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Hiding in Plain Sight How Retail’s Strength Is Masked

by a Relatively Few “Failed” Centers ANDREW J. NELSON* and SUZANNE MULVEE**

Abstract: The strong and improving performance of most retail centers is masked by the extremely poor showing of a relatively few failing centers. Almost 8% of the retail stock is redundant or obsolete, as evidenced by enduring vacancies of 40% or more, while another tenth is on the cusp, with vacancies of 20% to 40% and unlikely to recover. Excluding these centers reduces the measured vacancy rate significantly, while providing a more accurate view of industry performance and showing less volatility over the business cycle.

Introduction For years, real-estate economists and other

commentators have been decrying a purported surplus of retail space in the United States. Such claims are not new, but seemed to gain greater currency during the last real- estate expansion as the inventory of retail space mushroomed. Shopping-center space actually grew 2.5 times as much as population in the 15 years through 2008, as total gross leasable area (GLA) grew 45%, while the U.S. population rose only 18%. As a result, per capita GLA grew from under 20 square feet (sf) in 1993 to over 24 sf in 2008. By sharp contrast, the amount of shopping- center space in Europe is only 2.4 sf per capita—less than one-tenth the amount in the U.S.1 Overbuilding clearly has played a role; the inability or

unwillingness of many owners to demolish obsolete space is perhaps even more important. Moreover, since the 2007-09 global financial crisis, the impact of two other forces has been felt: 1) the growing migration of retail sales from brick-and-mortar stores to online retailers, and 2) new locational strategies from physical retailers that call for fewer and smaller stores, further reducing the need for retail space. But how much is too much? How much space is

obsolete? One difficulty for real-estate analysts and investors is that retail space cannot be graded primarily on the basis of physical quality, whereas property in other sectors can be quickly (if imperfectly) sorted by style and quality of construction (Class A, Class B, etc.). Rather, the

quality of a center depends on other, more subjective factors such as tenant roster, location and market share— factors that are difficult to quantify on a mass scale. Thus, all retail space is lumped together in standard industry data, distinguished only by type of center (e.g., power vs. community). Just as including Class C office in a pool of office

buildings would distort market data for the Class A office space, so, too, this aggregation of all shopping centers yields misleading metrics. Many obsolete centers are no longer competitive, or able to attract shoppers or tenants. However, though these centers cannot be identified by physical characteristics, a compelling alternative still exists: market performance.

The True Fundamentals of Shopping Centers In fact, more than 70% of shopping centers are quite

healthy, with vacancies pegged at less than 10%. These centers are succeeding—they are economically viable and rents are either stable or rising. While having almost three-fourths of the total GLA, they have less than one- fifth of the vacancies. (See Chart 1-1). Another 11% of shopping centers have vacancies between 10% and 20%. These centers are struggling; as much as one-fifth of the space cannot attract new tenants or customer traffic, severely handicapping prospects for success. Many of these struggling centers are victims of continued tenant consolidation and, more acutely, the mismatch in the size and quality of expanding vs. shrinking tenants.

* Director of Research & Strategy for Alternatives and Real Assets, a division of Deutsche Asset & Wealth Management

** Director, Retail Research, Property and Portfolio Research 1 U.S. figures based on data from “U.S. Retail Real Estate Industry: Size, Shape and Scope – The 2009 Industry Census,” Retail Real Estate

Business Conditions, Vol. 6 (No. 9), April 17, 2009. European data from ICSC Research, The Importance of Shopping Centres to the European Economy, The European Shopping Centre Trust and ICSC Europe, New York, March 2008.


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