How hot is too hot?
Reverberations from the flight to quality that followed the economic crash when retailers tried to avoid risky addresses are being felt today, with competition exploding for the spaces that remain on sought-after streets and at the best malls worldwide.
Market dynamics are causing rents to rise in those locations, sparking discussion in retail real estate circles about whether bubbles are forming in popular submarkets. Upward pressure on rents is being relieved slightly, however, by retailers creeping into relatively affordable alternatives surrounding pricy streets, malls enlarging their gross leasable area, and occasionally, rival shopping centers wooing prime tenants from their crowded mall neighbors.
“I don’t think they are quite bubbles, but there are markets like Beverly Hills that have come back nicely, and they are very competitive. There are spaces that are three, four, five deep with proposals,” said Robert Cohen, president of Southern California for retail leasing and investment sales brokerage RKF. “It’s all good when you look at where we were four years ago and nobody was doing anything. This is a positive development, but it ultimately creates some angst. Are rents pushing up because of competition and not actual sales? Is it going to be sustainable?”
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On the positive side, the retail real estate business has recovered tremendously. In April, the International Council of Shopping Centers reported that U.S. chain-store sales had increased 2.7 percent and forecast they would climb 2 to 3 percent in May, buoyed by seasonal spending. In ChainLinks Retail Advisors’ U.S. National Retail Report for this year, the retail real estate services firm predicted the shopping center vacancy rate would drop to 10 percent from 10.8 percent last year, and that rents in most markets would spike between 5 and 10 percent. Commercial real estate information company CoStar Group found that 70 percent of the retail markets in the U.S. saw rental growth in the first quarter of this year, a sign to U.S. research director Suzanne Mulvee of “a true turning point for the market.”
ICSC RECon in Las Vegas, which runs through Wednesday at the city’s convention center, is benefiting from the industry’s improved health. Michael P. Kercheval, president and chief executive officer of ICSC, anticipated that the number of attendees at the convention would be around 35,000, up from 25,000 to 27,000 when the economy soured — although not back to the prerecession height of roughly 50,000. There are more than 1,000 companies setting up shop in the 2 million square feet the convention occupies, a record for ICSC RECon, according to Kercheval.
“Anecdotally, I have noticed things like the number of hosted parties and receptions is way up. That is an indicator of the health of the retailers and developers,” he noted. “The retailers are looking for space, and they are not really finding it because there is no new space being constructed. The developers are all competing for who is the latest and coolest retailer on the block, as some of their leases are rolling over, and they are focusing on asset management and upping the quality of their tenant roster and cash flow. This is the first time since the recession where we feel this isn’t just about maintaining, there is a growth phase in our industry.”
Of course, there are concerns, including the fate of unsuccessful B and C malls, the surge in e-commerce, European economic problems, slowing growth in China and Brazil, and the dwindling American middle class. There is also rampant speculation about the future of Sears Holdings Corp. and J.C. Penney Co. Inc. Anthony Buono, executive managing director for retail services at commercial real estate services and investment firm CBRE Group Inc., doesn’t think there’s reason to panic about those retailers.
“J.C. Penney has a loyal customer base, notwithstanding what has happened in the last 18 months,” he said. “They are not going to die in a day. That’s not a possibility — but they are going to transform, change and evolve.”
Perhaps because of the troubles at these well-known retailers and fresh memories of the recession, Kercheval argued that shopping-center owners haven’t demanded excessive rent hikes. “Rather than a rent grab on the part of owners, what I’m hearing and seeing a lot more of is relationship-building. The comment might be, ‘Yes, I could technically double your rent, but let’s work out a partnership where I can make sure you’re healthy and sustainable,’” he said. “The increase in rents has been slower than you would have predicted, but I think the reason is this more mature relationship-building.”
The importance placed on relationships, however, doesn’t mean there haven’t been rent hikes. Dan Sheridan, president of retail properties at Irvine Co., owner of Fashion Island in Newport Beach, Calif., and Irvine Spectrum Center in Irvine, Calif., said, “Rents are a product of sales, and sales have been increasing. As the sales increase and you have the opportunity to renew or lease new space, the rents catch up with sales.” He added stores at Irvine Co.’s properties “are definitely seeing increases in sales in the 5 to 10 percent range….Food, I would cite as really being strong, almost becoming an anchor for Fashion Island and Irvine Spectrum Center. Women’s apparel at Fashion Island has been doing very well.”
Are the rent escalations causing bubbles? “Barring another major economic calamity, no,” said Faith Hope Consolo, chairman of the retail group at real estate company Douglas Elliman. “The world’s top shopping streets are expensive for a reason. They’re well located near an affluent clientele. That doesn’t change. Sure, prices may rise or drop a few percentage points given the state of the world economy, but you’re not going to see huge plunges on Madison, Fifth, Rodeo, Regent, the Ginza, etc.”
Laura Pomerantz, owner of a namesake global real estate firm, agreed: “I can tell you what I am seeing now in sales in these micro-markets is that they are holding up. They are justifying the rents.”
Whether or not bubbles are forming, towering rents have consequences. Buildings on strong streets are getting bought at unheard-of prices. In one instance of this phenomenon, LVMH Moët Hennessy Louis Vuitton SA acquired 319-323 North Rodeo Drive for $85 million, believed to be the highest purchase price on a square-foot basis in the street’s history.
Robert Siegel, ceo of Metropole Realty Advisors Inc., owner of properties on Rodeo Drive in Beverly Hills, Kalakaua Avenue in Honolulu, Fifth Avenue in New York, and elsewhere, has been regularly fielding calls from people inquiring about snatching up Metropole’s assets. “Interest rates are so low, it has broadened the market of buyers for properties,” he said. “Usually, for the high-end luxury properties, there are few who will pay because of the low cap rates. They’d rather invest in something that they are getting 8 percent on Day One versus 3 to 4 percent Day One, but with the interest rates so low, people who would not normally be competing are interested, which is driving up prices.”
Ancillary streets are becoming attractive to retailers seeking to steer clear of the steepest rents. “Side streets or extensions of those streets will pick up,” said Consolo. “We’re already seeing Carnegie Hill getting retailers who would have been south on Madison. Streets off West Broadway in SoHo are picking up. Third and Lexington Avenues are slowly being remade.”
Pomerantz added, “Cool neighborhoods are starting to get a lot of play. The cost is more palatable.” Talking about streets in these neighborhoods, she specified Bedford Avenue, North Sixth Street and North Fourth Street in Brooklyn; Damen Avenue in Chicago’s Bucktown; Abbot Kinney in the Venice area of L.A., and 26th Street and San Vicente Boulevard in L.A.’s Brentwood neighborhood. Scoop NYC chose 26th Street in Brentwood, and Pomerantz said, “They are doing New York numbers at much less rent.”
The responses to the heightened demand for premier space and rising rents at shopping centers are expansions of existing “A” properties, repositioning of shopping centers to court higher-end retailers and new projects, especially in dense downtowns. Pomerantz said there is a “need sometimes for a second mall in a city. You start to run out of space, and then you can then create another project because you have enough tenants that are not placed that still need a home and want to retail in that city.”
If not much additional square footage comes online, though, retail space should get even tighter in the years ahead as retailers kick up expansion. Unit growth in the U.S. is inching upward this year, with ChainLinks estimating the number of new storefronts at 41,000, compared with 40,000 a year ago. But further improvement in the economy could lead unit growth to swell in 2014 and beyond.