With 2010 halfway over, San Diego County’s retail real estate market holds opportunities as well as pitfalls for potential investors, though experts say the region is faring better than most as shoppers keep their spending in check amid employment worries.
In its recently released second-quarter market report, the commercial brokerage and research firm Marcus & Millichap noted that high barriers to entry, especially in the county’s mature communities, will restrict retail construction and “stabilize property fundamentals” throughout much of the San Diego metro area this year.
Alvin Mansour, a senior vice president of investments and a director of Marcus & Millichap’s National Retail Group in San Diego, said by phone that the local region continues to rank among the “top five or 10” U.S. markets for the overall health of its retail climate.
That’s because retail generally was not overbuilt in most of the county’s prime markets in the run-up to the recession, partly because of limited space available for new projects.
“It’s tougher to get things built, and land isn’t that affordable in some places,” Mansour said.
An exception is the northern part of the county. Marcus & Millichap’s report said local retail real estate weakness has been “concentrated in overbuilt areas in the northern suburbs,” particularly Vista, Oceanside and Escondido.
“While fundamentals in those areas will likely remain soft in the coming quarters as new business formation lags, tight vacancy rates will persist in most core retail submarkets, limiting metrowide rent declines,” the report said.
Overall, it said, store closings have slowed down considerably from what was being seen through much of 2009, and Mansour noted that many, if not most, of the prime spaces vacated by national retailers have since been reoccupied.
More Space to Fill
After 260,000 square feet of retail space came on-line last year, the research firm projects that 420,000 square feet will be completed in 2010, increasing local stock by 0.4 percent. In the past 10 years, annual deliveries of new space averaged nearly 1 million square feet.
The new supply is expected to drive up the county’s overall retail vacancy rate by year’s end to 6.1 percent. The metro area’s vacancy rate was 5.7 percent at the end of the first quarter.
The report predicts that operators will decrease rents in 2010 to retain tenants. Asking rents are forecast to contract 1.4 percent to $27.21 per square foot, as effective rents — with negotiated discounts and incentives factored in — dip 2.4 percent to $23.84 per square foot.
Consumer spending nationwide is slowly recovering, but some retail property owners face distress in paying off loans tied to construction and acquisitions. That has sent real estate investment trusts and other private investors into the market shopping for bargains.
“Money has been sitting on the sidelines the past three years, and as an investor you’re not going to make money if it stays there,” said Pete Bethea, an executive director of Cushman & Wakefield Retail Advisors in San Diego.
Fewer Bargains
Bethea, who focuses on several Southwestern markets for the brokerage firm, said coastal retail markets are generally in better shape than inland communities. But that also means that places such as San Diego and Los Angeles have fewer bargain-priced properties available for purchase than others, including the Inland Empire, Phoenix and Las Vegas.
In the coming year, Bethea said, shopping centers likely will continue to trickle onto the market as lenders decide to sell off assets tied to distressed loans. That’s currently not happening with great frequency among San Diego County retail properties, though some center operators are facing a cash crunch because they’re not generating the rents they expected when the properties were being developed.
Some local centers depend on smaller businesses rather national tenants to fill spaces, and those smaller firms face financial challenges of their own, Bethea added.
Matt Romney, a senior vice president with San Diego-based Excel, aka Excel Trust Inc., said the retail-focused real estate investment trust is scouting long-term for potential acquisitions in San Diego County. For now, however, its portfolio remains concentrated outside of California.
Since its April initial public offering of stock, which raised $193 million, the REIT has purchased 15 properties spanning Southwest, Southeast, Northeast and Midwestern states. Romney said Excel will likely purchase more properties with the IPO proceeds, with other purchases likely later this year or in early 2011.
Romney said most of the company’s purchases have been off-market transactions, meaning they are not listed for sale. Leads on potential acquisitions come through contacts cultivated by the firm in the past 30 years, within the financial and retail communities.
Excel seeks out well-located centers, with good customer demographics and tenant mixes, and he said a mix of factors is motivating sellers in the current market.
“In some cases there’s distress and the owner is having issues with payments to their lender, but other times the owner might just be unsure about the future and wants to sell,” Romney said.
Waiting for Employment Boost
He noted that many center owners and buyers around the country are waiting for consistent employment gains, to help boost consumer spending and fuel a larger economic recovery.
Marcus & Millichap’s midyear optimism about the San Diego County market is fueled in part by moderate improvements in the local economy, with an expected increase of 1 percent in employer payrolls this year — an addition of around 12,500 workers.
Near term, its report said, buyer demand will remain strongest for single-tenant assets with national-credit tenants, priced between $1 million and $2 million. A “deeper, more competitive” investor pool persists for these properties.
Fewer buyers will pursue single-tenant assets priced above $2 million or those leased to regional or local tenants.
Investment strategies differ for multi-tenant assets, “where many buyers have sought to secure discounted properties with upside revenue potential ahead of a market recovery.” Those buyers are targeting assets with high vacancy rates or significant deferred maintenance, the report said.
