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The U.S. retail property market saw little movement in the third quarter of 2013 as vacancies remained largely unchanged. Experts say the segmented market is losing in the middle as high-end retailers and discount stores continue to expand while malls and shopping centers that cater to the middle-class shopper continue to close. Malls appear to be performing better than smaller shopping centers, but even regional malls that serve wide population areas are being squeezed by the disappearance of the middle market. Analysts expect similar performance in the closing quarter of the year. For more on this continue reading the following article from National Real Estate Investor.

Vacancies for neighborhood and community centers were unchanged during the third quarter and now stand at 10.5 percent, just 60 basis points below the peak vacancy of 11.1 percent, recorded during the third quarter of 2011. This modest vacancy compression was predominantly due to weak demand with only 2.3 million sq. ft. of space absorbed this period, the slowest rate of increase in occupied stock this year. Much of the quarter’s net absorption can be attributed to new product coming online pre-leased, given the continued necessity of pre-leasing in order to secure financing for the development of new centers. A total of 1.5 million sq. ft. of new space was completed, the largest volume of quarterly additions from new construction thus far in 2013.

Retail remains a segmented market, with growth at the top, catering to more affluent consumers, and at the bottom, catering to a broader consumer base that has been more severely impacted by high unemployment and muted income growth. This is exemplified by the performance of the grocery segment, the most desirable of anchor tenants for neighborhood and community centers. High-end gourmet grocers and heavy discounters continue to expand while the middle market struggles with the loss of its customer base, closing stores in the process.
 

Asking rents grew by 0.3 percent this quarter, while effective rents were up 0.4 percent. This rate of growth follows roughly the pace of the last couple of quarters, and is a slight acceleration compared to 2012’s average quarterly growth. On an annual basis, asking and effective rents both grew by 0.5 percent in 2012, so the market appears on track to record approximately double the rate of growth in 2013. This is certainly a welcome development for retail property owners and investors, suggesting that landlord pricing power might begin to stabilize as vacancy gradually tightens. Cap rates are still hovering around 8.0 percent, but this average is somewhat misleading as the market continues to display selection bias and be dominated by high-quality deals. Many properties that would trade at far lower cap rates are not being consummated which is skewing the data.

A small step ahead

Malls have generally experienced a stronger recovery relative to their smaller brethren, shopping centers; national vacancies peaked at 9.4 percent in the third quarter of 2011, and have descended at a faster pace than neighborhood and community center vacancies. Third quarter mall vacancies stand at 8.2 percent, down 10 basis points from the second quarter and down 50 basis points year over year. Asking rents grew by 0.4 percent in the third quarter and 1.4 percent from twelve months prior.

However, much of the “have and have not” characterization of the world of shopping centers also applies to regional malls. The healthiest malls, usually owned or operated by larger REITs including Simon Property Group, General Growth Properties, Taubman Centers and others, benefit from vacancy rates much lower than the Reis national average: Simon Property’s latest results for their malls and premium outlets, for example, boast a 70 basis point decline in vacancies from September 2012 to September 2013 (with vacancy levels currently at a tight 4.7 percent). There are, however, millions of sq .ft. of older malls with vacancy rates often more than double that of Simon’s enviable sub-5 percent benchmark. For many of them, mall traffic remains anemic, trending flat to downward. This is reflective of increased competition from online retailing, a lack of fashion newness, little product innovation, and increased competition from high-end outlet centers. Growth at these outlet centers is accelerating; examples include recent new stores opened by both Nordstrom Rack and Saks OFF 5th.
 

Outlook remains muted

The near term outlook for the retail sector will continue to be challenging. For neighborhood and community centers, Reis expects vacancy rates to compress by no more than 10 basis points in the fourth quarter while rents grow at more or less the same pace of the last few quarters. For malls, we expect vacancy rates to continue to fall while rents continue to increase, at somewhat faster rates than we expect for shopping centers. On the bright side, recent job market reports have been promising. The nation added 200,000 or more jobs in two consecutive months for the first time since late last year. Should improvements in job growth continue, it would be a boost to consumer spending and retail properties nationwide.

Not surprisingly, the longer term issue for the sector is the inexorable rise of e-commerce. The most astute retailers—Apple, for example—have figured out an optimal blend of online versus physical delivery methods, managing pricing, product release timings, and distribution channels aggressively so that buyers of newly released iPhones can’t get a better deal by switching to online discounters. Retailers are also trying to utilize their physical stores as a competitive advantage versus online only retailers. By shipping from their stores they are able to deliver products faster than retailers who have to ship from "long-distance” warehouses while also saving money on shipping costs.

Lastly, satisfaction with e-commerce continues to increase and a growing proportion of consumers report that their online shopping experiences are more positive than visiting traditional stores. Retailers need to enhance their customers’ in-store experience or risk further deterioration in traffic and sales. Despite a decade of strong growth, e-commerce currently constitutes only about 5.5 percent of total retail sales. Experts predict that this will not plateau until it reaches the 25 percent to 30 percent range. Retailers will need to work even more diligently to attract customers into their stores as increasingly more commerce is conducted online.

Brad Doremus is Senior Analyst, and Victor Calanog is head of research and economics, for New York-based research firm Reis.