MILAN — Declining output, rising unemployment and a lack of cheap debt have made for a difficult year for the commercial realty market in Europe, and with the economy set to contract 4 percent in 2009, more pain is anticipated over the next 12 to 18 months.

Retail property capital values fell by a fifth in Europe last year and are set for further declines, according to real estate services firm Jones Lang LaSalle. Occupancy levels are down, particularly at secondary and tertiary retail locations and development is slowing. Realty advisers Cushman & Wakefield reported last month that up to 75 million square feet of planned shopping center development in Europe has been put on hold or canceled as a result of the credit crunch, including in emerging markets like Russia, Ukraine and Turkey. (The firm forecast 107 million square feet of new mall space would be built across the region in 2009 and another 75 million square feet in 2010. Next year would represent the slowest rate of expansion since 2005 and bring to an end five consecutive years of growth in shopping center development.)

Tenants are also becoming more demanding. Vittorio Radice, chief executive officer of Italian department store chain Rinascente, said he was renegotiating the group’s rental agreements, looking for more flexibility, shorter lease terms and even tying rates to turnover.

“Times are tough,” said Radice. “The pain has to be shared.”

But all is not doom and gloom.

Prime retail locations are so far proving resilient to the downturn due to high demand from luxury labels, which continue to clamor for doors on the most prestigious streets, despite declining profitability.

For example, so far this year, Lanvin has opened on London’s fashionable Mount Street, where spaces are said to rent for 200 to 265 pounds, or $290 to $390, a square foot. Marc by Marc Jacobs and Rick Owens opened boutiques around the corner on South Audley Street, Prada launched its second unit in Madrid on the Calle Serrano, Paul Smith opened his first women’s-only Paris boutique on Rue de Grenelle and Cartier opened a store in the 15th-century Palazzo Corsi-Tornabuoni in Florence.

Meanwhile, Belstaff is set to open units in Prague, Bucharest, and Barcelona over the next four months, and clothing retailer C&A said in April it plans to expand its retail network in Europe, after reporting a rise in full-year sales and market share.

Outlets are also gaining importance as consumers focus more on value and high-end retailers look to shift overstocked goods at discount.

Scott Malkin, chairman of Value Retail, which operates Chic Outlet Shopping in Europe, said there has been a dramatic uptick in demand for space at the group’s nine sites across the region.

“Our outlets are key retail streets….We serve a purpose that cannot be served elsewhere,” Malkin said of the shopping villages, which are an hour’s drive from London, Paris, Madrid, Barcelona, Milan-Bologna, Brussels-Antwerp-Cologne, Frankfurt, Munich and Dublin. “[Brands] that were focused on emerging markets are coming to us to help drive the performance of their current business.” Malkin cited double-digit year-to-date increases in foot traffic, gross sales and same-store sales per square foot overall in Europe.

By location, like-for-like sales were up by single digits at Laz Rozas Village near Madrid and La Roca Village near Barcelona and flat at Kildare Village near Dublin, which was “incredible” compared with 40 to 50 percent drops at department stores in Spain and Ireland, Malkin said. Meanwhile, comparable sales were up by double digits in Italy; Germany; Benelux, France, and the U.K.

Chic Outlet Shopping in Europe expects double-digit sales growth this year.

After luxury firms, Mark Burlton, who heads up Cushman & Wakefield’s cross border retail business in Europe, said discount players were by far the most active tenants in the region, citing TK Maxx — which operates in the U.K., Ireland and Germany and is part of U.S.-based TJX — and Primark as examples of companies that could take advantage of the economic situation.

By country, experts said the U.K. realty market had been hit hardest and fastest by the economic crisis, with capital values down more than 40 percent from their peak in June 2007 and yields down to around 4.5 to 5 percent from around 7 to 8 percent.

“Values have fallen much more quickly,” said Richard Barkham, group research director of real estate company Grosvenor Group Ltd. “We expect other regions to catch up.”

Compounding matters, economic output shrank by 1.9 percent in the first quarter relative to the fourth quarter of 2008, hitting occupancy levels. The average availability rate on top streets in the U.K. was 11.2 percent in February compared with 6 to 7 percent in previous years, following bankruptcies over the Christmas period, which added another 850 spaces to the market, Cushman & Wakefield said.

Accordingly, monthly retail rental values fell again by just under 1 percent in March. Some landlords are even offering 12- to 36-month rent-free periods to stimulate demand, experts said.

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