The building boom has slowed, but that's not all bad news for supermarkets
“Build it and they will come” may have been the motto for many shopping center developers this decade, but it's a whole new ball game now.
With the credit crunch making construction loans onerous; the housing crash cooling off previously hot markets; and the consumer spending slowdown dooming small-shop tenants, once high-flying commercial real estate developers are taking hard hits from the souring economy. Ultimately, observers say, this will mean fewer new supermarkets, with particular pressure being put on those food retailers that have grown along with the commercial building boom in the recent past.
For many supermarket operators, however, a building slowdown could be benign at worst, and could crack open opportunities to grow through other means, including recycled space, new formats or acquisitions, observers added. Established retail brands — particularly those with clean balance sheets and leading market share — are, not surprisingly, best suited to thrive in this new slow-growth environment.
Ironically, the building slowdown comes at a time when many supermarket operators were finally poised to grow, noted Terry S. Brown, chief executive officer of Edens & Avant, a leading East Coast shopping center developer and property manager located in Columbia, S.C.
“The development climate is very challenging today, and that will definitely impact the amount of new grocery-anchored centers,” Brown told SN in an interview. “But supermarkets, compared to most retailers, are positioned pretty well. In most markets the battle to be No. 1 or No. 2 is already settled out. We've been through a period where retailers like Safeway have renovated their stores, and many operators have focused on market share and improving their existing stores.
“I think these stores are ready to devote some capital to new store development,” Brown added, “but there are factors beyond the supermarket's control.”
Chief among the reasons for the slowdown in shopping center construction is the credit crunch, experts said. Whereas banks until a year ago were willing to finance any manner of projects, terms and conditions have become increasingly difficult hurdles.
“From an economic standpoint, developers are facing much more onerous requirements to get financing, and the financing they get is not nearly as advantageous as it once was,” Harvey Gutman, president of Brookside Advisors, Marlboro, N.J., and a former real estate executive with Pathmark, told SN. “Financiers are talking again about recourse loans, where they can go after the developer personally if the deal goes bad, and they're looking for additional equity in every deal. A few years ago a developer could get 90% financing. Now you're seeing 75% loan-to-value or even less.”
Banks are also looking more closely into the credit quality of tenants in a deal, Gutman added. And even if a supermarket anchor has an acceptable balance sheet, the same may not necessarily be said of the potential co-tenants in a center, often a prerequisite for a construction loan. It is those retailers — hair salons, apparel retailers, gift stores and dry cleaners, for example — whose rents make the economics of the shopping center work.
“Small-shop retailers, whether they are local or national chains, have definitely slowed down as consumer spending has dropped, and they're a big part of the traditional shopping center model,” said Brown.
Retailers that have slowed growth this year or announced store closures include Linens 'n Things, Steve and Barry's, The Sharper Image, Mervyns, Zales, Pier 1 Imports, Boscov's, Starbucks and Foot Locker, among others. Vacancies at shopping centers around the country in the second quarter were at a 13-year high, according to Reis Inc., a New York-based real estate services company.
Add to these woes land prices that have held up remarkably well, as well as an ongoing trend of new centers targeting urban infill areas that are costlier to build and slower to develop, and a slowdown in new supermarket builds is virtually assured.
“We will not see nearly as much growth in the next two years that we've seen for the last 20 years,” predicted Gutman.
A slowdown in new supermarket builds would have mixed effects, Gutman said, though established conventional stores would be more willing to welcome it.
“The big supermarket companies wouldn't say this publicly, but if we could just freeze — no new stores from anybody — it wouldn't be so bad for them,” Gutman explained. “Because they have good locations and good market share already; new locations can be tougher to build; and you're doing it to an extent so as to keep up with your competition.”
More likely to suffer are their would-be competitors — newer retail concepts which used the boom in recent years to expand their footprint.
“It's the innovative ones who need the new stores the most,” he said. “If the environment today was the same 15 years ago for Whole Foods, or five years ago for The Fresh Market, I don't think there would be a Whole Foods or Fresh Market, at least not as we know them today. I think this environment is more harmful to the start-up companies and probably neutral for the well-established companies.”
Although the news has been grim for a number of retailers, their problems have tended to be financial and not sales-related, according to Dan Hurwitz, president and chief operating officer of Developers Diversified, a Cleveland-based retail property developer. Speaking in a recent conference call with analysts from Citibank, Hurwitz said he is encouraged by data illustrating that overall retail sales have historically kept growing despite troughs in consumer confidence and spikes in oil prices.
“Historically, difficult economic times have not had as drastic an effect on retail sales as you might think,” Hurwitz said. “I know people are betting that the consumer is going to give up, but that hasn't happened over the last 60 years.”
Hurwitz said Developers Diversified, which specializes in large, open-air centers, is battling the development headwinds by targeting 1% greater returns on projects it undertakes than it would have a year ago. Leasing deals are still getting done, he added, but only those that can meet projections right away.
“Those ‘stretch’ deals you were asking retailers to do three or four years ago, where it makes sense to bet on growth coming? They're not happening today,” he said. “The market has to be there today. The economics have to make sense today. There is no three- to five-year window where they're willing to take a hit anymore. But if the deal makes sense, it's getting done.”
In a trend that mirrors residential building in both its boom and bust cycles, retailers are backing away from markets that until recently were among the hottest in the nation: California, Florida, Nevada and Arizona. Those markets became “overheated” while retailers chased new residents — and the ensuing market share — at any cost, said Hurwitz.
“Retailers aren't rethinking those markets, they're rethinking the pricing of those markets. They were willing to pay almost anything to get into those markets, because they thought the growth was endless,” he said. “Now those markets are coming into line with the rest of the country.”
Steven Brinn, a former real estate executive at Hannaford Bros. who now serves as a Falmouth, Maine-based consultant to New England retailers, said times call for an approach that is cautious, but aggressive for the right sites.
“While stores have always had to be careful about where they locate stores, I think the economy will have probably have them holding out for the ‘home runs’ now, and not be willing to take as many risks as they used to,” Brinn told SN. “But those that have financing have an advantage if they can move quickly. The deals come around only once, and you have to be ready to take advantage of them when they come.”
For chains in New England, maintaining their targets for new store growth is a matter of developers' ability to deliver quality sites, said Brinn. “Price Chopper, Wegmans, Whole Foods, Hannaford — they're all trying to grow. They are all still on the growth programs they set. But I think they would tell you they are having trouble finding developers able to bring them quality sites.”
Supermarkets also tend to turn their real estate focus to renovations and property management issues in the time of a slowdown — although the renovation trend dates back several years and relates in part to the rising expense of new projects. A slowdown “can also be a good time to buy stores that might not be in a growth mode but have solid locations,” Brinn said. “Hannaford was always pretty adept at that, and it's something a lot of smart retailers are probably considering at the moment.”
George Whalin, founder of Retail Management Consultants, Carlsbad, Calif., said he expects real estate will be one of several factors influencing a round of consolidation out of the current economic softness.
“I think we're going to continue to see mergers and acquisitions and outright failures,” Whalin told SN. “Real estate is one factor that will enhance consolidation; the other is just the sheer cost factor, the fact that every piece of merchandise you sell arrives on a truck and takes fuel. That's going to continue to put pressure on costs.”
Whalin said he also expects the economy will spark retailers to develop cost-efficient store concepts, such as the small boxes being rolled out by Fresh & Easy, Safeway and Wal-Mart in the Western states.
The fallout from nonfood retailers is another potential bonus of the slowdown, observers said. Though opportunities to build from the ground up are evaporating, they are reappearing in already built boxes left behind by struggling retailers, noted Brown of Edens & Avant. This could benefit food retailers like The Fresh Market, he said. “There will be plenty of reuse sites and reuse opportunities in places that are already out of the ground,” he said.
Despite the building slowdown, the U.S. population is continuing to grow at the rate of around 3 million a year — “about the size of the city of Dallas,” noted Rich Hollander, president of Buxton Co., a consumer research firm based there. Hollander said the downturn could be an opportunity to expand and gain market share.
“In times when money is plentiful and growth is obvious, people can go willy-nilly, make a mistake, and figure they can catch up next time. But when times are tough, they need to be smarter, and gain the confidence to add inventory and people and locations at a discount,” Hollander said. “A tough economic downturn is a terrible thing to waste.”
NEW YORK — The souring economy is accompanying a reduction in retail vacancy rates at neighborhood and community shopping centers nationwide, according to data provided to SN by Reis Inc., a real estate research firm here. Vacancy for the second quarter of 2008 reached 8.2% at these centers, the highest since 1995's year-end rate of 8.3%. A 50-basis-point increase in vacancy over the first quarter represents the largest single-quarter deterioration in shopping center occupancy on record, according to Sam Chandan, chief economist at Reis.
Reis estimates vacancy rates will rise to 8.6% by year-end.
The following table illustrates quarterly occupied square footage and vacancy rates for neighborhood and community shopping centers in the United States.
|Q1 / 2006||1.772||6.9%|
|Q2 / 2006||1.778||6.9%|
|Q3 / 2006||1.784||7.0%|
|Q4 / 2006||1.788||7.1%|
|Q1 / 2007||1.794||7.2%|
|Q2 / 2007||1.797||7.3%|
|Q3 / 2007||1.802||7.3%|
|Q4 / 2007||1.811||7.5%|
|Q1 / 2007||1.809||7.7%|
|Q2 / 2007||1.806||8.2%|
|*In millions of square feet. |
SOURCE: REIS Inc.
A Look at Store Closings
NEW YORK — About 144,000 retail establishments will close their doors for good in 2008 — an increase of 7% from 2007, according to the International Council of Shopping Centers here.
The increase in store closures projected for this year would be the largest year-over-year increase in the 14 years since the trade group has tracked such data. The number of store closures is projected to be the highest since 2001, ICSC added.
ICSC based its projection on a sample of store-closure announcements by retailers. It published the figures, along with a tally of store closures in the first half of 2008 in a report last month.
Figures for the first half of 2008 show that apparel retailers accounted for the largest percentage of closed stores — or 34.7% of a total of 2,831 store-closings. Home entertainment retailers accounted for 28.8% of closings.
The composition of closings by store category illustrates the expansion of the economic slowdown, the trade group said. In 2007, for example, the lion's share of store closings was announced by home-related stores — “a casualty of the housing bust,” ICSC noted. “By 2008, the impact spread to other discretionary spending areas such as apparel.”
Retail store closings have mixed effects for supermarket operators, sources said. The glut of new space can in some cases facilitate enlargements or provide space for conversion, but also pressure landlords and may contribute to a slowdown in opportunities to build new stores.
ICSC noted that store closures historically are balanced out by new openings. For example in 2006, which is the most recent year for U.S. Department of Labor Statistics data on the topic, 139,000 store closings were balanced by 123,000 new store openings.
Figures also show that even with a large projected increase in store closings, the number of closed stores is still likely to fall short of annual closings between 1993 and 2001. This data suggests a leaner, more efficient retail industry than in the recent past.
“This resiliency may be the retail industry's most valuable asset,” the report said.