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December 15, 2005

Here's what's in store for retail properties

  • New development will be primarily renovations of existing retail properties, small centers developed in infill locations and a few larger shopping centers.
    • By RICHARD MUHLEBACH
    KennedyWilson Properties NW

    mug
    Muhlebach
    The Puget Sound retail property market can best be described with two words: change and constant.

    New types of shopping centers are developed every decade, existing shopping centers continue to evolve, and new retail formats along with new retailers are created every few years. They replace obsolete retail formats and retailers who no longer meet the needs and desires of consumers.

    Amidst an ever-changing retail environment, the one constant has been a good retail property market for over 20 years.

    Two types of shopping centers have been developed in mass across the country in each decade from the 1970s until the end of the last century:

    • In the 1970s, enclosed malls were developed in every community and specialty centers, such as Ghirardelli Square, were developed in many major cities.

    • In the 1980s, the consumer was looking for value shopping, which lead to the development of power and outlet centers.

    • In the 1990s, the shoppers were searching for an environment that reminded them of a time past, which lead to the first generation of life-style centers. The second retail property type developed in that decade was the entertainment center anchored by large, state-of-the-art multi-screen theaters.

    No new retail property types were created during the first decade of the 21st century, but several evolved into their second or third generation. Power centers evolved into power towns with an expanded tenant mix, shopper amenities, upgraded landscaping and building designs that resemble a row of stores instead of a row of large sterile and boxy industrial buildings.

    A second generation of life-style centers was developed that included residential and hotels above ground floor retail space. This was shortly followed by the development of a third generation of life-style centers, which included traditional department stores with smaller formats. Enclosed malls expanded with a life-style center tail attached to the mall.

    Two old retail property types are being revitalized: neighborhood retailing, also known as street retailing, and downtown retailing.

    While all the other property types have experienced a couple of complete real estate cycles during the past 20 years, the one constant in the Puget Sound property market since 1983 has been a good retail property market.

    The last weak retail property market was in the early 1980s, when the country was in a recession and interest rates and the cost of living were in the low double digits. The recession slowed retail sales and the high interest rates made it difficult for many retailers to expand.

    One of the reasons, if not the primary reason, why the retail property market has been good to strong for so long is the limited number of vacant retail-zoned sites large enough to accommodate an anchored shopping center that has good access and visibility.

    Rental rates

    Retail rental rates in the Puget Sound reflect the good market for shopping centers and other types of retail properties. The rates that are quoted below are mid-range rates per square foot per year. There are some properties leasing at higher rates and others at lower rates, but the following rates are more typical of the market. Also, location of the property and of spaces within retail properties will influence rental rates.

    Ground floor retail space in the retail core of downtown Seattle ranges from $40 to $65, while outside the retail core rates range from $25 to $35. The rates for Seattle's neighborhoods are similar to the rates for good existing suburban anchored neighborhood shopping centers. Capitol Hill rates range from $25 to $35, while rates in Fremont and Ballard range from $20 to $35 and rates in Belltown are a little lower at $20 to $25.

    How does Seattle's rental rates compare to the best retail streets in the country? The rents at Union Square in San Francisco are $250, while rents for the most expensive street, Fifth Avenue in New York, are $950. The differences between Seattle rates and the rates for the most expensive streets are density, tourism, demographics and psychographics.

    Mixed-use and multi-use developments are the hot property type to develop today. Apartments or condos on top of ground floor retail space are being developed in neighborhoods throughout Seattle and in many of the suburban cities. The typical rental rates for the ground floor retail space range from the upper $20s to the mid-$30s.

    Moving to the suburbs, street rents in downtown Bellevue range from $22 to $45. The rates for the best regional and super regional enclosed malls are $50 to $75, while the next best malls are $25 to $40. Those little kiosk spaces at the malls can rent for up to $500 per square foot.

    New grocery-anchored shopping centers are renting from $32 to $40-plus in the Eastside and from $32 to $38 in the rest of King County, as well as Pierce and Snohomish counties. New unanchored strip centers rent from $25 to $35, while space with drive-thrus in these centers rent from $34 to $38. Box stores that are close in to Seattle and Bellevue rent from $25 to $30-plus and in the other areas from $17 to $20.

    Rents are strong because the overall vacancy factor is around 2 percent. Well-located shopping centers with good layouts seldom have a vacancy and when they do the space leases fairly fast. This is the reason why free rent is almost non-existent and tenant improvements are limited.

    In addition to the above rental rates, retailers pay triple net charges, which are from $2.50 to $4.50 per square foot for anchored strip centers and $15 to $20 per square foot for regional and super regional enclosed malls.

    With the retail market so strong, why have rental rates not spiked up? If the asking rents were to outpace retailers' sales, retailers would no longer look to open additional stores in our market. Retailers' rents must be within a tight range as a percentage of their sales for them to be profitable. If a retailer is going to open 100 stores across the country and the "numbers" — occupancy costs which include rent as a percentage of their sales — do not make sense in one area, they will pass on that area and open more stores in other areas. Local merchants will go out of business if their rent is too high for the sales they generate.

    Retailers serve as one of the industry's safeguards against rent spikes.

    The 2006 market

    How will the retail property market perform in 2006? The market should remain strong due to limited sites for new development of larger shopping centers. Rents will have limited growth because they are on the high side of what retailers can afford as a percentage of their sales.

    Neighborhoods will continue to get better with new mixed-use developments and the increased density will encourage retailers to locate in some neighborhoods they rejected in the past.

    New development will be primarily renovations of existing retail properties, small centers developed in infill locations and a few larger shopping centers.

    Communities should encourage the development and redevelopment of retail properties because they bring a vibrant street life to a neighborhood that no other property type or activity can generate.

    Richard Muhlebach, CPM, SCSM, CRE, RPA, is the senior managing director of the Bellevue office of Kennedy-Wilson Properties Northwest, a real estate service and development firm.


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