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Where will retail real estate sit throughout 2011?

BY Katherine Boccaccio

If Black Friday and Cyber Monday 2010 numbers were any indication, retail may well be prepping for some measurable bounce in 2011.

But the road to recovery isn’t going to be without frustrations, according to Chicago-based Jones Lang LaSalle’s North America Retail Outlook report, released in November.

The inaugural report examined retail real estate fundamentals such as vacancy levels, rental rates and investment sales volumes — and drew the conclusion that 2011 would see a “slow and arduous retail sector recovery.”

The report listed the following retail outlook highlights: National retail vacancy levels stand at a healthy 7.3%, with open-air shopping centers at 10.8% vacant and general retail at 5.1% vacant; investment sales volume for the first half of 2010 is 43% higher than the market trough in the first half of 2009; and rents are still declining with a year-over-year drop of 4.3%, averaging $15.18 in the third quarter.

“Although consumer confidence remains tepid at best, the industry is starting to make a gradual incline toward recovery,” said Greg Maloney, CEO and president, Atlanta-based Jones Lang LaSalle Retail. “Development is at an absolute standstill and this helps aid in the recovery process. We expect 2011 to be better than the last few years but nowhere near the peak of 2006.”

Plugging empty space with creative tenants is a 2009-2010 strategy that is projected to continue in 2011. Landlords have welcomed retail alternatives — think bingo halls, thrift stores, churches, medical outlets and community colleges — to their properties, and temp stores are the new black in shopping malls.

JLL’s report cited Gap, Target and Gucci pop-up stores as creative ways to introduce new lines, boost sales and generate buzz. Pop-up restaurants are another new and continuing trend, and temporary seasonal stores are on the rise. National retailers opening temporary, seasonal stores include Toys “R” Us, Build-a-Bear, Chico’s and Game Stop (MovieStop). Jones Lang LaSalle predicts that a small percentage of national temporary stores will become permanent tenants.

The big boys are driving innovation as well. National retailers such as Sears, Meijer and Wal-Mart are testing drive-through lanes aimed at convenience, and Target, CVS and Wal-Mart are beefing up their grocery sections. Wal-Mart is testing smaller concept stores within urban markets and convenience stores are amping up fresh food offerings.

Locals and regionals are poised for more growth in 2011. “Local and regional retailers are growing at a faster clip due to the recession,” said John Bemis, director of retail leasing and development for Jones Lang LaSalle. “Many former business executives that have lost their jobs are channeling their entrepreneurial spirit into new retail concepts. Landlords encourage incubator tenants that have necessary preconditions such as a unique concept filling a void in the marketplace, availability of personal savings and a target market that corresponds with the centers existing demographic.”

On the investment sales front, JLL reported that sales of significant retail properties increased more than 43% to $6.1 billion during the first half of 2010, and through August 2010, sales had increased to $10.5 billion. According to the report, a continued theme across buyer groups for the retail property market is frustration at the lack of product, which pushes sales volumes downward. Banks, however, would rather hold the properties than sell them at discounted prices.

“Banks have learned from previous recessions that the market does come back and they are not willing to drastically reduce pricing,” said Kris Cooper, managing director, Jones Lang LaSalle. “After conducting fire sales during the last downturn, they saw investors make huge profits not long after the recession ended. They won’t make that mistake again.”

The expectation for 2011 is one of continued recovery, though not as painfully slow as 2010. Jones Lang LaSalle expects that retail capital markets in 2011 will be extremely busy as substantially more retail product enters the sale market, which will be a combination of distressed and core as pent-up demand takes over globally. “Retailers will continue to grow at a slow pace but will focus more on optimizing their current portfolios to maximize savings. Landlords will continue to reinvent themselves to remain relevant to shoppers and will be happier in 2011 as rents begin to increase ever so slightly,” according to the report.

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REAL ESTATE

High rent, wrong use?

BY CSA STAFF

By Jason S. Baker

Some highly unusual tenant mixes have been popping up everywhere in the retail market over the past couple of years. Frankly, some of the non-retail uses now being welcomed into the retail lineup are so questionable that one day soon landlords may look around at their transformed shopping centers and wonder if they’ve made the right decisions. By signing too many onerous leases during the Great Recession and its aftermath — perhaps because a scary debt obligation was coming due or that conspicuous vacancy needed to be filled by something — some owners might just find that their top retail tenants are balking at lease renewals and, instead, fleeing for rival properties with more suitable co-tenants.

Consider one of the fastest-growing non-retail tenants taking over retail space these days — emergency room clinics. Medical services are valuable and needed, of course, and have been the saviors for a number of retail centers faced with recessionary vacancies. The fact remains, however, that not long ago very few, if any, landlords would have done a deal with these aggressively expanding businesses, which are now paying premium rents for prime shopping center spaces across the country. Understand, these are not dental practices or minor-emergency clinics — they are full-fledged ERs, replete with dedicated ambulance lanes and, in the worst-case scenarios, sick or injured patients being hauled into the center on gurneys. In one of the more remarkable examples of this phenomenon, the owner of an upscale Houston center, which faced a daunting vacancy after The Limited closed its approximately 7,000-sq.-ft. store, did a truly mystifying deal by dividing the space into two surprisingly polar uses — an ER clinic and a hamburger joint. Today, these incongruous co-tenants sit side-by-side, raising the prospect of life-or-death dramas unfolding before the eyes of families strolling into the burger concept for a quick bite. Around Houston, this center had been noteworthy, not only because of its architectural beauty, but also because it was one of the few grocery-anchored projects with enough cachet to attract mall-quality soft goods retailers such as Gap, Express and Bath & Body Works. It is still a bit shocking to the center’s shoppers to see ambulances idling in front of this highly visible storefront.

One might wonder why any landlord would strike such a deal. In all likelihood, the initial conversations with these ER clinics were no longer than a minute or two with the landlord kindly declining the offer of this tenant to pay top-dollar rents to relieve the center of its vacancies. Eventually, though, the clinics come around with an offer that is 35 or 40 percent higher than average, and the landlord relents. Indeed, these ER clinics, which tend to be either independently owned or part of regional hospital systems, are intent upon positioning themselves for the future while they can. Like the banks a few years ago, they will pay ceiling-busting rents in order to lock up the best-possible real estate.

The same goes for many of the other non-retail uses that have started to proliferate in Houston and other markets. For example, a well-known Texas pediatric association now has some 40 locations throughout the Houston market, many in neighborhood shopping centers. While this particular tenant usually leases in professional buildings and offices, it is relocating more of its clinics into retail properties, which offer advantages like easy-access parking, great signage and close proximity to the customer base. While some non-retail uses are more tolerable than others, these pediatric clinics are legitimate traffic draws and a far cry from emergency rooms.

While the short-term payoffs involved in some of these non-retail deals can be considerable, the potential long-term repercussions on co-tenancy are clearly worrisome. Because medical tenants, in particular, sink so much money into their build-outs, they usually must sign very long-term leases in order to make the numbers work. Thus, today’s decisions will reverberate for years to come. These economically lopsided deals — high rent paid over the long term, with minimal build-out cost to the landlord—certainly have their upsides. But as the economy improves, how many landlords will realize with horror that a non-retail use has put them at a serious disadvantage for future retail success? If a key retail tenant can go down the street and be with Gap, Ann Taylor and Bath & Body Works, why should it stay next to an ER or other non-retail tenant? Retailers can simply relocate stores and add new restrictions to their standard lease clauses — “no gyms, karate studios, massage parlors … or ERs.” A landlord with a 25-year lease to an undesirable tenant is stuck with that situation, and all its ripple effects, for the duration.

We all have to make tough decisions, and the right decision often can be a little scary. Today, we are seeing cash-strapped landlords take leaps of faith and invest in new facades, launch expensive marketing campaigns, hire more leasing people and take other painful steps in order to stand behind their properties over the long term. By contrast, sometimes the seemingly safe decision is the functional equivalent of hitting the panic button. And panicking is never good. The basic message here is simple enough: High rent from the wrong tenant can fundamentally alter the basic character of a center in counterproductive ways. And, it could be for much longer than the original deal intended.

Jason S. Baker is an X Team International partner and co-founder and principal of Houston-based Baker Katz, a full-service commercial real estate brokerage firm specializing in first-class retail tenant representation, project development and leasing, and investment sales.

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News

AutoZone powers through difficult economy

BY CSA STAFF

MEMPHIS, Tenn. — The nation’s largest automotive parts retailer announced another quarter of record results in which earnings per share advanced nearly 36% to $3.34 on same-store sales that grew 7.1% for the quarter ended Feb.12. The earnings per share performance was well above the $3.06 analysts were expecting as was the same-store sales figure which analysts had forecast would rise 6.3%.The company’s gross margins increased to 50.9% from 50%, operating costs were essentially flat and overall net income increased 20% to $148 million as the company ended the quarter with 4,425 stores in the United States and 249 stores in Mexico.

“This marks the ninth consecutive quarter of 20% plus growth in earnings per share and our eighteenth consecutive quarter of double digit growth,” said chairman, president and CEO Bill Rhodes. “We continued our focus on improving parts coverage, hiring, retaining, and training the best automotive parts professionals, and growing our commercial business.

The company’s return on invested capital reached a new all time high of 29.3%, according to Rhodes, who asserted the company will, “remain committed to our disciplined approach of growing operating earnings while efficiently utilizing our capital.”

The improvement in gross margins resulted from improved sourcing of the company’s Duralast brand and increased penetration of that brand in the product mix. Meanwhile, the company noted that expenses benefitted from improved leverage of store operating costs that resulted from higher sales volumes.

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