Rents for Retail Space Expected To Increase By Year-End

Near-Term Outlook for Retail Real Estate Remains Positive despite First-Half Pause in Net Absorption

Rising demand for well -located retail space is expected to bring about meaningful rent growth in most U.S. markets by the end of 2011, according to CoStar Group economists.

Growth in employment and moderately rising demand fueled by greater numbers of shoppers and little new supply of retail development on the horizon should set the stage for a significant drop in vacancy rates, which CoStar expects to fall as low as 5% by late 2014.

That rate of decline would be in keeping with other commercial property types, closely paralleling commercial office space, which is also expected to see a decrease in the supply of available space.

The near-term outlook is promising for retail properties, but longer term, starting in 2013, uncertainties such as employment growth, rising oil prices, delivery of new supply and mounting pressure to generate continued high levels of retail sales could challenge the strength of the recovery, CoStar analysts noted.

"While it is the negligible new supply that is allowing retail real estate to turn the corner, the future depends on job and wage growth levels," said Chris Macke, senior real estate strategist for CoStar Group.

Retail sales have already returned to 2007 levels, with year-over-year growth in the 6% range for the last couple quarters -- well above the historical range of 4.5% to 5%. Spending should remain strong if jobs and economic growth stays on track, Real Estate Strategist Suzanne Mulvee said.

Though appliances, electronics and other big-ticket purchases are still down, spending on health care and personal care is up just under 5% over the last 12 months, with increases also reported in online sales, food and beverage, general merchandise, clothing and sporting goods spending. The level of sales per square foot of retail space has also moved well above pre-recession levels -- evidence that retailers are doing better and may eventually need more space.

Leasing volume has also picked up robustly, with CoStar projecting about 110 million square feet of retail space leased in the first half. While it’s not yet translating into large net absorption gains, the heightened activity and diminished supply kept the national vacancy steady in the second quarter at 7.1%.

One bright spot is that demand growth in the largest markets is gaining momentum, with most markets showing a distinct improvement. Denver, Seattle and Houston, markets associated with energy or high tech, are seeing the strongest growth. Even housing bust markets such as Atlanta, Inland Empire and Phoenix are seeing momentum toward growth, and most CoStar submarkets are seeing vacancy rate declines.

With many national retailers seeing improved financial results and beginning to cautiously think about expansion, malls enjoyed the lowest vacancy rate among retail property segments at 5.4%.

On the other end of the extreme, strip centers and neighborhood centers, where mom-and-pop and independent tenants continue to struggle, are seeing vacancies of 11.6% and 11.5%, respectively.

Another silver lining is power centers. The most heavily built product type over the last cycle; they remain the most actively leased space in retail. At 6.8%, power center vacancies are in line with historic averages. Outlet centers, where supply is also tight, are at 6.5%.

With little new space available, vacancy rates are finally cresting. Underscoring the breadth of the occupancy recovery, as much as 60% of the 1,000 retail submarkets tracked by CoStar showed declining vacancy rates, with the strongest declines in Northeast and Texas markets like Houston, Detroit, Denver, Boston and Philadelphia.

Housing-bust markets like Phoenix and the Inland Empire still are seeing vacancies well above their historical average.

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Randyl Drummer is a well known Commercial Real Estate Editor who provides valuable insights on commercial property Trends & Listings. He regularly writes about the various investment opportunities in commercial properties.