Hot 100 Retailers The Nation’s Fastest-growing Retail Chains
Many of the nation’s hottest retailers are either on a growth tear or coming off a major acquisition — which may be a good thing or bad long term, if too much baggage was included in the transaction. Next year’s Hot 100 report will likely tell tales of what happened to several of this year’s leaders. Various scenarios are well-represented at the top of this year’s STORES Hot 100 Retailers report, with Bi-Lo Holdings, a collection of struggling supermarkets, ranking No. 1, followed by Michael Kors, one of the hottest brands in clothing.
While the economy is improving, the outlook isn’t overly rosy, notes Bryan Gildenberg, chief knowledge officer at Kantar Retail.
“We are looking at retail growth over the next five years as roughly the same as the rate of inflation, about 4.5 percent, but that isn’t to say everyone will be growing equally,” Gildenberg says. “We see non-store and online growth of 11.4 percent and the bricks-and-mortar segment growing at 3.5 percent … [and] losing market share. Right now, non-store accounts for approximately 7 percent of non-automobile consumer sales, but we see that doubling to 14 percent by 2020.”
Food for thought B i-Lo emerged from Chapter 11 in May 2010 after operating for 14 months under bankruptcy protection. Controlled by private equity fund operator Lone Star, it acquired the remnants of the Winn-Dixie chain in December 2011. Bi-Lo was the smaller of the two entities, hence 2012’s triple-digit sales increase.
This spring Bi-Lo also acquired three groups of supermarkets from Delhaize Group: 72 Sweetbay stores in Florida; 72 Harveys markets in Georgia, Florida and South Carolina; and 22 Reid’s Groceries in South Carolina.
Grocery retailing is a $450 billion business and supermarkets “have always been a bit of a mirror as to what is happening in retailing in general,” says Gildenberg. He sees further contraction among traditional supermarket chains while specialty supermarkets will grow as they “get their value message across to the consumer.” Kantar sees a scenario in which “20 supermarket chains control as much as 90 percent of the market” at some point in the future.
No. 3 Sprouts — 2012’s hottest retailer — is one of the specialty grocers that Kantar sees as driving supermarket growth. Earlier this year, the company hit a milestone by opening its 150th store just a decade after its founding. Though its origins can be traced to 1943 when Henry Boney opened a fruit stand in Southern California, the company marks its modern era from the time Boney family members opened the first Sprouts store in Chandler, Ariz.
Also in the top 10 is The Fresh Market, another specialty supermarket. Emphasizing customer service and presenting an unconventional store layout, it has grown to more than 100 locations in 25 states over the past 30 years. Rather than growing progressively, it clusters stores by region: In the past few months, the company opened its fourth store in Pennsylvania, its eighth in Illinois and its sixth in California, with four more slated to open later this year. In all the company plans to add 19 to 22 new stores in 2013.
Craig Carlock, Fresh Market’s CEO, suggests that there are three reasons consumers shop The Fresh Market stores, which average just over 21,000 sq. ft.: Food quality that emphasizes healthy, fresh, local and regional; extraordinary customer service; and the stores’ neighborhood grocery atmosphere. In the first quarter of this year, sales remained in “hot retailer” territory with a 12.9 percent increase and same-store sales growth of 3 percent.
Wearing it well M ichael Kors, which went public in December 2011, posted a 57.1 percent jump in revenues and same-store sales gains of 36.7 percent in the first three months of 2013. The company has increased revenues at a compound annual rate of about 50 percent over the last five years and has tripled its store count over the past three years.
No. 4 Lululemon Athletica has been through a dramatic year that included a quality control issue that led to the exit of its chief product officer and, subsequently, the abrupt and unanticipated departure of chief executive Christine Day. In March, Lululemon was forced to remove nearly one-fifth of its inventory after its black stretch pants were deemed too sheer when the exclusive Luon fabric was stretched. The recall would cost between $57 million and $67 million, the company said.
“While we regret that we had quality issues … we are proud of the organization’s ability to get Luon delivered back into our stores within 90 days of having pulled it from our line, all the while keeping our guests happy and engaged with the brand,” Day said in announcing her resignation. In June, Lululemon said it would begin opening stores devoted exclusively to menswear by 2016.
No. 6 Under Armour, which sells almost as much merchandise through Dick’s Sporting Goods as it does through its own stores and website, may see tougher competition as it expands into global territory controlled by Nike and Adidas. Well-represented among American high school, college and professional teams, last year only about 6 percent of Under Armour’s revenues were from abroad; Nike and Adidas each generated about 60 percent of their revenues in non-U.S. markets.
Company executives acknowledged that “international was underinvested because they were trying to find the right team,” noted Kate McShane, a securities analyst with Citi Research. Under Armour outfits one team in the English Premier soccer league and plans to outfit many athletes at the 2014 Winter Olympic Games in Sochi, Russia, and the 2016 Summer games in Rio de Janeiro.
Hot 100 newcomer H&M has experienced a slowdown in sales so far this year and says it will step up store openings in response, particularly in China and the United States. American store openings include a high profile location on New York’s Fifth Avenue about a block from Saks Fifth Avenue, and another three-story, 42,500-sq.-ft. site at Broadway and 42nd Street. The company also plans to launch an e-commerce site catering to U.S. customers.
H&M, which was stung three years ago when news media reported the retailer disposed of unsold inventory by putting holes in the garments and leaving them on the street for trash collectors, in February launched a program to encourage customers to recycle old garments in exchange for discounts on new merchandise.
“We don’t want clothes to become waste, we want them to become a resource,” says Henrik Lampa, H&M’s sustainability manager. “We want to make new commercial fibers out of this, to make new clothes and textiles.”
The online factor No. 5 Apple’s hot growth continued last year, but this spring’s e-book pricing trial was a distracting sidelight for company executives seeking to keep consumers’ attention focused on products and services. iTunes Radio, a streaming music service offering more than 200 free stations, was launched in June; later this year, Apple is expected to introduce its Mac Pro, a sleek new desktop computer. One of Apple’s more significant retail moves was last fall’s ouster of Scott Forstall, a long-time associate of Jobs who oversaw Apple stores.
No. 7 Amazon.com’s most recent splash in the retail arena was entering the Los Angeles market with a grocery delivery service honed for years in its Seattle home territory. Called Amazon Fresh, the operation was jump-started when Amazon acquired Kiva Systems last year for $775 million; Kiva employed concepts and technology used by early Internet grocer Webvan.
Citing Amazon as “one of the few large-cap [businesses] to have secular exposure to e-commerce,” Oppenheimer & Co. analyst Jason Helftstein says the company “continues to gain share of U.S. e-commerce with its deep product selection, low-cost express delivery through its Prime program and breakthrough successes of its Kindle e-reader platform.”
Amazon also has an advantage because of its “head start and deep operating capability,” says Kantar’s Gildenberg. “It’s hard to see other e-commerce start-ups replicating what Amazon has done.” There is still plenty of opportunity for Amazon, he says, noting its relative weakness in such areas as consumables and apparel.
The expansion of Amazon Fresh to a second major market may turn out to be as significant a game-changer as Wal-Mart’s entry into the grocery business, Gildenberg says. “There are a lot of parallels” in that both Amazon and Wal-Mart went about showing the retailing establishment “a fundamentally different way of selling,” he says. “They operated with business models that were different from the way consumers bought things before.”
Curation and convenience Kantar predicts drug stores, dollar stores and membership warehouse clubs will remain in growth mode.
“One reason club stores and dollar stores will be successful is that they both do a good job curating product,” Gildenberg says. Drug stores will also see an anticipated $15 billion increase in prescription medication spending as a result of coming changes in health care coverage, he says. Even if dollar store openings see a temporary slowdown after the past five years’ explosive growth, Gildenberg sees expansion in the sector continuing as they exploit their capability “in curation and proximities as competitive advantages.”
The most successful retailers will be those that “best present their business’s value proposition to consumers,” he says.
Whatever the economy is doing, consumers were out and about in their cars more often in 2012 than 2011, as evidenced by the presence of eight convenience store chains on the Hot 100 Retailers chart, up from seven last year. Kantar’s researchers say c-store chains are growing through “acquisition of smaller chains and independents, rapid organic store growth and big investments in store remodels, food service and private label merchandise.” The numbers back that up: At the end of 2012, there were nearly 150,000 convenience stores in the United States, according to Nielsen Research — accounting for a little more than a third of all retail stores in the country.
As much as a quarter of the population says it shops convenience stores as often as supermarkets, according to a study released in June by Imprint Plus. The survey, which polled 1,000 consumers, also found that 60 percent of respondents bought something at a convenience store at least once a week.
C-store sales are segregated into two major categories: Fuel sales, which last year amounted to $501 billion, according to the recently-released State of the Industry Report by the National Association of Convenience Stores; and in-store sales of $199.3 billion. The three hottest categories for in-store sales were “alternative snacks” like meat snacks and health/energy/protein bars, which grew 12.2 percent year over year; liquor, up 11.6 percent; and cold dispensed beverages, up 11.3 percent.
The highest-ranked c-store chain on the Hot 100 Retailers chart is No. 24 Stripes, owned and operated by Susser Holdings. Stripes, which has locations throughout Texas, New Mexico and Oklahoma, has opened eight new stores so far this year. The company recently brought in Sid Keswani from Target stores to serve as senior vice president of store operations.
No. 73 7-Eleven, owned by Japan’s Seven & I Holdings, is the largest c-store chain among the Hot 100 Retailers in terms of sales and has plans to double its North American footprint over the next several years, both through takeovers of small operators and increased penetration of urban areas.
The chain “could increase … store numbers to 20,000 or even 30,000,” says Toshifumi Suzuki, chairman of Seven & I, declining to specify a timetable for the expansion. The company acquired more than 650 stores last year and controls nearly a quarter of the North American market. 7-Eleven has also invested heavily in remodeling and renovating both its own older units and acquired stores. It has been an industry leader in improving the quality and freshness of its offerings along with increasing the amount of private label products.
USA Retail Sales (000)
Sales Growth (’12 v ’11)
Worldwide Retail Sales (000)
USA % of World Sales
Growth (’12 v ’11)
Michael Kors Holdings
Sprouts Farmers Market
Apple Stores / iTunes
Helzberg’s Diamond Shops
N. Kansas City, Mo.
The Fresh Market
Ulta Salon Cosmetics & Fragrance
Fort Myers, Fla.
Whole Foods Market
Bed Bath & Beyond
Corpus Christi, Texas
Dick’s Sporting Goods
American Eagle Outfitters
Pier 1 Imports
Fort Worth, Texas
North Bergen, N.J.
IKEA North America
Tractor Supply Co.
City of Industry, Calif.
Yankee Candle Company
South Deerfield, Mass.
C & J Clark
The Woodlands, Texas
Harp’s Food Stores
Sally Beauty Holdings
Abercrombie & Fitch
New Albany, Ohio
99 Cents Only Stores
City of Commerce, Calif.
Academy Sports + Outdoors
Ascena Retail Group
Basking Ridge, N.J.
Casey’s General Stores
Trader Joe’s *
Burlington Coat Factory
VPS Convenience Store Group
The Home Depot
City of Industry, Calif.
Pilot Flying J
Wakefern / ShopRite
San Diego, Calif.
Ethan Allen Interiors
BJ’s Wholesale Club
Harris Teeter Supermarkets
Source: Kantar Retail
Notes on Methodology
USA = 50 States and District of Columbia; sales in Puerto Rico, the U.S. Virgin Islands, and Guam have been estimated and removed if reported as part of the U.S. business segment for that company. All retail sales estimates are excluding wholesale and non-retail services (not sold at store). Fuel sales are included, except where revenues of fuel exceed 50% of average store revenues, in this case sales are reported exclusive of fuel sales. All figures are estimates based on Kantar Retail research and company reports.
* Trader Joe’s Worldwide figures are for ALDI NORD.
While housing marches to the slow, steady drumbeat of recovery, the grass is getting greener and optimism is creeping back into the hearts and minds of both real estate professionals and homeowners. But the wild ride isn’t over, and hiccups remain as the sector struggles to find its footing yet again.
At the National Association of Realtors (NAR) Conference and Expo in San Francisco, real estate consultant Scott Muldavin outlined what he believes the top 10 issues affecting real estate currently are, and by issuing a statement to the press on the topic, NAR agrees.
1. Interest Rates. Muldavin indicated, and our recent news coverage supports, that the top issue affecting real estate is interest rates. They were historically low for so long that as rates begin to rise, capitalization rates are likely to follow, which could spark anxiety about investing in real estate.
2. The Aging Population. As the population ages, there will be greater demand for senior housing, requiring a change in the configuration and size of available housing, and for greater medical care, resulting in an expansion in medical facilities.
3. Tight Credit. The capital market resurgence has positively impacted real estate – credit has become less restrictive for the commercial sector and transaction volume is up, and while underwriting remains a challenge for residential markets, interest rates are low and affordability remains high.
4. New Developments for Future Homeowners. Future housing demand from echo boomers, the 80 million Americans born between 1982 and 1995, will also impact real estate markets, he said. “We are the only developed country that has had an echo boom, and that’s a positive thing if the country can react and respond to it,” Muldavin said. This segment of the population prefers an active urban lifestyle, relies on public transit and often chooses location over size – suburbs are catching up, Muldavin notes, with better mass transit, new bike paths and the like.
5. Climate Change and More Extreme Weather Patterns. These will also continue to have a strong impact on coastal homes and many other properties across the country. Muldavin cited the impact of recent storms like Hurricanes Katrina and Sandy, and how property owners in these markets are now dealing with changes in code and zoning standards and paying significantly higher insurance premiums.
6. Global Events, Including Crises. Like weather and geologic events, major global events can also impact real estate markets, such as acts of terrorism, war, the global debt crisis and financial and economic downturns, he said. “The risk of future events is high, and while it’s always hard to anticipate these risks, they need to be considered because their impact is often great,” Muldavin said.
7. The Gas and Oil Industry. Natural gas and oil production is on the rise in the U.S., and though that is creating greater employment opportunities and reducing U.S. dependence on foreign oil, it’s also contributing to climate change, environmental degradation and contamination.
8. Other Countries’ Economies. Muldavin also cited globalization, foreign investment and the economies of other countries as variables that will continue to have a greater impact on the U.S. economy and real estate market.
9. Tech. Another issue is how technology will continue to impact office spaces. Muldavin said many corporations are employing work-from-home policies and other mobility solutions that are allowing individuals to work when and where they want, significantly reducing office space requirements.
“Many people are replacing physical items with electronics and free or virtual products, such as e-books and smartphones enabled with cameras, GPS and flashlights. This means businesses will continue to require less retail space, so I believe the trend in the future will be for fewer and smaller stores,” he said.
10. The Demand for Actual Storefronts. Muldavin said the impact of the Internet on bricks-and-mortar retail stores is also a growing issue. He said retail demand is down across the country due to an increase in Internet sales, which are expected to rise from the current 6.5 percent to nearly 15 percent by 2020.
Real Estate Forecasts See CRE Recovery to Accelerate in 2014
Commercial real estate firms are moving into the New Year with a renewed sense of optimism – a positive outlook not seen for the past seven or eight years.
While many in the industry predicted a recovery in 2013, they did so with a sense of nagging worry over slower than expected job growth and concerns that the political brinkmanship in Washington could threaten the nation’s credit rating and pitch the economy into stagnation or, even worse, recession.
Much of those concerns have ebbed as the two parties came to terms in December over next year’s budget. In addition, the Federal Reserve has established a clear path for rolling back the so-called quantitative easing steps taken in years past to bolster the economy. By spelling out its path for reducing debt purchases, the Fed has taken out much of the guesswork for when those financial supports will end.
Given the overhanging sense of dread seems to have disappeared from most forecasts, experts are predicting a better year in 2014.
CoStar News has encapsulated Following 14 outlooks for 2014 from forecasts offered by respected industry participants and observers. We’ve sorted them alphabetically by the firm making the forecast.
Cassidy Turley: Impact from Rising Rates If the big economic story of 2013 was policy vs. housing, this year doesn’t promise much in the way of variety. Policy vs. Housing, Part II will see the same threats to economic growth as we continue to struggle with dysfunction in Washington and, most likely, more political brinksmanship that may undermine confidence in the economy. But, while the challenges will be the same, the underlying fundamentals will be slightly stronger. Perhaps the biggest difference is that by the middle of 2014, economic growth should be strong enough for inflation to start to be a possibility once again. This is actually a good thing. The timetable could vary, but we anticipate the Fed raising interest rates by the end of the second quarter-likely in May or June. So long as interest rates don’t move too far too fast, the impact on the overall economy will be minimal. But there will be one. This could slow the housing recovery and it will certainly have an impact on commercial real estate pricing as the price of borrowing becomes more expensive. But that is assuming the underlying economic fundamentals have heated up to the point of warranting such a move-which is ultimately a good thing. A stronger economy may bring higher interest rates, but it will also bring higher earnings, lower unemployment, greater consumer spending and-for landlords-better rental rate growth and NOI. In the meantime, look for the first big political squabble (over the debt ceiling once again) to start up again in late January.
CBRE: Office Market Recovery Poised To Accelerate The office market recovery is poised to accelerate in 2014, as an improving economy should result in increased office-using employment according to CBRE, the world’s largest commercial real estate services and investment firm. The growth in office-using occupations, particularly in high-tech industries, is expected to increase demand for office space. The U.S. office market vacancy rate will continue to decline next year, falling by 80 basis points (bps) to 14.3% by the end of 2014, Steady improvement in the office market is expected to continue in 2015, with the vacancy rate forecasted to dip another 80 bps to 13.5%. CBRE forecasts that office rents will increase by 3%, on average, in 2014, and rise another 4.4% in 2015, as vacancy levels fall steadily toward the “equilibrium” level over the next two years.
Cornell Univ. and Hodes Weill: Big Money Will Continue To Rule Institutions are significantly under-invested in real estate and are poised to allocate significant capital to new real estate investments. The weight of this capital can be expected to have broad implications for the industry, including transaction volumes, fund raising, lending activity and property valuations. The supply of capital may sustain current valuation and financing metrics (including capitalization rates and the cost of debt capital), according to Cornell University’s Baker Program in Real Estate and Hodes Weill & Associates, which co-sponsor the Institutional Real Estate Capital Allocations Monitor.
Deloitte: Steady Growth but Not Enough To Spur Much New Development CRE fundamentals continue to improve across all property types, including vacancy, rent, and absorption levels, according to Deloitte’s real estate forecast. However, demand is yet to increase enough to drive development activity, except for multifamily and hotel construction, which continues to be robust. These same sectors, which were the first to grow and recover after the recession, may see some tapering off in fundamentals as new supply comes to the market. Overall, it appears that fundamentals will continue to improve at a moderate pace, in line with the macroeconomic situation.
DTZ: Business Tenants Keep Bargaining Clout The U.S. economy will continue to expand at a moderate rate, which will lead to more job growth and a related increase in demand for occupational space, reports global property services firm DTZ. However, with the expected moderate job growth, vacancy will only trend down slowly. Occupiers will remain in good bargaining positions over the next two years and occupancy costs will increase in line with inflation. They will continue to receive concessions as landlords compete to increase their properties’ net operating income. Occupiers will gravitate to the most affordable markets and continue to reduce their costs through more efficient internal space build-outs.
EY: Private Equity Funds Getting Hands Dirty Having emerged from the global recession and its aftermath, the real estate private equity sector is finally positioned for growth in 2014, according to a global market trends outlook in real estate private equity published by EY (Ernst & Young). Strategies being deployed by different PE firms and even funds to take advantage of this growth opportunity differ, as fund managers seek to differentiate themselves in a hotly competitive fundraising environment. But EY sees fewer opportunities in the future for fund managers to capitalize purely from the financial structuring side of their investments. The funds that come out ahead of the competition in this next phase of growth will have one thing in common: an ‘old school’ asset management approach that realizes maximum investment value by working closely with service providers to fill buildings and manage real estate.
Freddie Mac: The Emerging Purchase Market Led by a resurgent housing sector, 2014 should shape up to be better than 2013 with a quickening recovery pace leading to more job creation. Freddie Mac expects single-family home sales and housing starts to be at their highest levels since 2007, and expect multifamily transactions and construction to post gains as well. The big shift ahead will occur as the single-family mortgage market begins transitioning from a rate-and-term refinance-dominated market, to a first purchase-dominated market. The emerging home-buyer purchase market should gather momentum in the coming year.
Grant Thornton: Huge Boost Ahead for Industrial Markets U.S. companies will bring production, customer service and IT infrastructure back home, reports tax-advisory firm Grant Thornton. The reshoring trend is real and about to dramatically reshape the U.S. economy. More than one-third of U.S. businesses will move goods and services work back to the U.S in the next 12 months, which means that as much as 5% overall U.S. procurement may return home. The Grant Thornton LLP “Realities of Reshoring” survey found that even IT services, one of the first business functions to move offshore, are likely to return within a year. The trend could provide an enormous boost to domestic manufacturers, retailers, wholesalers/distributors and service providers.
Jones Lang LaSalle: Pent Up Retail Demand Will Drive Investment Total retail investment is expected to increase upwards of 20% in 2014, according to Jones Lang LaSalle, as pent up demand that was not satisfied in 2013 fuels investments and investors look to balance their portfolios. The retail market will continue to turn around despite store closings and consolidation. Vacancy rates are projected to inch downward driven by power center popularity, while rents are expected to increase albeit slightly for the fourth consecutive quarter. JLL also expects the number of retail property portfolios coming to market, which combine a broad spectrum of B and C retail assets, will increase as REITs look to sell assets and recycle capital in the year ahead.
Kroll Bond Ratings: Multifamily Resurgence in Conduit CMBS The Federal Housing Finance Agency (FHFA) has begun to implement strategies to reduce the multifamily footprints of the two GSEs it oversees. As a result, Kroll Bond Rating Agency expects we will see a gradual decline in Fannie and Freddie’s securitized market share, which could revert to levels not seen since before the run-up to the CMBS market peak. At the peak of market in 2007, the conduit market’s share of the $36 billion securitized multifamily loan market was just over 78%. As the financial markets spiraled, that trend reversed and the GSEs became the primary source of loan production, dominating securitized new issues with more than a 95% market share.
Nomura: Muted CMBS Loan Maturity Risk Based on the performance of loans maturing in 2012 and 2013, the investment bank Nomura estimates that 84% of loans maturing in 2014 will pay in full, a decline of just 3% from 2013 levels. Similar to 2013, Nomura expects the balance of loans rolling to delinquency to decline over the coming year, influenced by muted maturity risk and fewer term defaults resulting from improving CRE fundamentals. Most of the loans maturing in 2014 have 10-year terms and were underwritten prior to the sharp rise in property values that began in 2005. However, 15% of maturing loans have 7-year terms and were underwritten at the market peak. This set of loans has an increased risk of default at maturity.
PKF: U.S. Hotel Investors Poised To Do Well in 2014/2015 After a slight deceleration in growth during the last half of 2013, PKF Hospitality Research, LLC (PKF-HR) is forecasting very strong gains in revenues and profits for the U.S. lodging industry in 2014 and 2015. PKF projects national revenue per available room (RevPAR) to increase 6.6% in 2014, followed by another 7.5% boost in 2015. Concurrently, hotel profits should enjoy growth of 12.8% and 14.5% respectively over the next two years.
PwC US and ULI: Investor Activity Continues To Expand Beyond Core Markets The U.S. real estate recovery is set to continue into 2014, with investors increasingly looking beyond some of the traditionally popular markets to secondary markets in search of higher yields, according to the latest Emerging Trends in Real Estate 2014, co-published by PwC US and the Urban Land Institute (ULI). The predicted growth in secondary markets will be driven by investors searching for returns as opportunities in core markets become harder to find and the most sought-after properties become more expensive. The move into secondary markets is underpinned by the anticipated increase in both debt and equity capital during 2014.
Transwestern: More Opportunities in Sale-Leasebacks and Net Lease The cost of capital for owner occupants is on the rise, thanks to increasing interest rates. To cope with higher costs, owner-occupants are increasingly looking at selling their owned real estate as one strategy to generate funds for operating expenses, company expansion or retiring debt. This scenario presents an excellent sale-leaseback opportunity for investors looking to acquire real estate that comes with a long-term tenant in place. The lending environment is expected to bring more net-lease properties to market, as well. As interest rates increase, a larger number of office, industrial and retail buildings are projected to be marketed for sale.
That’s 14 predictions for 2014. We look forward to covering these and many other major trends in commercial real estate in the year ahead. Here is a bonus prediction from CoStar’s Property and Portfolio Research group:
CoStar: 2014 Best Year of Office Occupancy Gains in Recovery Cycle Heading into New Year, office employment has been growing at the fastest rate since the start of the recovery, with the sole exception of early 2012. But there are two key differences between today’s market and that of the past few years. First, the office market now has far less under-utilized “shadow” supply space, which will drive a higher level of net absorption as more office-using tenants expand. Second, with the demand outlook improving and new construction still at bay in most markets, the 2014 occupancy gains in US office markets should be the best of the entire recovery and should tip the scales toward greater rent growth during 2014 than in the past few years. However, developers have already shown their willingness to break ground at the first sign of improvement. This has already happened in Boston, Houston, Silicon Valley and most recently, San Francisco. As developers ramp up new supply, the office occupancy gains are likely to slow in 2015 and certainly by 2016. Investors should enjoy the benefits of occupancy gains in 2014, which are expected to be the best in the current recovery cycle.
GlenStar Properties, a Chicago-based commercial real estate company, along with an institutional capital partner, acquired the office building at 2400 Cabot Dr. in Lisle, IL.
The 4-Star, 205,633-square-foot building delivered in 1987 as Pansophic System Inc.’s headquarters and features various amenities. According to GlenStar, the property includes a 100 percent electrical building back up system via two 1500-kilowatt generators, conference and training facilities, indoor executive parking, a full service cafeteria and dining area, as well as a 20,000-square-foot raised floor data center.
Located in the East-West Corridor, the property was vacant at the time of sale and GlenStar plans to expand and upgrade the on-site parking as well as provide some base building enhancements with the intent to lease the property to a single tenant.
Empty Big Boxes Getting Help from Unexpected Quarters as Dollar Stores, Warehouse Grocers and Large Discount Retailers Like Wal-Mart and Target Take Space.
During the recession, hundreds of retail power center tenants went dark, putting millions of square feet of vacant space back on the market. Store chains like Circuit City, Borders and Mervyns went bankrupt, while others such as Best Buy and Linens N Things, sharply reduced their number of stores, leaving vacant holes in many shopping centers.
Power centers, unenclosed retail centers ranging in size from 250,000 square feet to 750,000 square feet that typically contain three or more big-box retailers along with smaller infill retailers, saw vacancies spike above the total retail vacancy rate from 2008 to 2010.
Since then, power centers have experienced a steep drop in vacancy rates as the flood of store closings has slowed and a new crop of tenants has stepped in to occupy empty big box and in-line store space.
“Power centers have had an extremely outsized recovery,” observed Ryan McCullough, who presented CoStar’s Third-Quarter 2013 Retail Review and Outlook with Suzanne Mulvee, director of U.S. research, retail. “The complexion of the power center real estate market is certainly changing, and the base fundamentals have really improved rapidly.”
By the end of third quarter 2013, the vacancy rate for national big-box power centers had fallen to below 5.5%, from a high of nearly 8% in 2009. The total retail center vacancy rate has declined more gradually, from a high of about 7.5% in early 2010 to below 7% at the end of the most recent quarter.
Many of the retailers taking space in power centers have traditionally leased space in community shopping and other smaller types of spaces, but are increasingly eyeing big-box space, especially in centers with good traffic and demographics.
While the leasing activity varies by market, dollar stores have taken up vacancy slack in many power centers. In other markets, tenants like TJX Cos., Ross Dress for Less and various soft goods retailers have been especially active.
For example, western and work wear retailer Boot Barn recently opened a store in a former Circuit City space west of the Greeley Mall in Greeley, CO. The retailer has occupied shuttered Circuit City stores in several markets.
Eric Tumbleson, senior associate with Colliers International in Las Vegas, said he expects an influx of tenants will continue to move into abandoned big boxes.
“But if you’re asking me, am I advising my investment clients to buy power centers? No way. Stay away, unless you’re the type of investor or developer that can reposition these centers into a different use. The problem is, you can’t acquire these centers at a significant enough discount so that it makes sense,” Tumbleman said.
Most owners also don’t want to go through the costly and time-consuming process of redevelopment or repurposing of the space, agreed Peter Sengelmann of Pinnacle Real Estate Advisors in Denver. “They’re just getting more creative in the ways they’re filling the (empty spaces) with tenants,” he said.
Within the highly competitive retail market, power centers appear to be stealing some of the tenants from neighborhood centers, especially their grocery store anchors.
“We’re seeing a lot of expansion from the Wal-Marts, Targets, warehouse clubs that are stealing some of the thunder from neighborhood centers,” said CoStar’s McCullough. As a result, it’s only over last couple of quarters that CoStar has started to observe any material vacancy compression within neighborhood centers.
On top of that, the mom and pop stores that occupy in-line spaces of neighborhood spaces are still having creidt issues, unlike the power centers, said Mulvee.
“Power centers almost exclusively lease to national credit tenants that have better access to capital today,” she said. “For a full recovery in neighborhood centers, you need those smaller in-line tenants to come back. In stronger markets like Boston, we’re starting to see mom and pop startups opening new storefronts.”
Overall, CoStar’s recent research shows that retailers and tenants are seeing healthy sales, making money and seeing higher productivity from their stores. An index created by CoStar measuring sales per square foot for different types of retail center shows that power center sales at up some 15% from the recession more than six years ago.
There’s also hope for the recovery of neighborhood centers in the CoStar index, which shows, despite the weakness of smaller tenants, that per-square-foot sales are up 25% over the same period.
“With strong productivity by neighborhood center tenants, once the flow of credit is restarted to those smaller tenants, it will set the stage for a fairly strong recovery,” McCullough added.
Announced store openings are picking up in 2013 and closings are down. Overall absorption is getting stronger in retail across the board. A number of retailers have announced plans to open a significant number of stores, many of them in power centers.
So far in 2013, Bed Bath and Beyond leads with about 2.25 million square feet of new stores announced. Others run the gamut of the retail spectrum, from value retailers like Big Lots to luxury tenants such as Bloomingdale’s and Nordstrom Racks.
“We’re seeing a more broad-based group of tenants seeking space, thus, we’re at an inflection point in the market and 2014 will be a much stronger year,” Mulvee said.
Although retail numbers have been choppy in recent quarter, the four-quarter trailing average shows that momentum for demand is building, with the highest point in net absorption since start of recovery.
“We’re now averaging 19 to 20 million square feet of net absorption per quarter, the best we’ve seen in a number of years, and we think it’s going to pick up,” said McCullough. “We’re still below the 50 million square feet of 2007, but the trend is pointing to an increased rate of recovery.”
Shopping Centers Seeing Healthy Demand from Retail Tenants
Continued healthy demand for retail space is driving strong occupancy increases for many of the nation’s shopping center landlords and is even beginning to show up in rent increases.
“We’ve seen occupancy increase for a couple of years now and landlords are showing increasing net operating incomes and some are starting to see rents pop,” said Ryan McCullough, senior real estate economist CoStar Group (PPR division), speaking at CoStar’s 2013 Q3 Retail Review & Outlook webinar last week. “However, rents for most retail space are still low to the point that they are not an undue burden on the tenant,” a positive for both sides, said McCullough.
In fact, he added, the decline in vacancy appears to be accelerating. Net absorption of retail space reached its highest point since the start of the recovery with 19 million to 20 million square feet of net absorption per quarter, the best results in years.
McCullough said there is still plenty of upside for quarterly net absorption, which remains well below the height of the market in 2007 when national net absorption per quarter was approximately 50 million square feet.
With the increasing net absorption, retail rents are even starting to tick up.
“We’re just talking about a 0.8% gain over the year, not a huge number,” McCullough said, but also noting that some of the stronger U.S. markets are seeing retail rent gains of from 4% to 5% and even higher.
McCullough’s comments on the CoStar webinar are backed up by other comments made by senior executives for some of the largest publicly held retail REITs in their third quarter earnings conference calls.
Demand Coming from National, Regional Tenants “We’re still not seeing the formation of new mom-and-pop businesses; and most of our new leases are coming from national, regional or franchise operators. These tenants want to be in Weingarten properties because our top tenants, supermarkets and discount closing retailers, continue to drive sales and traffic to our centers.
Rent growth for new leases continues to accelerate. We produced an increase of 9.4% in the third quarter and 12.6% year-to-date. We do see leverage slowly shifting to the landowner, particularly in urban markets that have more depth of retailer demand. Johnny L. Hendrix, Chief Operating Officer and Executive Vice President of Weingarten Realty Investors
New Retail Outlet Concepts Spur Growth We love all the new outlet concepts that are coming. There are several that have announced plans to expand, such as Francesca’s, Asics, Talbots, Vince Camuto, Cache. We’re also working with folks like Helzberg Diamonds, Joe’s Jeans, MaxStudio, Theory, Andrew Marc. There seems to be an ever-increasing list of high-quality designer and brand names that want to enter or expand in the outlet space. Steven B. Tanger, President and CEO of Tanger Factory Outlet Centers
Demand Driving Tenant Turnover The demand we’re seeing is from domestic retailers looking to expand the existing footprints to scale up new concepts, international retailers seeking to enter or expand within the U.S. market and the traditional destination retailers that are coming into the mall.
It is also an opportunity for us to replace lower productivity tenants with a higher productivity tenant, thereby supporting a continued growth in sales at the malls. Sandeep Lakhmi Mathrani, CEO of General Growth Properties
Occupancy Increases Up for both Anchors and Small Shops Quarter over last quarter, overall occupancy was up 30 basis points pro rata and 20 basis points gross. Anchor occupancy increased 40 basis points to 97.4%; small shop occupancy was up 40 basis points to 84.7%, an 80 basis points increase from third quarter of 2012. The increase in small shop occupancy continues to be driven by positive net absorption from the disposition of riskier assets.
Given that demand for large boxes is very strong, and occupancies are high for this space across our sector, Kimco is benefiting from this trend through higher rents for a larger portion of our portfolio. Additionally, we continue to see the advantage of old leases in our portfolio coming to the end of their term. Conor C. Flynn, Chief Operating Officer and Executive Vice President of Kimco Realty
Retailers Making Up for Over-Reacting Three Years Ago You know everybody probably overreacted in terms of closures in 2010. And so a lot of [what] you see is a lot of these national guys who are really scrambling to find space.
There has been a real strong increase really across the board and demand from national tenants. A good example is Starbucks as an example. Eighteen months ago people would say ‘they’re done, they’re closing stores, they’ve got too many stores.’ Now Starbucks is opening lots of stores or re-opening stores that they [had previously] closed. John Kite, CEO of Kite Realty Group Trust
Lease Terms Also Becoming More Landlord Favorable On a same-property basis, the operating portfolio is nearly 95% leased at the close of the quarter, and shop space occupancy stands at roughly 89%, the highest it’s been since 2008 and a 130-basis-point improvement over 2012. With this increase in occupancy, aided by strong tenant demand and limited new supply, we continue to gain pricing power. Rent growth returned to double digits this quarter. Average rents for side-shop tenants continue to trend upward and are now 34% above the trough.
And not only are starting rents improving, but we’re also seeing more favorable lease terms as a whole, including better rent steps and more aggressive commencement dates.
Retailers are acting on this positive sentiment. Many are making significant investments in their current spaces, as well as in new ones. Given the underlying strength of tenant demand, we see no slowdown in the positive momentum in all of the key operating metrics. Brian M. Smith, President, Chief Operating Officer of Regency Centers
8% Rent Increases in Core West Coast Markets We have seen a considerable increase in retailer demand across each of our core markets this year, coming from a broad range of large national retailers, as well as regional and local tenants. Needless to say, we have been working very hard to capitalize on the increased demand and as a result, our overall portfolio occupancy has risen to 95.3% as of September 30.
In terms of same-space comparative numbers, cash rents increased by approximately 8% on average for the third quarter.
Increasing your value on a commercial property is not that simple. As an asset, land purchase has many subtleties that require keen analysis, local knowledge and an eye to the faraway horizon.
Dean Saunders, ALC, CCIM, of Coldwell Banker Commercial Saunders Real Estate in Lakeland, Florida, is one of the top land-sale brokers in the United States. Dean Saunder’s experience is long and wide. He stresses that a knowledgeable, local professional is critical to a successful purchase. A local professional will have a network of useful relationships and a thorough understanding of political and/or environmental issues that are unique to the location. You have to know the right questions to ask in order to fully evaluate a potential transaction. Saunders maintains that understanding land purchasing is primarily a matter of economics and covering the basics. “The basics” means doing the research on the obvious (the title is clear, the land has been surveyed) and thoroughly investigating what he calls “the three constraints to value: political, physical and market.”
“You make your money when you buy land,” he says. “You realize the profit when you sell. If you know you bought it right, then you know you will make money on it.” But what is the right price? This is where careful analysis benefits potential investors.
Agricultural land in the Midwest and the Mississippi Delta tripled from 2007 to 2013. A combination of high commodities prices and low interest rates is making farmland attainable, which in turn is driving prices. USA Today reported, “In Iowa, where rich soil, favorable weather and ethanol and livestock production help foster demand for limited growing space, farmland values have soared 90 percent since 2009. An acre of farmland that a decade ago sold for an average of $2,275 now sells for $8,700.”1 This is a very attractive return on investment, by any measure.
Fred Schmidt, president and COO of Coldwell Banker Commercial Affiliates, believes recent demand on agricultural land as an investment is putting pressure on prices. “Prior to the 2008 recession, that had not been the case,” he says. Additionally, land is attractive to overseas buyers. “The United States is number one in property rights. Conveyances of property by deed with the chain of title available for investors to see in the United States helps to drive secure investment in the United States. International investors are looking at secondary and tertiary markets for sound investments, and for opportunities to convert them into revenue-producing vehicles.”
Saunders recounts the past decade’s land-market turbulence. The boom prices in Central Florida and other parts of the country were sky high and highly speculative in late 2006. By 2008, the market corrected and prices went down dramatically—in his opinion, below where they should be, creating potentially profitable opportunities. “There is art in knowing when and for how much. Buying land, assuming it will always go up in value, is simply not realistic,” says Saunders. In the heady speculative days of 2007, buyers paying over-the-top prices were validated by lenders who were willing to lend on the sky-high prices. Many were badly burned. Whether you are a buyer or a lender, “Don’t neglect the basics, and be diversified,” says Saunders.
DO THE GROUND WORK ON LAND
Saunders says that basic research includes understanding the water rights, road access and frontage, taxation, zoning, power sources. All are important factors. “Is it in the path of progress?” asks Saunders. “Look at fundamental demand: Where is the growth going to be? Is it logical?” He talks about three “constraints to value.” He says the first constraint is physical. “What can actually be built on the property? What are the physical characteristics of the land?” For example, does it have wetlands, and if so, where; what soil types do you have; and what can you grow on them? The second constraint is political. “What does the government say I can do on the land?” Saunders cites land use and zoning, water and sewer lines, endangered species, tree ordinances etc. Then there are market considerations: “Is there demand for what you want to build? Will they come if you build it?”
Saunders stresses that having a knowledgeable professional on your team is key. Your consultant should be able to tell you what is in the public record, and also what is in the wind, as it will likely pertain to future legislation or other projects in the same locale. Those subtleties will be invisible to someone who does not have in-depth local knowledge. Expensive missteps occur when potential buyers do not know the right questions to ask. “Hire the best counsel you can,” he says. “You need someone on the beach who can tell you whether it is safe to be in the water right now. All real estate is local.”
DEEP IN THE HEART OF TEXAS
The pivotal role of working with a professional who has local expertise is echoed by Beau Tucker, CCIM, a commercial land specialist at Coldwell Banker Commercial Rick Canup in Lubbock, Texas. Tucker specializes in all aspects of land, build-to-suits and commercial real estate investments. He maintains an inventory of more than $100 million in land and investments and is among the most active land brokers around. He does a lot more than help buy and sell tracts. “I help landowners get the most out of their land.” Tucker invests a lot of time and talent in building relationships with potential tenants as well as landowners. He knows what commercial buyers/tenants want and need. Perhaps their businesses depend on being near multifamily dwellings or offices or Lubbock’s large college community. Through his extensive networking activities, Tucker considers himself as much a matchmaker as a commercial real estate adviser. He brings project partners together to their mutual benefit.
For instance, he worked closely with a large land developer to strategize the “big picture” for 500 acres. Rather than simply transacting sales of parcels, together they created the vision for a retail corridor that houses a synergistic mix of tenants and links major transportation routes through the city. The whole was greater than the parts. It elevated the value of the land, the value of the economic activity and the value to the community.
COMMERCIAL REAL ESTATE AND PHYSICS
Saunders says that the economics of land purchase is the same as the laws of physics. What goes up must come down. Every action has an equal and opposite reaction. When there is money to be made, everybody wants to jump in, causing the market forces to rebalance. Among the reasons farmland is expensive now is that corn prices are high, as it is being used to produce ethanol for fuel. Inevitably, higher prices for corn will mean that more growers in the United States and overseas will find corn economically viable. More supply will cause corn prices to moderate. The land that is being used to grow it will be affected, too. Similar forecasts are echoed in Agricultural Commodity Markets Outlook 2011 – 2020, which states, “Current high commodity prices result in a supply response which puts downward pressure on prices, easing from current high in nominal terms.”
On the other hand, burgeoning demand from China for agricultural products will support demand. Former Senator Thomas Daschle told the U.S. Department.
of Agriculture’s 2013 Agricultural Outlook Forum, “To keep up with this rapidly rising demand, we will need to increase global food production 70 percent by mid-century.”
“These are the kinds of susceptibilities that must be observed with caution,” says Saunders.
EVERYTHING OLD IS NEW AGAIN
Schmidt emphasizes the central role of accessibility and transportation in the future of land values. In the industrial sector, accessibility to rail is re-emerging as a desirable factor. “The rail siding is coming back. It is part of the long-term planning, as a hedge against high fuel costs. We haven’t seen that in the past 15 to 20 years,” said Schmidt.
“There is a trend toward adaptive reuse around urban markets and exurbs, repurposing older factories and obsolete buildings into mixed-use developments. In part, it is a demographic shift, because millennials are looking for high-density living,” Schmidt notes. “Developing commercial land and high-density residential carries a higher degree of risk because there is not an immediate revenue stream. It is predicated on approvals, zoning, financing. It requires a sophisticated knowledge base and astute advisers.”
WATCHING FOR RISK FACTORS
The economy of West Texas fared well through the Great Recession. It has been growing at a rate between 2 percent to 5 percent in various cities for the past several years. In 2013, housing inventory was at pre-recession levels, signaling robust health and opportunity for retail, hospitality and health care. Yet it takes an expert with local knowledge to keep a cautious eye on market pressure and risk factors.
Tucker says the market dynamics in West Texas have changed dramatically over the past few years. Development is raging. Reasons include the region’s stability throughout the economic downturn, historically low interest rates, an oil boom, the growth of Texas Tech University, major medical districts and a population shift from small towns to the larger cities.
Low interest rates have been major drivers in land sales and development growth. They have allowed developers to build, get the returns they need and still charge rents that are reasonable in the West Texas market. Some of Tucker’s investors are doing 1031 tax deferred exchanges into new investment properties to get better returns. Tucker’s expertise in doing financial analyses steers them toward the best solutions.
The role of keeping or transferring mineral rights along with property has become infinitely more important in land-sale negotiations in the Lubbock area within the past five years, although other cities in Texas have dealt with it for a long time. At the same time, buyers need to make sure that they have 100 percent of the surface rights so there are no unpleasant surprises in the future.
Tucker has his eye on potentially higher interest rates and how that will affect the volume of commercial real estate activity. He believes CAP rates will follow the interest rates and make the industry more attractive to cash buyers; higher interest rates have the potential to slow down some investors. He believes that in rural subdivisions, making sure that there is sufficient, sustainable well-water is going to be increasingly important. While West Texas has ample room for development, Tucker thinks it needs to be done in a thoughtful and deliberate way. A land professional will help make sure that happens.
“Every single land sale requires a specialist in that area,” he says. But it isn’t only in flat, mineral-rich West Texas. “In East Texas and Oklahoma, where there is timber or other issues pertinent to the area, professionals in that particular market are the best equipped to advise on this particular issue. Buyers need to seek out a professional in each market,” he says.
Unquestionably, transacting land is both an art and a science. Thorough research and the best advisers will help you see the potential in all aspects of the deal. That’s rock solid.
Fred Schmidt is president and COO of Coldwell Banker Commercial Affiliates. He is a veteran commercial real estate professional with more than 30 years of experience in the industry. He is a member of CoreNet Global, the leading professional association for the corporate real estate industry, as well as IAMC and ICSC.
Dean Saunders owns Coldwell Banker Commercial Saunders Real Estate (land sales) and its new division, Coldwell Banker Commercial Saunders Real Estate | Forestry (timber land and management), and Coldwell Banker Commercial Saunders Ralston Dantzler Realty (commercial property) in Florida. He has more than 30 years and millions of acres of land-sales experience. He is an ALC (Accredited Land Consultant) and a CCIM (Certified Commercial Investment Member).
Beau Tucker is a top land-sales representative for Coldwell Banker Commercial Rick Canup in Lubbock, Texas. He is a CCIM (Certified Commercial Investment Member), a Member of Realtors Land Institute, Member of International Council of Shopping Centers and a Member of (ULI) Urban Land Institute.
REITs Turning to Office Properties for Future Growth
Surge in Office Buys Follows Moves by Investment Trusts to ‘Harvest Returns’ by Selling Other Property Types
The nation’s equity REITs are selling more property this year than they are buying compared to the past couple of years. In fact, they have already become net sellers of industrial properties.
Notably, however, the REITs are pivoting their investment strategies to increase their office property holdings at a faster rate than they are selling them. The spread has almost doubled so far this year compared to last year.
The pattern signifies what is happening across the REIT investment spectrum this year, according to Dennis Duffy, managing director of Landauer Valuation & Advisory Services, a division of Newmark Grubb Knight Frank in Washington, DC. Increasingly, Duffy said, REITs are turning to invest in office property as they ‘harvest returns’ by selling other property types in the current low cap rate environment.
“The trend is being precipitated by the desire for secure yield,” added Duffy. “Suburban office acquisitions are now considered ‘value-add’ properties, in many cases. Alternatively, CBD office properties offer secure, stable cash flows. And, especially regarding suburban office buildings, REITs do not want to sell at prices lower than historical acquisition basis. They will tend to hold and re-tenant buildings more often than institutional owners.”
John F. Myers, managing director at Cassidy Turley in Bethesda, MD, is seeing the same trend.
“REITs are looking to bolster the quality of their portfolios. They are selling industrial (because it is a seller’s market) and buying into office where they can be all-cash buyers and leverage the asset at a later date, thereby allowing them to make cleaner offers more certain to close,” Myers said.
According to analysis using CoStar COMPs, last year, REITs acquired twice as much property as they sold. This year, the difference between their buying and selling activity has been cut in half. While the pace of acquisitions is almost even with last year; the pace of REITs selling properties is up almost 25%.
However, analyzing REIT sales activity by property type, the reverse is happening in the office sector. Office property purchases are up nearly 37%, while office sales are holding even.
Capital Markets Conducive To Investment Trends
Jason Bates, vice president of investments at Parkway Properties in Orlando, explained that current capital market trends are conducive to the strategy.
“REITs have generally felt comfortable paying today’s market prices given the stability of the assets and the cost to replace these assets,” Bates said. “Generally, REITs are still buying below replacement cost and are able to finance them effectively,” Bates added. “In addition, REITs are generally able to buy without financing contingencies, which is attractive to many sellers. This is because the debt market has still been very discerning of the borrower when making asset specific loans.”
The trend is also logical from a long-term fundamental perspective for REIT’s, added Tyler Boyd, market research analyst at Voit Real Estate Services in Roseville, CA.
“If you look at the three (major) sectors of commercial real estate (office, retail, and industrial), office is the sector that has the least risk to dramatically evolve over the next 20 years,” Boyd said. “Industrial continues to evolve towards the big-box, modern distribution age; and retail, as always, evolves with the consumer and has become a game of seeing which retailers can become the most e-commerce resistant.
“Office has actually evolved little over the last 50 years, other than relatively smaller floor plates and greener buildings,” Boyd added. ”This provides REIT’s with the assurance that if they buy a newer, LEED building their income stream over the next 20 years should be fairly safe. Combine this with the fact that the office sector has been the last sector to recover from the recession, especially in the suburban and tertiary markets.”
Brian Merzlock, real estate strategist for Williams Auction, a division of Williams, Williams & McKissick in Tulsa, OK, has noticed that REITS are particularly keen on medical or tech office space.
“Most REIT managing members are seeking high-end office space (as well as multifamily and retail candidates) – properties ideally located in ‘money districts,’ inside the beltways, or within walking distance to key metro linkages,” Merzlock said. “Key indicators for most REITS include cap rates, NOI and low vacancy (below 15% to 20%).
“Another key factor to understanding the surge, is the thinning of the trees in the forest that is occurring with an increasing number of REIT mergers occurring where millions of square feet can be represented in one merger/acquisition… some of the largest recorded sales prices of late have occurred via mergers,” Merzlock added.
Another driver of the current REIT investment pattern is that many REITs are in a realignment stage during which they are disposing of non-core assets, while striving to get back to core competencies and markets.
For example, that’s the case for Tier REIT (formerly Behringer Harvard Real Estate Investment Trust I).
“I believe this trend is a result of REITs having capacity to grow after shoring up their balance sheets and feeling less uncertain about the direction of the economy,” said Scott Fordham, president and CFO of Tier REIT. “Throughout 2013, prior to the [federal government] shutdown, the economic angst had waned somewhat and as a result, we, and I believe REITs in general, have been increasingly more comfortable underwriting rental rate growth in markets where new supply has been held in check.
“Provided the dysfunction in [Washington] DC, [politics] does not result in the economy losing its foothold on recovery, we believe we will be in a position to continue to underwrite rental rate growth and make investments that meet our return thresholds,” Fordham continued.
This week, Tier REIT agreed to sell to an unnamed buyer 10 and 120 South Riverside Plaza in Chicago for a contract sale price of $361 million.
Chicago Suburban Office Market Small Step Towards Recovery
The suburban office market has taken another small step toward recovery, with vacancy falling to the lowest level since early 2009 but still harsh.
Overall vacancy during the third quarter was 24.2 percent, down from 24.4 percent in the previous two quarters and 24.5 percent a year earlier, according to Chicago-based commercial real estate firm Jones Lang LaSalle Inc. It is the most encouraging number since the first quarter of 2009, when vacancy was 23.9 percent.
The last time vacancy was below 20 percent was the second quarter of 2007, before the recession.
It will likely be years before landlords regain the upper hand in leasing or for office building values to rise significantly, said tenant broker Diana Riekse, an executive vice president at Jones Lang LaSalle.
“It’s hard for buyers to get excited about the suburbs,” said Ms. Riekse, who specializes in the west suburban market along Interstate 88, the East-West Tollway. “We need a good six quarters of positive net absorption before people get excited about it from a landlord perspective.”
Demand for space was a meager 195,818 square feet during the third quarter, nudging the year-to-date total to just 315,615. Demand is measured by net absorption, the change in the amount of leased and occupied space compared with the previous period.
That expansion pales in comparison with the 895,418 square feet Zurich North America announced it will vacate in Schaumburg in 2016. The subsidiary of the Swiss insurer said in September that it will build a new headquarters on the campus of communications device manufacturer Motorola Solutions Inc., which is also in the northwest suburb.
Zurich has not disclosed the size of the new building, but the announcement will mean some heavy lifting for the building’s Oak Brook-based owner, Retail Properties of America Inc., which is faced with holding two empty towers.
“Everybody’s talking about Zurich,” Ms. Riekse said. “That’s going to be a step back for Schaumburg, but not for three years.” Of the six submarkets in the Chicago suburbs, Lake County maintained the highest overall vacancy, at 28.3 percent, while Cook County remained the lowest, at 16.5 percent.
SHORTAGE OF BIG DEALS
The weak absorption of space is simply because of a shortage of big deals. Just two new leases of more than 100,000 square feet have been signed in 2013, compared with 10 in 2012.
The third quarter was highlighted by college bookstore chain Follett Corp.’s 163,000-square-foot lease at Westbrook Corporate Center in west suburban Westchester, the largest deal of the year to date.
But small deals prevailed, with nine other leases of at least 20,000 square feet, including Power Construction Co. LLC’s 35,000-square-foot deal at 8750 W. Bryn Mawr Ave. near O’Hare International Airport.
Cutting back space when leases are up for renewal has become commonplace nationally, as companies seek more open layouts that encourage collaboration and save space. In many cases, reducing space prompts tenants to move to higher-quality and better-located buildings, since it’s often easier to move than to try to rebuild space while workers are present, Ms. Riekse said.
Another troubling trend for the suburbs has been tenants migrating downtown in pursuit of young, urban workers. Companies with deep roots in the suburbs are now exploring alternatives to a complete move into the city, such as creating satellite offices, she said.
Loft buildings in areas close to the Kennedy Expressway, such as River West, are becoming popular destinations for those small offices. “Right now it’s a small percentage (of tenants) that actually do it, but I’d say half of them are evaluating it,” Ms. Riekse said.
Source: Crains Chicago Business Ryan Ori October 07, 2013