The shopping center industry has made good progress as evidenced by improved quarter-to-quarter vacancy rates. At the end of last year, total vacancy for all retail formats came in at7.0%. While still elevated from the best-of-times, it is a notable improvement over the 7.6% ratehit in early 2010. Likewise, vacancy has edged lower in all the major property types, such asmalls, powers centers, and community shopping centers.This gradual improvement speaks to a healthier asset sector. Retail sales for the majorshopping categories (excluding autos and the often included fuel & gas that skew the numbersduring pricing run-ups) are also slowing increasing. Retailers have become more disciplined incost control during the recession, as well. These look very much like the ingredients necessaryto fuel a more robust retail investment climate – something that many have been waiting for asoffice and apartments took center stage as the preferred vehicle over the last couple of years.As we wait for 1
quarter vacancy to be finalized, one metric that I have found to be a key earlyindicator of shopping center health is the
share of space operating below 85% occupancy
.Quite simply, whether an asset is secured by a bank loan, held in a CMBS pool, or owned – when occupancy declines below 85%, bad things can begin to happen. At a minimum, theproperty is not hitting on “all cylinders”, which strains net operating income. If a loan is on theasset (construction or permanent), lending covenants, such as loan-to-value and debt-service-coverage, are at the threshold to be tripped. And, if this is not enough stress – co-tenancyprovisions often kick-in below 85%, further challenging property occupancy and eroding NOI iftenants opt to leave.Ultimately, if this scenario plays out, it can create a spiraling down in performance that financialmanagers cannot tolerate. We have been fortunate in this downturn that the financiers lookedthe other way, waiting for the economy to heal all but the most serious problems. This difficult-to-manage risk, however, is a major reason why retail has seen little investment thus far in therecovery, compared to the more predictable office and multi-family asset classes.When I began to track this measure, the average rate in the US was around 15%. That waswhen the downturn was in full swing. In fact, some of the major “suspect” markets impacted bythe housing slowdown showed serious distress. In 2010, markets like Detroit, Houston, Dallas,South Florida, and even Chicago were all elevated into the high-teens, with Atlanta holding thetop spot at 24%.While this metric is not available historically, what was telling from my periodic snapshots washow little the share had moved. When I looked at this measure in mid-2011, I expected to seeimprovement. Instead, most markets were static, with a handful still declining. This made astrong argument for the “haves” and the “have-nots”. In other words, if an asset had a solidlocation (attractive demographics, above average access, good visibility, etc.), tenants tended tostay or be interested in leasing space – even if center vacancy was above average. Here inWashington DC, Fair Lakes Promenade is a good example of a well-located center that losttenants early in the recession, but rebounded strongly though proactive management andleasing. In contrast, centers in second-tier locations and that lacked good demographics or acompelling tenant roster were off the radar.In looking at the current state-of the industry, the overall average for the US has improvedsignificantly – coming in at 12.5%. The lack of new construction has contributed to this changeby allowing leasing professionals to fill vacant space. More important, though, is the fact that allof the major markets have progressed in their leasing of the “at-risk” space. While Atlanta stilltops the major markets at 19%, this is a vast improvement. Although I did not monitor LasVegas and Phoenix earlier, both show stress, with 16% and 18% of the shopping center spacenow operating at below 85% occupancy – high rates, but not wildly out of line.