Economist's Commentary: Retail Fundamentals

Commercial Real Estate Trends: Retail Fundamentals

By George Ratiu, Research Economist

Consumer spending, the main driver of the economy over the past years, is in decline. During the fourth quarter of 2008, consumer spending dropped 4.3 percent. The drop follows a revised 3.8 percent decline in the third quarter of the year, making for a dismal traditional shopping season.

Compounding the problem, with economic activity in decline, businesses are cutting costs by shedding jobs. From November 2008 through January of this year, there were 1.77 million jobs cut. The unemployment rate moved from 6.8 percent in November last year to 8.1 percent during February 2009. Faced with job losses, a stock market in continuing decline and growing home equity losses, consumers have scaled back their spending.

The abrupt drop in consumer spending has prompted retail businesses to scale back their operations, close stores and even go bankrupt. Circuit City proved to be a case-in-point of the dramatic shift in retail sales-the company filed for bankruptcy protection in November, but closed all its stores and went out of business this month. With the company's folding, more than 560 stores closed, pushing retail availability upward nationwide.

Demand for retail space, as measured by net absorption, is expected to drop by 12.4 million square feet during the first quarter 2009. Demand is estimated to decline by 49.8 million square feet during 2009. Completions of new retail space have adjusted for the change in demand, but not fast enough. As a result, vacancy rates are on the rise. The vacancy rate for retail in the first quarter 2009 is expected to reach 11.8 percent, 28 basis points higher than a year ago. The vacancy rate is estimated to jump to 13.4 percent by the third quarter 2009.

Regionally, the retail sector is feeling the squeeze in areas hardest hit by the economic recession, highly concentrated in the Midwest. The top ten metro areas with the highest retail vacancy rates include Detroit (18.7%), Columbus (16.9%), Indianapolis (15.3%), Cleveland (15.2%), and Chicago (13.8%).

At the other end of the vacancy spectrum are coastal markets. In particular, markets on the West Coast are finding lower availability rates for retail space. For the first quarter 2009, San Francisco takes the top spot of lowest vacancy rates, at 3.4 percent. Honolulu, HI (4.7%), San Jose (5.4%), Orange County (5.6%), and Miami (5.6%) maintain resiliency with low availability.

In step with rising vacancies and store closings, average retail rent is declining. Rent growth is expected to decrease 2.2 percent in the first quarter 2009. For the year, rent growth will likely post a 9.0 percent drop.

The retail outlook for the year is dim. The economic recession is still taking a toll on the financial markets, consumer credit is scarce and expectations of job losses continue. In an effort to contain losses and mitigate risks, banks are reducing or cutting altogether revolving credit, placing consumers in a position to further trim spending. The only glimmer of hope came in this week's Commerce Department report that revised January retail sales upward by 1.8 percent, and pointed to February sales that, though down 0.1 percent, declined less than expected. The slight improvement in indicators may point to stabilization in the decline of retail spending. However, for the retail sector, the road promises to be bumpy.

This is one in a series of commentaries by the Research staff of the National Association of REALTORS®. Read more commentaries >

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