More Empty Storefronts Ahead

With recreational shopping on hold, retail real estate -- even strip malls -- is in a rut.

By Laura Kennedy, Researcher-Reporter, the Kiplinger letters

August 20, 2009

The downsizing of the American retail sector has a ways to go. Retail space vacancy rates won’t top out until at least the middle of next year. About 150,000 stores across the U.S. will shutter their doors this year, with the pace of closures remaining high for months after overall economic growth turns around. In a more typical year, about 135,000 stores close and 120,000 new stores open. Last year, however, net closures ran about 40,000 to 45,000, with both more closings and fewer openings. This year should be about the same.

The fact is, retailers have to keep closing stores. “At this point, they can’t cut inventory and expenses much more” to match consumers’ continued low spending levels, says Roxanne Meyer, a specialty retail analyst with UBS. And the slender improvement likely in sales during the second half of this year won’t come close to offsetting the decline during the first half. Indeed, even though sales in the later months of 2009 are likely to look markedly better than in the same month a year earlier, the increase will be deceptive -- a product more of the dismal 2008 performance than of strong sales in late 2009. All told, 2009 sales will come in about 1% lower than the 2008 level.

Even strip malls are feeling the pain. Typically anchored with grocery and drugstores that sell necessities, strip malls can usually count on weathering economic downturns reasonably well. Not so this time: In the second quarter, vacancy rates for the centers hit 10%. That’s especially bad news, considering that this type of property accounts for about 2 billion square feet of space across the U.S. In contrast, regional malls make up 600 million square feet or so. Worse, of new strip malls coming on line -- having been in the pipeline for the past year or two -- about two-fifths are suffering with vacancy rates of at least 50%.

Victor Calanog, director of research at real estate analysis firm Reis Inc., attributes some of the struggle to the rise of big-box discounters and warehouse clubs, which are often stand-alone stores. Shopping centers are in stiff competition with volume discounters such as Wal-Mart and Costco, not to mention American consumers’ desire to spend less in nearly every category. But “the supply situation in retail is also complicating matters,” Calanog says. Developers that started most of the new projects a few years ago are going to keep on rolling. They’ve got too much invested already to just call a halt. “But if the economy remains weak…they’re not going to find tenants and will have to lower prices to rock bottom,” Calanog says.

The fact is, retail space may be maxing out -- at least for a time -- on a per capita basis. Over the past 30 years or so, per capita retail space grew nearly every year, as well-heeled Americans increasingly indulged in recreational shopping. That trend came to an end, however, as the housing bubble burst, the stock market took a steep dive and recession put more than 6.5 million workers out of jobs. Now, as Americans boost their savings and pare consumption, the drive for ever more shopping venues and more square footage of retail space has faded. New stores will continue to be opened, but the trend is toward smaller formats.

About 15 million square feet of strip mall space is set to open for business in 2010, versus 17 million square feet in 2009 and the 20 million to 25 million a year that was typical between 2005 and 2008, according to Reis. No new enclosed mall has been built since 2006.

Despite that decline, it’s still a renter’s market. Landlords will continue to cut rent deals with retailers to keep storefronts from going dark and will scramble to fill empty space with less traditional mall tenants -- such as libraries and local mom-and-pops -- as well. The upside of the high vacancy rate: More retailers are able to afford space. “Even some of the better malls are starting to crack when it comes to negotiating power,” says Meyer.

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