Confidence and the Consumer
This is an HTML version of a story that ran in the May issue of Real Estate Forum. To see the article in its original format, click here.
Younan Properties Inc. is known for its investments in office properties, but it’s no stranger to retail product. In April, chairman and CEO Zaya Younan expanded the company’s footprint in that arena as it re-entered the Phoenix market through the all-cash purchase of a 137,552-square-foot foreclosed retail center, Scottsdale Promenade.
The appeal of the center, Younan told Real Estate Forum sister publication GlobeSt.com, was that it occupies a great location in a fast-changing and improving market. Furthermore, with a 65% occupancy, the property offered plenty of upside potential and wouldn’t require much work or repositioning other than deferred maintenance.
Overall, Younan is convinced that now is a good time to buy retail. In addition to Phoenix, the firm is eyeing potential properties in Dallas and Houston, as well as other areas, and hopes to reveal more transactions in the coming year. “There’s a lot of opportunity out there now that may not be available two years down the road. It’s a great time to build out a portfolio,” he says.
Companies like Younan are not only betting that now is a great time to invest in retail, they’re also betting on the consumer. And according to a ChainLinks Retail Advisors’ US National Retail Report, although the market is dealing with a host of issues—including elevated unemployment, weak job growth, inflated sovereign debt and continued policy uncertainty—many of the retailers who occupy centers like the one bought by Younan are betting on consumer confidence as well.
The confidence that retailers have in consumer spending is reflected in their expansion plans. Restaurant concepts alone currently account for 42% of all the planned growth (in unit counts) that ChainLinks is tracking in the marketplace today. Among the leaders in this category are Subway, which wants to roll out about 2,500 units in 2013, and Five Guys Burgers and Fries, which hopes to open as many as 500 new stores in 2013, says the firm. “Dollar stores also continue to aggressively grow and are single-handedly changing the net lease investment market, which has traditionally been dominated by drugstore, fast-food and automotive retail concepts.”
But according to ChainLinks—and to the retail specialists we interviewed—many challenges remain for the retail market. In the view of ChainLinks, the slightly improved consumer confidence and modest improvements in job growth, when compared to last year, certainly aren’t enough to support a fully optimistic economic outlook, especially when weighed against the potential disaster of the fiscal cliff. But there are still a few reasons to be hopeful, it says.
“The greatest challenges to the economy are questions of policy that can be shaped, determined and controlled,” says the ChainLinks report. Another reason the company is optimistic is related to underlying economic fundamentals. “It’s about the sector of the economy that led us into the recession initially and that will likely finally lead us out—housing.”
New York City-based Faith Hope Consolo, chairman of the retail leasing and sales division of Douglas Elliman, is also optimistic about retail’s future. In a recent video interview, she told GlobeSt.com editor Ian Ritter that “all reports are looking positive,” when asked about what to expect at ICSC’s ReCon event this year. “Across the country there are a lot of renovations of the malls and a lot of new developments,” she said. “From the East to West coast, there is activity in the market, and that is all very upbeat.”
But not everyone we spoke with is as convinced that things are looking up. While some sources wonder if the national election and job growth trends have done anything to improve consumers’ world views, many of them say it’s only a small piece of the puzzle, with just a “marginal influence.” One of the factors with the biggest long-term impact, some sources say, is payroll tax.
Chris Wilson, founder and chairman of Wilson Commercial Real Estate, tells Forum that the grocery stores and retailers he speaks with in the discount and promotional categories cite the effects of payroll tax increases, rising medical costs and inconsistent energy prices among the reasons for declines in both consumer confidence and spending.
Wilson says that although working Americans are beginning to feel more confident about their incomes and stability of employment, and some are even earning higher incomes, “We all know people who continue to be unemployed or underemployed.”
The re-implementation of the payroll tax has directly impacted take-home pay in the first quarter, so families and individuals will have to assess how to factor this in over the months ahead, according to Derek Layne, associate director at Stan Johnson Co. “It’s hard to have increasing consumer confidence when the realities of these figures are personally felt in middle America,” he says.
Jackie Baker, an associate director at Stan Johnson, points out that although consumer confidence is rising, it’s at a slow pace. “The national election didn’t have as much long-term impact on consumer confidence as the 2013 increase in payroll taxes, which have translated into weaker Q1 sales numbers for retailers,” she says. “It feels like consumers are very cautiously optimistic and would like to see government trim spending vs. additional tax hikes that hit them in the wallet.”
Another who cites the slow pace of change in consumer confidence is Los Angeles-based Alan Araki, managing director of investments at Primestor Development. “The results of the past US election don’t appear to have had a huge impact on the overall consumer confidence, since the frustration level with what appears to be perpetual gridlock in Washington, DC has been around for a long time now,” he says. “I do believe that consumer confidence continues to improve, but it’s clearly more cautious.”
Like others who see a mixed bag of forces at work in shaping consumer confidence, he points out that a slowly improving overall economy and job market, rising house prices and a strong stock market are obvious positive variables. However, the government’s lack of urgency in solving some policy problems, and negative news since the first of the year regarding budget issues, the sequester and euro problems, remain a drag on consumer confidence, but that could turn very quickly if those issues are resolved, he explains.
A chief reason that consumer confidence is rising slowly despite improving market fundamentals is general uncertainty, according to recent reports by CBRE and Jones Lang LaSalle.
Greg Maloney, CEO & president of Jones Lang LaSalle Retail, tells Forum, “Consumer confidence levels remain low due to economic uncertainty, as job growth has been extremely slow. Before we see renewed confidence and increases in spending, consumers will need to feel stable on two fronts: their job prospects and income. Despite the instability, housing has been a bright spot. We expect to see continued improvement in this sector, albeit very slow and measured. The recovery will remain slow during the next few years, until we see a shift in debt levels and real job growth–any negative news could bounce us back into a recession quickly.”
The JLL report presents a variety of forecasts. For example, the global outlook for retail sales in 2013 is expected to be highly bifurcated, with sluggish growth expected in North America and declines across Europe. Emerging markets such as China and Brazil are expected to be momentum markets this year.
CBRE Group Inc. says that the slowly rising consumer confidence reflects a gradual improvement in fundamentals, and that retail market fundamentals are trending in the right direction. Still, factors other than fundamentals are in play. “The trajectory of consumer spending growth has been tempered by political uncertainties, particularly by ongoing federal taxation and sequestration negotiations in Washington, DC,” say CBRE researchers. “Although improvement in the housing market brought some much-needed respite to consumer confidence levels—and, ultimately, retail sales—at the end of last year, the prevailing political climate is expected to be a continued hindrance to US economic expansion through the first half of 2013.”
On the other hand, some local markets can expect the improvement to continue. In San Francisco’s prime shopping district, Union Square, for example, regional employment growth and a strong tourism market have fueled retailer demand for space. According to CBRE’s John Vitou, senior research analyst of the Americas, educational attainment and wages in the region are significantly above national averages. “High-tech employment in the region has driven the recovery of the employment base,” he says. “Total non-farm employment in San Francisco is expected to rise, with nearly 35,000 new jobs to be created in 2013.” The longer-term employment outlook for the region also remains bright, as Moody’s Analytics forecasts total non-farm employment to rise by nearly 8% between 2012 and 2017.
Despite their general reluctance to expand in the US, Vitou adds, demand from luxury and fashion retailers is high on Union Square. What makes the Union Square area so hot, among other things, is international tourism, which is doing well and expected to rise. San Francisco International Airport expects passenger air travel to rise consistently over the next five years and leisure and hospitality services in 2013 will be bolstered by the hosting of the America’s Cup races, according to Moody’s Analytics.
Overall, reports and forecasts suggest that the San Francisco and Silicon Valley areas of California may be bright spots in retail despite what happens elsewhere. Craig Killman, SVP of JLL, notes that given the increasing levels of venture capital investment in the high tech community from San Francisco to Silicon Valley, “Consumer confidence in those markets is on the rise, tenant performance is following suit and vacancy factors are virtually nonexistent in ‘A’ properties.” He points out that “the Bay Area’s retail market is very healthy and while there are many barriers to entry, there are several mixed-use projects planned in infill locations in primary trade areas, which will relieve some of the pressure for retailers demanding space in this dynamic market.”
According to the firm’s outlook for tenants, retailers are focusing their expansions on the periphery of the CBD as well as in surrounding residential areas. In addition, the firm points out the there will be a booming rent recovery—a product of low vacancy rates and lower construction. “Rent growth should be highest from 2013 to 2015, then start to decelerate as more space is delivered.”
Top-tier markets like San Francisco and the Silicon Valley often buck the general trends within an industry, however, so a big question that remains is how the overall national retail market will fare. Despite the importance of consumer confidence in the scheme of things, the outlook for the industry also depends on some hard facts about the incomes of US workers. For example, Layne of Stan Johnson Co. points out that the dollar has lost 10% of its value in four years and the average middle class worker’s take-home pay has declined by more than $4,000 since 2000. At the same time, the costs of goods at the supermarket have increased dramatically. The price of milk, for example, is up 23% in a year in California, and gasoline prices have climbed exponentially over that time. The Federal Reserve doesn’t include food and energy prices in “core inflation,” but Layne points out their importance to the average consumer: “People feel the real effects of inflation in their pocketbook.”
Some of the other factors that might seem at first glance to bode well for the retail market are not the sure-fire signs of improvement that they might seem to be, according to Layne. For example, he points out that the coupling of a rising stock market and rising home values has created a perceived ‘inflated wealth’ phenomenon much like the perceived wealth increase of 2005–2007, when many Americans felt that they had more wealth than they actually did, thanks to inflated home values. The perception of wealth boosted consumer confidence because it led Americans to feel confident in spending more, but the subsequent crash wiped out that wealth and dashed consumers’ confidence. Layne says that jobs numbers reflect accurately what is going on in America: a shrinking work force, fewer quality jobs and insecurity about one’s job. He adds that a recent Reuters poll showed 40% of workers are worried that their jobs may be eliminated or scaled back.
“We have small businesses, the core of our employment base, who are not hiring due to costs related to Obamacare and other regulatory measures that have a direct impact on job creation,” Layne says. “Regulatory measures are also directly affecting the bottom line for these businesses.”
Small business is either reducing headcount, cutting hours or simply not hiring due to uncertainty and these burdensome regulations, Layne notes. “The jobs reports are abysmal if one actually looks at what is occurring in our country,” he says. “Most hiring is being done at low-wage positions.”
Media and government reports that focus solely on the unemployment rate only tell part of the story, Layne says. Such reports fail to point out that the labor force is at its lowest point since 1979 and low-wage positions are mostly what make up the positive employment numbers. For instance, while recent reports said that 88,000 jobs were created in March, those reports failed to mention that 496,000 workers either dropped out of the labor force or stopped looking for work. Consumer spending is up, but Layne says that, ironically, it has less to do with an improving job market or higher wages and more to do with the “inflated wealth” phenomenon he describes.
These analyses by Layne and others suggest that, ultimately, how the retail market will fare will depend on whether consumer spending continues to rise. The likelihood of that hinges on whether consumers’ confidence is founded on fundamentals or based on unwarranted optimism, as well as the effects of government policies on those fundamentals.