-By Holly Richmond

Retail therapy is taking on new meaning moving into the second quarter of 2008. Economic indicators show a significant pullback, though most economists are not tossing around the "r word" just yet. (The estimate of U.S. economic growth came in at an annual rate of 0.6 percent, slowing markedly in the fourth quarter of 2007.) As recession looms, so too do the woes of the commercial real estate, construction, and design communities.

The National Retail Federation (NRF) released its 2008 economic forecast in January, predicting that retail sales—excluding automobiles, gas stations, and restaurants—will increase 3.5 percent from last year. According to its Retail Sales Outlook report, NRF expects the slow pace in sales growth to continue before picking up in the second half of the year. "Lack of credit in the marketplace is what it boils down to," says Michael Wiener, president/CEO of Excess Space Retail Services, a Lake Success, N.Y.-based disposition and restructuring firm. "The economy is psychology based, and it is suffering. The GDP is consumer driven, and when there is no credit in the marketplace, psychology is bad and people don't spend."

In particular, Wiener notes that home furnishings and home improvement retailers are struggling most, with difficulties in the housing market putting on extraordinary pressure. "Landlords are tentative about their ability to fill locations, while lease holders are imminently concerned with reducing their occupancy costs to avoid lease termination." He goes on to note that the geographic outcome of the economic crunch on the commercial real estate market is still unclear. "Space is showing up everywhere, though California and Florida showed the most weakness in the fourth quarter of 2007, and we expect that trend to continue into the first half of 2008."

Experts agree big-box stores will be the hardest hit by the economy's downturn. In 2007 commercial construction spending rose 16 percent overall with the retail sector up 13 percent, totaling $33 billion. Multi-retail was the largest category within this sector by far. Ken Simonson, chief economist with the Arlington, Va.-based Associated General Contractors of America, predicts that growth in this category will level off at best. "There has been a sharp decline in retail sales in the past three months, and nearly all retail chains are adjusting construction and development plans. Some are reorganizing while others are going out of business entirely," he notes. Simonson believes the economic stimulus package passed by congress on February 7, 2008, may give a boost to consumers and retailers but will not affect construction spending. "It is only a temporary fix," he says, "and contractors are well aware of that."

Suzanne Mulvee, senior real estate economist with Property and Portfolio Research (PPR) in Boston, has a slightly different perspective. "PPR does not expect the government stimulus package to provide a significant boost to spending in the first half of 2008 since checks will not get into people's hands until June," she says. Even then it will not do much to assuage the retail sector's downward spiral. Statistics are not promising: Retail fundamentals are unwinding as supply races ahead of demand. Vacancies have risen 1.5 percentage points since bottoming out in 2006 and are expected to continue rising. Risks are to the downside, and a deeper pullback in consumer spending will force fundamentals to unwind faster and likely lead to more pronounced deflation of retail assets. Trying to infuse a bit of humor into the forecast, Mulvee says, "The question is, 'Is it stinky or putrid?'"

There is, however, a sweet spot that economists agree on: the luxury market is strong and steady. Sandra Page Mitchell, principal of Studios Architecture in Beverly Hills, Calif., reports robust business with high-end retail clientele, especially in trendy West Hollywood, New York, Dubai, and Moscow. In the past two years, Studios has completed stores for 7 For All Mankind, Nicole Miller, Stella McCartney, and Alexander McQueen, and rollouts will continue throughout 2008.

Mitchell says that because these clients are internationally based, it reduces the U.S. economy's negative impact. "Foreign developers," she says, "are not afraid of opening retail locations in these burgeoning luxury markets whatsoever, in fact, they seem energized. Our business is not yet feeling an impact from the weakening commercial real estate sector, nor does it appear wealthy consumers are either."

Wiener concurs, concluding, "In comparison to the crash in 1992, the wealthy are much wealthier now, so I do not see a collapse happening again in this high-end sector of the retail marketplace."

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In Review:

The Bad News:
The consumer appears to be faltering and may finally tap out in 2008
Historically, consumption has contributed about 70 percent to headline GDP growth; however, the last three quarters have shown that the consumer is having a more difficult time supporting the economy…. Businesses have been picking up consumer slack, but we are seeing corporate profits and business confidence decline, indicating more tepid business investment in 2008.

The Good News:
The retail market will get a lift from the credit crunch
The disruption in the financial markets last summer sent financing costs climbing and led to a pullback in lending. Higher financing costs, which include increased equity contribution requirements, culled the market of more marginal projects. Supply totals are expected to throttle down by 37 percent in 2009 and continue to moderate in 2010, which should help stabilize the market despite a tepid outlook for retail sales growth.

Source: Property & Portfolio Research
February 2008 Retail Edition