Retail Construction Starts will Stay at Record Lows until Debt Maturities are Resolved

By Elaine Misonzhnik

The recent opening of Taubman Centers’ new mall in Salt Lake City might have marked a nice symbolic moment for the retail real estate industry, but it’s not about to usher in a new era of construction abandon.

In spite of a slight rebound in retail real estate fundamentals, U.S. developers still feel skittish about investing in new construction projects, forecasts from several different research sources show.

The CoStar Group, a Washington, D.C.-based firm, estimates that in 2012, a total of 21.4 million sq. ft. of new retail space will enter the market, a record low figure, according to Suzanne Mulvee, CoStar’s senior real estate economist. Mulvee notes that next year promises to be only slightly better in terms of deliveries of new space, largely due to the fact that retailers are not expanding the way they once had.

“This is a paradigm shift, a shift to growing revenue primarily through online sales versus growing revenue through physical locations,” she notes.

As a result of the difficulty of getting tenants to pre-lease space in new construction projects, lenders prefer to stay away from retail construction loans, while developers don’t want to invest as much equity as they need to put shovels in the ground. Exceptions can be found only in core cities with strong income growth and substantial tenant interest in opening new stores, according to Bill Rose, director of the national retail group at Marcus & Millichap Real Estate Investment Services, an Encino, Calif.-based brokerage firm.

Marcus & Millichap forecasts 32 million sq. ft. in new retail completions this year, down from approximately 35 million sq. ft. in 2011.

“In strong gateway markets, there is an appetite for financing new projects—provided they’ve got a good credit tenant base,” Rose says. “There are projects getting financed in Washington, D.C., Baltimore, New York and Houston, but they need a good story and a good tenant mix. If you are saying to the lender ‘can we get a deal done somewhere in Wisconsin?’ the answer is ‘Probably not.’”

Light at the end of the tunnel?

In addition, most of the centers getting built today involve necessity retail—grocery-anchored shopping centers, centers anchored by drug stores and discount stores and net leased fast food restaurants, Rose adds. Construction of new malls and lifestyle centers remains on hold. But today’s developers are cautious on all projects, not just those reliant on discretionary spending dollars.

Reis, a New York City-based research firm, estimates that there will be 8 million sq. ft. in new neighborhood and community shopping centers delivered to the market in 2012. The figure will be higher than the annual average of 4.7 million sq. ft. of new construction in 2010 and 2011, according to Victor Calanog, vice president of research and economics. But the prior 10-year average for annual completions of neighborhood and community shopping centers was 29 million sq. ft., he points out.

“Developers are certainly paying attention to weak fundamentals with their hesitancy in bringing product to market,” he notes.

Research firm Trepp has updated its Commercial Mortgage Maturities outlook with fourth quarter 2011 data. It now estimates that $362 billion of commercial real estate debt will be maturing in 2012 (up from $346 billion in 2011). For the five year period 2012 to 2016, the estimate is $1.73 trillion of commercial real estate maturities.

In fact, new construction will remain anemic until the industry works through the record amount of debt maturities scheduled to come due between 2012 and 2016, according to Rose. Given the hundreds of millions of square feet of retail space that was delivered in 2006, 2007 and 2008 (approximately 507 million in all, in CoStar’s estimates), there is no shortage of available space for retailers to choose from right now. That means that in the near term, new project completions are not likely to rise above the 35 million sq. ft. a year figure, in Rose’s view. Eventually, however, the industry will see an uptick in new construction.

“That will occur post-2016, when all the legacy debt will clear the system,” Rose says.

About the Author: Elaine Misonzhnik is Senior Associate Editor at Retail Traffic Magazine