays, is the Class A deal. De Marco notes that the Class A deals will be priced strongly, but there is a great deal of product to fulfill the demand. “In general, projects in the New Jersey area have strong fundamentals and will continue to be attractive to investors, but the cost of capital will be a hot topic for the near term,” says De Marco.

The future of any market can be tough to predict, but most of our experts agreed that the retail market in New Jersey should remain strong, but developers and investors need to remain cautious due to the extenuating circumstances on Wall Street and stringent barriers to entry. “I think the market will remain strong if people don’t overextend themselves,” says Samtmann. “If the population density isn’t in an area yet, rushing to build a store there isn’t prudent. Some areas may be better positioned for additional retail a few years down the road. Developers and retailers have to be patient and cautious.”

Philadelphia

Much like neighboring New Jersey, falling vacancy rates, rising rental rates and a limited supply of new growth are all factors driving the Philadelphia retail market. According to Marcus & Millichap’s second quarter 2007 Philadelphia Metro Area Retail Market Update, retail vacancy rates dropped to 7 percent in the first quarter of 2007. This number reflects a drop of 40 basis points lower than year-end 2006 and 50 basis points lower than the first quarter of 2006. The neighborhood/community center market also experienced a drop in vacancy rates. The rate dropped to 6.4 percent in the first quarter, which is a 30-basis-point improvement from year-end 2006.

In the heart of Philadelphia, Center City is growing with the influx of new residents, and new office developments are also bringing in more daytime population. According to Stuart Conston of Equity Retail Brokers, the health of the retail market in Center City is in great part due to many retailers taking advantage of the ground-floor retail space being offered in new office developments. The most notable of which is the new 100 percent-leased Comcast Center on the northwest corner of 17th Street and JFK Boulevard. The 58-story building, which is being developed by Liberty Property Trust, will contain 1.25 million square feet of prime Class A office space, 35,000 square feet of which will be retail space located right in the heart of Philadelphia’s CBD. Conston notes that the best properties in Center City are leasing retail space at rates in excess of $150 per square foot.

In Center City, retail space along Chestnut Street, between 16th and 20th streets, is in very high demand. “This area has been seeing an influx of first-time retailers and movement of some secondary retailers from Walnut Street to Chestnut Street, which is more attractively priced and closer to the business population,” says Conston. “There is a strong spirit of redevelopment in this section of Chestnut Street, which indicates more growth in 2008.”

Another hot spot of retail activity in this area is in the historic Rittenhouse Square district. “The 1800 block of Walnut Street along Rittenhouse Square will also be redeveloped over the next 2 years, and retailers are eagerly awaiting to see what those plans will bring,” says Rich Zeller of Equity Retail Brokers. In addition, retailers hoping to capture the daytime office population in Center City are looking to the area east of Broad Street and on Market, Chestnut and Walnut streets.

Taylor says, “Leasing activity remains very strong, especially in Center City.” However, he notes that compared to other similar markets, the Philadelphia retail market is still under retailed. “Given supply constraints on land, there is intense competition for quality parcels. More than 2 million square feet is scheduled for delivery over the next year, with another 10 million square feet in the planning stages,”  he says.

Outside of the CBD, the retail market is seeing its shar of successes and struggles. Location is playing a key role in the viability of a store or center. “Once you move outside the business district, you see that the good properties on strong pedestrian arteries are successfully leased, but mid-block properties are moving a bit slower,” says Zeller. 

Older shopping centers located in the southern and northeast areas of Philadelphia have been experiencing a downturn. Conston notes that the centers have been outpositioned in the last 5 to 7 years by newer, big-box developments. “The older centers often don’t show as well, and many have lost tenants to the newer centers, which makes it harder to invest in the capital improvements that might help them stay competitive,” says Conston.

On the horizon, some underperforming neighborhoods will be driven by some new highly anticipated development. “In the longer term, the casinos coming to Columbus Boulevard will hopefully spur regeneration in the Fishtown and Northern Liberties neighborhoods of Philadelphia, adding more residential and retail properties into the mix of redevelopment there,” says Zeller.

As per usual, banks and pharmacies continue to be in-demand retail tenants in Philadelphia. “Banks and financial institutions are always desirable because they generally pay the highest rent,” says Conston. “If a site is large enough, pharmacies continue to also be strong tenants.” In addition, Conston noted that in Center City, fashion retailers are garnering quite a bit of attention from developers as well as “fast casual” and high-end, sit-down restaurants.

Despite the influx of retailers and residents into Center City, the investment market is not as strong as it has been previously. According to De Marco, the first half of 2007 did show a sharp increase in investment sales volume in the Philadelphia area; however, this was due to the sales of two significant assets — Franklin Mills and Suburban Square. “Excluding those deals, reports for first half volume is relatively low compared with the last 3 years, and the adjusted trailing 12 months ending June 2007 volume was 28 percent lower than the prior 12-month period,” remarks De Marco.  

However, despite this downturn, the future of the Philadelphia retail market looks steady and stable with our experts predicting steady rent growth, decreasing vacancy and a possible uptick in sales velocity in 2008.

Raritan Town Square — Raritan Township, New Jersey Raritan Town Square Short Hills, New Jersey-based Garden Commercial Properties is tapping into the national trend of lifestyle centers with its development of Raritan Town Square, a 510,000-square-foot lifestyle center in Raritan Township, New Jersey. With Lowe’s Home Improvement Warehouse and Wal-Mart as anchor tenants, the center combines elements of a power retail center, community retail center, entertainment/civic center and office park into a pedestrian friendly downtown atmosphere. Raritan Town Square is expected to open in summer 2008. The center is situated in the Flemington corridor of Hunterdon County, which has become a hot area for both commercial and retail development, says Scott Loventhal, director of development with Garden Commercial. “The quaint atmosphere and relatively low cost of living has fueled an influx of new residents over the past years,” he says.            —Amy Bigley

County Plaza – Randolph, New Jersey County Plaza Vita & Vita Realty Corp. is currently developing County Plaza in Randolph, New Jersey. The four-phase mixed-use development is situated on 9 acres at the intersection of Route 10 and Dover-Chester Road. Phase 1 of the development includes a CVS/pharmacy, which is currently open. The CVS, the co-anchor of the project, includes 13,000 square feet of retail space and drive-up windows. Phase 2, which broke ground in August, will include a two-story, 25,200-square-foot Medical Arts building that will encompass 2 acres and parking for 135 cars. Phase 3 will include 9,900 square feet of retail stores that will front Route 10 at the main entrance of the property. The building, which will measure 165 feet by 60 feet, will be similar in design to today’s popular lifestyle centers. The retail building, which is scheduled for groundbreaking in spring 2008, can be divided up into six separate stores. The final phase, phase 4, will feature a freestanding bank with drive-up windows. — Stephanie Mayhew

Valley Square — Warrington, Pennsylvania Valley Square Grasso Holdings is utilizing the need for brand awareness by tapping upscale retailers for its new lifestyle development Valley Square in Warrington, Pennsylvania. The more than 400,000-square-foot center features approximately 300,000 square feet of high-end fashion and lifestyle retailers and 125,000 square feet of professional office space. The center will offer a wide array of retailers in a Main Street atmosphere, complete with wireless Internet access. Already signed tenants include Wegmans Food Market, Banana Republic, J. Jill, Eastern Mountain Sports, Ann Taylor Loft, Panera Bread, Borders Books & Music, P.F. Chang China Bistro, Victoria’s Secret, Bath and Body Works, White House|Black Market, Starbucks Coffee, Olily, American Eagle Outfitters, JE Caldwell & Co., Sunglass Hut, Aveda, Chico’s, LensCrafters and Planet Ten. — Amy Bigley

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