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FEATURES Table 1-1

Vacancy Rates by Shopping-Center Type (as of Q4 2012) All

Centers with Vacancy > 40% Increase since 2006

Share of All Centers (Count) Share of 40%+ Vacant Centers

7.6% +4.2pp.

Lifestyle Power Neighborhood Community 4.2%

2.1% +2.5pp

100.0% 0.4% 100.0% 0.2%

+1.3pp. 1.8% 0.5%

* Includes theme/festival and factory outlet centers, and airport retail Sources: CoStar, PPR, Deutsche Asset & Wealth Management

Neighborhood centers similarly suffered, losing many

local in-line tenants, and today, 7.3% of this segment’s centers have “failed.” (See Table 1-1.) The reason for this is more than the fallout from the last recession. It is largely due to competitive pressures in the grocery industry; grocery stores often anchored neighborhood centers. Groceries have emerged as the bulwark in combating declining traffic volumes due to increased online shopping. As such, there has been a rapid expansion in the amount of floor space devoted to food and personal-care items by non-traditional grocery, including aggressive unit growth by Wal-Mart and Target, in addition to specialized niche players like Trader Joe’s, that have far smaller prototypes than traditional supermarkets. With the growth in the space devoted to food items far outpacing population growth, traditional grocers are getting squeezed, and 2013 will be a year of more consolidation—bad news for marginal neighborhood centers. Malls, on the other hand, were only mildly hit, with

under 3% of the inventory carrying vacancies of more than 40%. Surely the selling of “B” and “C” assets by the top REITs demonstrates that some malls should never have been built for the long-term. Still, the depth and quality of tenants that locate in malls predispose these centers to success and better insulates these assets from new competition.

Rent Levels and Growth Disaggregating the retail sector data also yields new

insights into rent dynamics. Both rent levels and rent changes are highly correlated with the occupancy levels of shopping centers. In short, the obsolete centers with the highest vacancies have the lowest rents and have seen the greatest rent declines in recent years, while superior centers command higher rents, experienced smaller rent declines during the recession, and now are demonstrating greater rent growth. Retail rents overall declined 12% from the peak to the trough, as observed in Chart 1-4. The declines are much greater at centers with high vacancies. Centers with at least 40% vacant space have


+3.7pp. 28.5% 28.2%


+2.4pp. 8.4% 6.1%

Strip 8.3%

+4.8pp. 59.1% 64.0%

Malls 2.9%

+2.1pp. 1.3% 0.5%

Other* 7.9%

+4.8pp. 0.5% 0.5%

seen asking rents decline 20% from peak, while centers less than 10% vacant saw rents drop only 12%. This bifurcation helps explain the stubborn lack of rent

growth momentum since the recession. The reality is that most centers started to see rent growth one to two years ago, but obsolete centers continue to drop rents in their unsuccessful attempts to lure new tenants and help support failing tenants. As with vacancy rates, the extremely poor showing of a relatively few failing centers is masking the improving performance of most centers.

Chart 1-4 Peak-to-Trough Retail Rent Changes by Vacancy Rate of Shopping Center, 2006-2012*

* Two-quarter moving averages Sources: CoStar, PPR, Deutsche Asset & Wealth Management

Conclusion The retail sector is going through a period of

consolidation brought on by rapid technological change and excessive building during the housing boom. But rather than dragging all centers lower, stronger tenants are consolidating into better locations, fortifying these assets and creating a bigger gulf between the weak and the strong. With online spending growing at a double-digit pace, it is hard to see these weaker centers emerging intact. Rather, these properties should be converted into alternative uses (including heavily service-oriented centers). Absent this needed house cleaning, industry data will remain misleading and understate the performance of market fundamentals in the sector.


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