Tough Sell

One day during a trip to Arizona in the middle of March, David Jacobstein, a senior retail advisor for Deloitte & Touche USA L.L.P., drove his rental car past a row of furniture stores in Scottsdale. He could almost count the cars sprinkling the acres of ghostly parking lots on the fingers of one hand.The sparse turnout at those Scottsdale furniture stores symbolizes the toll that the consumer spending slowdown is taking on retail expansion and the retail real estate development pipeline. “It hasn’t been shut off, but there’s an enhanced filter that has been put in there,” said Webber Hudson, executive vice president for Related Urban Development, the retail and mixed-use development affiliate of The Related Cos. “There’s no risk tolerance in the market right now.”Retailers and shopping center developers alike are taking a hard look at their plans for adding stores and building new centers. As a general rule, only the surest bets among retail projects will go forward. “Anybody that was going to open 50 stores is going to open 10,” said Ivan Friedman, president & CEO of RCS Real Estate Advisors, a consulting firm that specializes in retail expansion and disposition strategies. Rather than spend money to expand, retailers are generally holding on to their cash as a cushion against a worsening market, he explained.Consumer pessimism is hampering development at a time when volume is already slowing. According to Marcus & Millichap Real Estate Investment Services Inc., 125 million square feet of new retail product will come online this year, a 20 million-square-foot decline from 2007. Most executives and analysts expect an uptick in leasing and development activity to arrive no sooner than next year.As the nationwide housing slump wears on, few retail sectors are taking more of a pummeling than sellers of home-related products. This year, home-building-materials sales will drop 2.5 percent from 2007 totals, according to an estimate by the International Council of Shopping Centers. Such a performance would contrast with the 9.7 percent year-over-year gain registered just two years ago. In the furniture and home furnishings category, sales volume will dip 1.5 percent, a giant step backward for a category that grew 8.3 percent in 2006. Still, there are some positive signs. The Home Depot’s sales have been slipping for more than a year, yet it is perhaps noteworthy that the company is reducing, not eliminating, its growth plan. The retailer expects to open more than 100 new U.S. Home Depot stores this year.Furthermore, declining furniture sales were the last straw for familiar regional and national retailers like Wickes Furniture Co., The Bombay Co. and Levitz that have closed in recent months. But those closures may give other major retailers the chance to grow. The Raymour & Flanigan furniture chain, for example, is snapping up a portfolio of 18 Levitz leases in the New York City metropolitan area and may open its own furniture stores in many of the locations.Sure ThingsMost developers and retailers have turned away from promising but untested markets that looked appealing a year ago. Retailers and real estate executives hope that the federal stimulus payments will invigorate consumer spending, but many believe the impact is still too uncertain to incorporate into strategies. Thus, only markets that offer strong demographics and proven consumer spending power command development dollars. Those markets, though, continue to offer considerable potential for necessity retailers, according to a study prepared for CPN by Claritas, a consulting firm that specializes in demographics research (see the charts below)According to Claritas, many of the markets that provide the highest potential are the usual suspects. In Washington, D.C., and the surrounding areas in Maryland, Virginia and West Virginia, 2007 per-household consumer expenditures reached more than $23,500. Other leading markets include Boulder, Colo.; Ann Arbor, Mich.; Florida’s Naples-Marco Island market; Santa Fe, N.M.; and the San Francisco-Oakland area. (click here to see Consumer Spending: Potential by Region )Retail owners’ strategies reflect the renewed importance of demographics. Retailers and developers feel confident only in betting on markets that offer attractive income levels and population size. Community center developer Regency Centers Corp. is constructing projects valued at a total of $1.1 billion. Last year, sensing the coming slowdown, Regency evaluated its $1.6 billion pipeline of planned and proposed projects, explained COO Brian Smith. Faced with hard choices, the firm decided not to break ground on those projects located in secondary markets that rely on future housing and population growth, such as Upper Midwest regions that have been hit hard by job losses and a shrinking economy. Instead, Regency is focusing on established urban markets that offer strong demographics and high barriers to entry and that have largely escaped the subprime residential mortgage crisis, including Los Angeles’ affluent San Fernando Valley, the Pacific Northwest, Texas and Washington, D.C., Smith reported.Edens & Avant is pursuing a similar strategy for its $1.5 billion retail development pipeline, which spans the eastern United States. The firm is under contract to acquire a city block in Downtown Wellesley, an affluent Boston suburb. Specifics are still pending, but Edens & Avant intends to redevelop the parcel as Village at Wellesley, an upscale mix of retail and residential space. It is also considering putting up a center on a recently acquired parcel at New York and Florida avenues in D.C., according to CEO Terry Brown. However, the firm has shelved plans to build a center in a northern Atlanta suburb and has put that parcel up for sale, Brown reported.Hot PursuitFaced with more cautious strategies from retailers, owners are growing aggressive in the chase for tenants. Since the start of the economic slowdown, Edens & Avant has hired eight additional agents—a 25 percent expansion of its leasing staff—to handle its 14-state portfolio of more than 130 lifestyle, neighborhood and power centers.At a time when businesses in every industry are in cost-cutting mode, ramping up staffing initiatives goes against the tide. But Brown insists that leaner times demand just such a move. To begin with, retailers’ store closings and curtailed growth plans are tipping the balance in the tenant’s direction for the first time in memory. “The deals are harder to come by,” he argued. “You’re not going to get your leasing done without the staff.”Edens & Avant is also targeting the tenants that are most likely to expand. Leading that list are specialty fashion stores that cater to young people, as well as drugstores, supermarkets, big-box discount retailers and pet-supply stores.To round up new tenants and keep current ones, property owners are also willing to sweeten the deal. In more robust times, five-year leases were the norm for Edens & Avant properties. Now, the firm readily accepts three-year terms. For strong credit tenants, the company will even lease space for as little as one year, aiming for extensions. Retail real estate owners also frequently offer months of free rent and restructured pricing. Urban Retail Properties L.L.C., for example, offers discounted rents in the early years of leases in exchange for steeper price increases in later years, said chairman & CEO Ross Glickman.Third-party property managers are also sharpening their pencils in an effort to improve their clients’ bottom lines. Jones Lang LaSalle Inc. scrutinizes expenditures for the more than 100 U.S. retail properties it manages and is seeking opportunities to clip operating costs by a few percentage points wherever possible, reported Greg Maloney, CEO of Jones Lang LaSalle’s retail unit. At the same time, the firm is searching for ways to boost revenue, such as sponsorships.In the months to come, retailers and landlords will watch closely to see how well the federal stimulus payments propel consumer spending (see “Too Little, Too Late?” below). T
he sector may also be overlooking an ace in the hole. Historically, the election of a new president, whether a Democrat or a Republican, breeds a spirit of optimism. That, in turn, could itself give consumer confidence a much-needed lift. “In an election year, people generally have a sense that change is going to come,” Maloney pointed out. “That, generally, is a good sign.”Lifestyle ChangeA worsening economy and fading consumer confidence have taken a particular toll on one major retail center type, agree executives and analysts. In the past several years, the lifestyle center’s upscale focus and combination of store types have made it a favorite of retailers and developers, but store openings within these pedestrian-friendly, destination shopping centers may drop by 50 percent this year, said David Jacobstein, a senior retail advisor for Deloitte & Touche USA L.L.P.The upscale qualities that have propelled lifestyle center development may be working against it now, as customers reduce their visits to higher-end stores and restaurants. Additionally, the proliferation of the format may have created a market that cannot support store openings in competing centers. And as conditions tighten, retailers may gravitate to more established formats than the lifestyle center, still considered the new kid on the block.Too Little, Too Late?After several robust years, the consumer spending that drives the retail real estate industry is clearly contracting in many categories. An International Council of Shopping Centers forecast published in March projects that food services and retail sales, excluding motor vehicle sales, will grow 3.6 percent this year, compared with 4 percent in 2007 and 6.2 percent only two years ago. If the trend holds, the increase will be the smallest in six years.Many real estate executives are optimistic that the federal economic stimulus package will give consumer spending a shot in the arm when it starts filtering through the economy around the middle of the year. Others, however, doubt the effectiveness of giving taxpayers $600 or even $1,200. “It’s too little, too late,” contended Ross Glickman, chairman & CEO of Urban Retail Properties L.L.C.Surveys on consumer plans for their rebate checks offer results that are inconclusive, if not contradictory. A study sponsored by the National Retail Federation shortly after Congress passed the stimulus package in February estimated that consumers intend to spend $40.6 billion—of the $105.7 billion to be distributed—on retail purchases. That would represent a notable though still relatively modest infusion into the retail economy. And a more recent survey by the International Council of Shopping Centers and UBS Securities L.L.C. concluded that only one-quarter of recipients expect to spend their money on retail purchases.Greg Maloney, CEO of Jones Lang LaSalle Inc.’s retail unit, calls the current retail slowdown “a self-fulfilling prophecy.” Fed a steady stream of bad news about job losses and other economic problems, consumers have slowed their spending. The resulting store closings and bankruptcies are hardly good news, but he emphasized that fundamental rules of business will shape the outlook for each retailer, even in a dubious market. “Well-run companies will weather the storm and will be effective,” he said.—Retail editor Paul Rosta can be reached at paul.rosta@nielsen.com.Retail Chart 1Retail Chart 2Retail Chart 3