Developers Expected to Selectively Ramp Up Store Construction in 2017 as Retailers See Shortage of Competitive Space

Posted on November 14, 2016

More Developers Eschew Suburban Fringes in Favor of High-Density Downtown Projects

With retailers approaching record occupancy levels and running out of space they find desirable, developers are expected to selectively ramp up construction levels in 2017 to accommodate the rising tenant appetite for the highest quality and best located retail space.

The U.S. retail vacancy rate continued to decline in the third quarter, falling from 5.7% at midyear to 5.4% at the end of the third quarter as retailers absorbed another 30 million square feet nationally. That amounts to an aggregate total of 470 million square feet of retail space absorbed since 2009, noted CoStar senior real estate economist Ryan McCullough, who was joined by Suzanne Mulvee, director of U.S. Retail Research for CoStar’s Third Quarter 2016 Retail Market Review and Forecast.

While retail demand has consistently exceeded new deliveries of store space to produce steady quarterly declines in the U.S. retail vacancy rate for six consecutive years, that vacancy compression may be coming to an end, CoStar’s McCullough noted.

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“Our expectations are for vacancies to start to flatten in the upcoming year and start to move sideways from here,” as new supply comes online McCullough said.

A Lack of Competitive Space

In another notable trend, retailers are finding it increasingly difficult to find available space in the best and most well-located centers. At the same time, they’re refusing to settle for subprime locations and submarkets, a trend expected to yield a stronger influence on vacancy rates than new supply, McCullough added.

“We’re running out of room that tenants find desirable and pushing up against the ceiling of occupancy. These competitive centers can’t get much fuller than they are today,” McCullough said. “We’ve seen limited appetite for tenants to go into other not as well-located spaces with less demographic strength.”

To account for this trend, CoStar Portfolio Strategy devised a new metric for measuring “competitive vacancies,” excluding retail centers in the largest U.S. markets with a vacancy rate of 40% or higher to illustrate how tight this higher quality space has become compared with the “headline” vacancy rate.

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This national competitive retail vacancy rate is now 2.5% and below 4% in most markets, “lower than we’ve ever seen before,” as the high-quality, well-located assets desired by tenants fill up, McCullough said.

While retail construction is expected to pick up moderately in 2017, don’t expect a slew of new shopping center and mall construction in the outer suburban fringes, however.

Retail builders that previously targeted markets in the path of population growth with fewer barriers to entry have now reversed course and now are targeting higher-density urban areas.

From 2004 to 2007 period, an average of just 27,241 households were located within three miles of construction of a retail center greater than 50,000 square feet. Today, that number has doubled, with more than 55,559 households located within three miles of significant shopping center projects.

Also as momentum continues to shift away from power centers, neighborhood shopping centers are starting to glean stronger demand and declining vacancies on par with the last cycle, largely due to the improving health of in-line tenants, which is lifting the performance of grocery anchored centers.

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Despite the retail construction increasing to its highest levels in the current recovery, retail development remains well below previous cycles. In fact, for the first time new retail space is coming online at a lower rate than population growth, a major anomaly to historical trends, said McCullough.