Retail:Tight Vacancy Persists in Retail Market

Retail properties in Northern New Jersey continue to perform well, despite the effects of an economic downturn on retailer space demand. Retail sales are growing at a slower rate than a few quarters ago, and a modest pace of spending growth will persist in the months ahead. Reflecting the reduction in retail spending, overall vacancy has inched up in the past few quarters, although the rate remains tight in the mid-4 percent range. Within specific segments of the market, softening demand has lifted vacancy in smaller strip centers and at properties in Hudson County, where the housing market has become sluggish. On the supply side, deliveries of new space will increase to 3.5 million square feet this year. Most of the total is attributable to the Xanadu project, which will have a mix of traditional mall merchants and entertainment-oriented tenants. Although pre-leasing has been slow at Xanadu, other projects such as Center City Paterson and the Promenade Shops at Clifton lifestyle center have enjoyed relatively strong pre-leasing. Recent development announcements in the market include an 89,000-square foot lifestyle center addition at the Paramus Park mall.

By the numbers, a slowing regional economy will hinder job creation, leaving total employment unchanged in 2008. Last year, 11,500 new workers were hired, a 0.5 percent gain. Builders completed 1.1 million square feet of space in 2007 and will increase production to 3.5 million square feet this year. Most of the amount is attributable to the Xanadu project, which is slated to come online in the fourth quarter. Assuming reasonably strong pre-leasing at large projects and softening demand for existing properties, the marketwide vacancy rate is expected to climb 70 basis points this year to 4.9 percent. In 2007, the vacancy rate was unchanged. Rent growth will continue to slow in step with weaker space demand. In 2008, asking rents are forecast to rise 2.4 percent to $28.63 per square foot, while effective rents tack on 2 percent to $26.51 per square foot.

During the past 12 months, velocity in single-tenant assets has declined 58 percent, compared with a gain of 61 percent in the preceding period. Velocity has slowed to a trickle for all single-tenant property types, including drugstores and fast-food restaurants. In a limited number of fast-food deals, prices have ranged from $284 per square foot to $432 per square foot for a regional chain along a heavily traveled stretch of state Route 35. Generally, assets leased to highly rated national tenants can trade with cap rates in the mid- to high-6 percent range, extending to 8 percent or more for lesser tenants and locations. In 2008, lenders will continue to draw distinctions on credit quality, effectively limiting single-tenant activity to assets occupied by tenants with the best credit profiles.

Trades of multi-tenant properties have slackened considerably. In the past year, transaction velocity for these assets has declined 45 percent. Activity has been very limited so far this year, but during the last 12 months, the median price has increased 21 percent to $234 per square foot. Some strip centers and grocery-anchored properties have sold for more than $300 per square foot, but those deals were executed before credit market problems intensified late in 2007. Cap rates for the best properties in established retail corridors in Bergen County, for example, start at about 6.5 percent. Initial returns rise from there to approximately 8 percent for assets in highly urbanized areas of the region. Multi-tenant activity is expected to pick up in 2008 as owners adjust pricing to satisfy buyers’ requirements. High population densities and generally strong demographics in most areas in the region are expected to sustain investor interest during the long term.

In the investment market, transaction velocity for all assets has decelerated. Underwriting criteria have changed during the past several months, and deals are taking longer to execute as buyers scrutinize tenant mix, re-leasing risk and rent growth assumptions more closely. Owners have been slow to respond to changes in the investment climate and are only now beginning to price properties at the higher cap rates buyers require. Cap rates vary widely in the market, though it is not unusual for top multi-tenant centers in high-density areas with solid demographics, such as sections of Bergen and Passaic counties, to price with rates in the mid-6 percent range. Cap rates move higher from there, reflecting property location and potential near-term upside.

Michael Fasano is the regional manager of the New Jersey office of Marcus & Millichap Real Estate Investment Services. He can be reached at [email protected] or (201) 582-1000.