Marin retail sales hit by economic worries

Fears that the economy is sliding back into recession have had a negative impact on retail sales in Marin County. According to data released by the State Board of Equalization, just $2.6 million in sales tax distributions were made to cities in Marin in September. That total represents a fall of 6.5% over September 2010, and is also 3.9% less than the September total in the depths of the 2009 recession.

As the chart below shows, the rolling 3-month average for 2011 is tracking an almost identical path to 2008. Does this mean 2012 will turn out to be another 2009? Let's hope not.

Commercial real estate finance

Today I went to the Fairmont Hotel in San Francisco, to listen to the speakers, sages and pundits at the Fisher Center's annual Real Estate and Economics Symposium.

The main economic take-away was that the recession is over, employment is not falling as fast and may soon start growing and the housing market has bottomed out.

Great news then: but not for commercial real estate, which has a whole different set of problems. CRE values are down 41% from the peak. RCA's Robert White estimated there's $1.8 trillion of real estate loans originated over the last 6 years where values have fallen more than 25%, effectively wiping out any equity holdings. The value drop hasn't led to many foreclosures yet because net operating income remains cushioned by long leases. Also, banks are choosing to "pretend and extend" while properties can still cover their debt service payments.

This won't continue for long. Around $800 billion of CRE debt will need to be refinanced over the next two years, and commercial vacancy rates are rising and rents still falling. While the banks' cost of capital is essentially zero, they are willing to extend the loans on any property that is cash flow positive, and only foreclose on the weaker under-performing assets. But zero percent Treasuries aren't sustainable. Once they rise (and Ken Rosen expects T-Bills to be at 2.1% by the end of 2010) the performance hurdle will also rise and that will result in many more foreclosures of commercial properties. Only then will the real CRE losses begin to be recognized.

And it'll also be a great time to buy.

More pain ahead for retail real estate

News for retailers - and especially retail real estate - continues to get worse. The rotten housing market and rising employment are pushing consumer spending down. Retailers are shuttering stores and heading to the bankruptcy court in record numbers. This week it was JJill, Eddie Bauer and RUEHL. Which retailers will it be next week? And there's a tidal wave of commercial real estate loans due for maturity in the next two years.

Seeking Alpha sums up the pain with an article about how to profit from the fallout. The unhappy answer is: go short on mall REITs.

Now the good news: Trader Joe's will open August in Larkspur! Yay!

RREEF's retail outlook is too dismal

RREEF yesterday published a dismal view of the outlook for retail real estate. “Done Shopping: Structural Shifts in the US Retail Sector” concludes that the retail sector is going through profound structural changes that will result in lower rates of growth in retail spending in the future, which will translate into fewer stores and more failed retail centers: up to 10% of shopping centers may be forced to close.

Whilst the cyclical impact of the recession is causing pain throughout the sector, with store and mall closures in abundance, the report identifies longer term structural changes that will have a lasting effect, causing retail spending to grow at only half the rate that it achieved over the previous cycle.

RREEF’s main argument is that consumer spending in recent years was boosted by the housing boom and stock market rally, and without these factors spending will expand at only half the rate. The problem is that the data doesn’t show any evidence of such a boost:

“real retail spending including motor vehicles actually grew at about the same rate during the housing bubble as during the preceding four decades”.

I guess what RREEF is implying is that retail growth over 2002-2008 should have been below the historic trend rate, but the housing and stock market booms kept the growth rate artificially inflated. So when the recovery occurs without these factors, retail spending will reset at a lower rate.

The report claims that the key structural changes that will impact retail sales growth are demographic. As the baby-boomer generation moves into retirement, boomers will cut back on retail spending. Census data shows retiree age groups tend to spend less than pre-retirees. That may be true historically, but this is the baby boomers we’re talking about. They are wealthier than previous generations of retirees; many will be retiring with generous pension plans, mortgages paid off, kids left home, medical plans in place and plenty of leisure time. I’ve heard a lot of talk about the great opportunities that will be provided by the huge baby boomer retirement market. I don’t buy the RREEF line that

“as they age, baby boomers will have decreased needs for retail goods and will be conserving more cash as they retire.”

I think they’re more likely to take their spending habits with them into retirement.

RREEF also concludes that that population growth will be regionally focused and will be biased towards ethnic groups, and these ethnic groups tend to live in different locations and have different shopping habits. This is certainly an ongoing trend, but this is nothing new and nothing that retailers and retail real estate owners aren’t already fully aware of. And at the macro level, unless this trend has a negative impact on household income growth, I don’t see it impacting retail spending growth.

Overall, I disagree with RREEF’s pessimistic view. The data shows that retail growth didn't accellerate during the housing boom, and there's no evidence that structural changes will have a negative impact on retail spending. I don’t see any significant reasons why the retail sector won’t bounce back strongly when the economy recovers. Innovation will fuel economic growth once more, household incomes will grow again and retail spending will too. New retailers will emerge to challenge the existing chains and retailing – and retail real estate – will continue to change, adapt and grow.

More pain on the national retail scene

Reis reports that vacancies at US malls are now at a 10-year high and expected to rise further:

“So much of consumer spending depends on the wealth effect,” said Victor Calanog, director of research at Reis. “Unfortunately, all three conditions are still in flux. Even when they stabilize we often observe anywhere from a 12- to 24- month lag until commercial retail properties begin benefiting.”

US mall vacancy rates increased to 7.1% in 4Q 2008, with shopping centers rising to 8.9%.

Meanwhile, retailers are exerting pressure on landlords to lower rents as the recession impacts their sales. Leasing conditions are the toughest they've been for several years, with landlords having to decide whether to offer concessions or force retailers into liquidation.

Going, going, gone..

As 2008 came to a close the list of retailers that closed their doors for good in Marin was getting longer. High profile chain stores made news headlines when they announced mass closings, while many smaller independent stores were put out of business quietly.

In October, department store Mervyns finally gave in and announced the closure of 149 stores, incluidng the one at Northgate San Rafael. In December, Kohl's was revealed as the new tenant for the site.

Circuit City announced the closure of 155 stores in November, including it's San Rafael outlet.

Back in May, Linen & Things, which used to have a store at Marin City, announced the closure of 120 underperforming stores.

Also gone are The Sharper Image and KB Toys, two well-known retailers that previously had stores in Marin.

In addition to these, there are empty storefronts appearing in all of the downtown areas and strip centers across the County, as independent boutiques and Mom & Pop stores struggle to survive. One of the great things about Marin is the abundance of small communities that still have a thriving retail presence; this is almost unique in modern-day stripmall America. If you want to maintain the character and viability of your local neighborhood center, now is the time to shop at your local stores and eat at your local restaurants.