Mall-Building Industry Takes Stock To See How Long Growth Will Last

By Ryan Chittum
From

As the retail real-estate industry launches for its big annual show -- the International Council of Shopping Centers convention in Las Vegas this week -- one question is increasingly being asked in the business: How long will the strong sales and easy money last?

The shopping-center industry outlook remains solid, lenders are funding deals at record prices and retailers are looking to expand, while new construction remains restrained.

But retail real estate and the economy at large have been buoyed over the last several years by consumer spending, thanks to record run-ups in home prices and the home-equity loans used by owners to keep spending. Now those props could be weakening with a slowdown in the housing boom and consumers paying near-record prices to fill their gas tanks.

There also are signs of a peak in some parts of the market. Bernie Haddigan, who heads the retail group at Encino, Calif.-based Marcus & Millichap Real Estate Brokerage Co., says some lenders are putting tighter restrictions on loans for single-tenant properties. He adds that capitalization rates -- the expected return on investment in the first year of ownership -- are edging up in the Midwest and in some small towns, a sign that investors are pulling back from riskier properties in slower-growing markets.

Those signs are likely topics of conversation at the industry's four-day convention, where typically about one quarter of all U.S. retail lease agreements are reached. The meeting opens Sunday with a speech by former President Bill Clinton.

Top-notch properties are seeing capitalization rates stay flat and in some cases edge down, despite rising interest rates, Mr. Haddigan says. But capitalization rates are rising on lower-quality properties in lesser markets with riskier tenants, signaling that at least some parts of the retail real-estate market have reached a peak. Lower capitalization rates typically mean investors are paying more for real estate.

But the tremendous amount of capital investors are putting into real estate is keeping prices high for well-positioned properties. "There's a lot of money chasing too few deals still," says David Frosh, of Sperry Van Ness, a commercial real-estate services firm based in Irvine, Calif.

Hal Purcell, an executive vice president with Capmark Finance Inc., points to a Standard & Poor's report showing that delinquencies in retail commercial mortgage-backed securities have crept up for two straight quarters as a possible warning sign. He's also seen an increase in applications for loans to purchase land to build on, a red flag because land doesn't produce income, he says. "For those of us who have been scarred many times in the past [by downturns] those kinds of things give me pause," Mr. Purcell says.

Still, shopping-center owners are on solid ground fundamentally. Vacancy rates are low, at 5.5% for malls and 6.9% for strip malls for the first quarter, according to Reis Inc., a New York-based real-estate research firm. Rents are rising modestly in both sectors and demand from retailers is solid.

Sales per square foot went up 5% to an average of $253 at all shopping centers last year and jumped 8% to an average $431 at properties owned by regional mall REITs, according to Bear Stearns REIT analyst Ross Smotrich. Luxury-mall owner Taubman Centers Inc.. became the first landlord to top $500 a foot, ending 2005 at $508.

Construction of new centers is picking up but is still restrained, especially when compared to the average over the past 25-plus years. Last year, developers built 861 shopping centers containing 106.5 million square feet of space, well below the historical average of 177 million square feet a year, according to the Bear Stearns report. That's a 1.7% increase in a six-billion-square-foot retail market.

Almost no enclosed malls are being built these days. Instead the focus has shifted to so-called lifestyle centers, which are open-air, pedestrian-friendly shopping venues with easier parking and more entertainment functions, such as restaurants. Retailers like lifestyle centers because they attract higher-end consumers and the common-area costs are much lower. Regional mall owners are increasingly converting their old fortress-style malls to hybrids by knocking down shuttered department stores and adding lifestyle-center elements.

U.S. population growth is also benefiting shopping-center fundamentals by boosting retail sales. Soaring housing prices created a "wealth effect" that helped consumers keep spending during recession and war. The economy as a whole is now growing smartly, creating jobs and putting upward pressure on wages. That is helping to mitigate the negative effects of the cooler housing market.

Those factors have helped capitalization rates remain relatively stable at near-record lows in the last few months despite rising interest rates.

All that said, any letup in the housing boom is sure to have an effect on spending. "Given the slowdown in housing in some of the hottest markets, the effect on the consumer could be substantial even though there's healthy job growth and household-income growth," says Hessam Nadji, managing director for research at Marcus & Millichap.

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