Tight Quarters

By Ryan McCullough

Source: CoStar Group Inc.

Source: CoStar Group Inc.

The U.S. retail market passed a milestone in the second quarter, as vacancies dropped below their 10-year average of 6.7 percent. Net absorption has been climbing over the past few years, but remains at roughly half of the average pace from 2006–08. Since development has fallen off even more, this run has been sufficient to keep occupancies on the upswing.

Those markets at the forefront—Boston, New York, San Francisco—are nearing an end to their retail recoveries, with second-quarter occupancies flat or even down from year-ago levels. In these core coastal areas, competitive space is nearly all spoken for. Retailers’ unwillingness to venture into marginal and broken centers means that further absorption will be constrained by the pace of development.

Away from the coasts, there is still plenty of occupancy upside left for the cycle. Texas has been at the forefront of demand gains over the past year, with Houston and Dallas-Fort Worth each notching about 5 million square feet of net absorption in the past four quarters. Other strong demand gains have been occurring in what had been some of the worst housing-bust areas. Completions are picking up as well, but development has not been able to keep pace with demand.

A significant inventory of vacant retail space remains, yet rents are rising as if the market were undersupplied. In a sense, that’s true: Much of today’s vacant space is uncompetitive in nature. Centers that aren’t dead (i.e., those at least 60 percent leased) and are located in a viable node of at least 500,000 square feet are reporting tight conditions today. But while these competitive centers are thriving, the rest are not. Changing shopping patterns due to demographics, consumer preferences and technology mean that today’s dead and/or remote centers may never again regain their competitiveness.

—Ryan McCullough is a senior real estate economist at CoStar Portfolio Strategy.