Retailers Can Succeed In A Recession

Creative strategies can help companies adjust to changing economic climate

Jack Gallagher, Associate Vice President, NAI NBS

Retail is one of the more visible segments of the commercial real estate market. And since the nation entered an economic downturn in late 2007, the focus on retail has even increased.

Today it’s difficult to read the newspaper or watch the news without hearing about another store or restaurant closing, or how much consumer spending has decreased.

The retail market is struggling in the current economic environment. Yet retailers are adapting to this more challenging landscape, and those who are surviving (and thriving) can benefit from the disposition of properties. Though this downturn hasn’t run its course, industry experts are optimistically anticipating a turnaround hopefully near the end of 2009 or the start of 2010.

Retailers have to change their game plans in order to stay afloat, because consumers’ expendable income and credit is diminishing. January chain store sales fell 1.6 percent from the previous year, according to the International Council of Shopping Centers (ICSC), and Wal-Mart was one of the only stores that had respectable sales numbers. As consumers deal with pay freezes, job losses, and diminished retirement accounts, retailers across the board are competing for their dollars by discounting merchandise, from clothing to furniture to groceries. Though this can help move product, it can definitely impact profits.

Some retailers are cutting back the hours they’re open to save on labor and utility costs. Mall operators in New England, for instance, have reduced their hours of operation, closing malls earlier or opening them later. Other retailers have chosen to lay off workers.

Retailers are definitely focusing on customer service in these challenging times. With fewer dollars circulating and consumers becoming choosier, retailers are going above and beyond to attract consumers with the highest level of service.

Retailers of all types have closed stores during this downturn, and ICSC predicts that more than 100,000 stores across the country could close in 2009. Pier 1, for instance, recently announced that it would close up to 125 of its stores, and Home Depot is shuttering 34 of its large EXPO Design Center stores. Retailers like Circuit City, Linens ’n Things and Mervyns have been forced to file bankruptcy.

But the ICSC also indicated that about 50,000 stores will open, and some of these openings could come when retailers secure new locations during the disposition of properties. For instance, Circuit City had stores ranging in size from about 20,000 square feet up to nearly 85,000 square feet, including four locations in the Portland-metro area. That presents valuable opportunities for other retailers.

Here’s one example: Mervyns filed for bankruptcy and closed all of its stores at the end of 2008. The department store Kohl’s and the clothing retailer Forever 21 joined together to bid at a bankruptcy auction and take over the leases on 46 former Mervyns stores in the western United States. Kohl’s will take about 30 of the stores and Forever 21 will take the remainder, at a total cost of $6.25 million – a very attractive deal.

These big-box stores seem to have large chunks of vacant space that would be suitable for a variety of uses, such as hard goods or soft goods retailers or supermarkets. And real estate professionals are getting creative with this type of space. Traditional retailers could certainly fill it, but the space could be used by nonprofit stores, medical uses or call centers. The square footage could also be subdivided to accommodate a few different mid-size retailers.

Because of the economic uncertainty and the plentiful existing retail space available, new retail development has largely been stalled, with few projects moving forward at this point. That’s why, in some cases, retailers are opting to renovate their stores in order to stay competitive.

The Fred Meyer store on Southeast Hawthorne Boulevard, for instance, is undergoing a renovation aiming for Leadership in Energy and Environmental Design (LEED) silver certification. Improvements include exterior wall insulation to limit energy loss, water-saving fixtures and higher efficiency ventilation and refrigeration systems. These changes will cost the company about $3 million more than a normal renovation, but the company says it’s worth it because it will result in considerable savings on future utility expenses.

New construction will pick up eventually, and when it does, LEED certification will be increasingly popular, especially in Portland. Mixed-use centers are also continuing to gain popularity.

No one can predict when this recession will end, but the retail industry is doing its best to remain optimistic. The chief ICSC economist predicts limited recovery in the second half of this year, with sales improving in 2010. Until then, retailers, landlords, and real estate professionals are working closely together to be creative and weather the storm.

This Land Problem Needs a Solution

A lack of ready-to-develop industrial sites is hurting the Portland-area economy

Jack McConnell, Senior Vice President, NAI NBS

When Senate bill 100 went into effect in Oregon in 1974, it required each Oregon town to maintain within its Urban Growth Boundary a 20-year inventory of land for ongoing residential development. Yet the bill was incomplete because it neglected to include a similar requirement for maintenance of an inventory of land for retail, office and industrial development.

Today, in the greater Portland area, there is a significant shortage of ready-to-develop land sites zoned for industrial use, especially along freeway corridors where an increasing number of businesses prefer to locate. Yet demand is still present for local firms to construct their own facilities and other firms to enter the region. In fact, it would be accurate to describe this shortage of land sites as “a clear and present danger” – a situation that will continue to hurt both our economy and our image.

Metro will tell you there is a more-than-adequate supply of industrial property to accommodate expansion and new development. And when considering only the number of acres available, that conclusion may seem accurate. However, such a conclusion is wrong and damaging to our community’s economic health, now and in the future. Numbers alone can be seriously misleading.

A recent study by a Portland engineering firm identified 9,300 buildable acres inside the Portland-metro UGB. But of these 9,300 acres, the great majority represent very small sites; many are just one acre or smaller.

Also, as many as 4,600 of these 9,300 acres (49 percent) are not even available to purchase and use (that is, the owners simply do not want to sell their land). This fact makes it unreasonable to include those acres in the inventory, because doing so implies availability.

Finally, most of those acres identified as buildable have serious development constraints (i.e. wetlands, lack of adequate utilities, sloping topography, poor configuration, environmental contamination, undesirable location, etc.), making them impractical to use and/or too expensive to correct for new construction.

There is only one sector of Portland that has significant industrial lands available for sale and new development. The largest inventory of such lands (approximately 300 acres) is located along Highway 26 in the Beaverton-to-Hillsboro corridor. However, the great majority of firms prefer to locate on or near the major north-south spine of Portland (Interstate 5), or on the east-west I-84 corridor. These routes allow quicker and less costly travel within the Portland area and beyond. Also, they provide the easiest routes to the Port of Portland’s marine terminals on the Willamette and Columbia rivers and the Portland International Airport.

Here’s another way to address the real issue here: If a local or new company wants to purchase, say, a 5- to 10-acre industrial-zoned site along the I-5, I-205 or I-84 freeways in the Portland area (from Wilsonville north to the Columbia River, or east from state Route 217 along I-84 to Troutdale), the list would include no more than six available ready-to-develop land sites. If the need was for a site 10 to 20 acres, the list would include no more than two parcels. And for sites of 20 acres and larger, there would be no list, because no ready-to-develop sites of that size exist today in these corridors.

Why should the citizens of Portland and the state of Oregon be concerned about this? Because a lack of land sites available for local firms looking to expand and others eager to enter our marketplace conveys a lack of commitment to business development and the creation of jobs. Such a realization by companies will drive them out of the area, to seek land sites (and more business-friendly environments). This is true at any time, in good and not-so-good economic times.

Here is what our civic leaders (both in Portland and throughout all Oregon communities) need to do now, to address this very real problem:

Remember that “quality of life” starts with a job, for every Oregonian.

Recognize that current land-use laws within Oregon are broken, slowing the creation of new lands for expansion and new development, which hinders job creation, which hinders quality of life for us all.

Stop talking about the problem. Identify the real problem and take steps to fix it … sooner rather than later.

Create an accurate inventory of “truly usable, truly available, ready to develop” industrial-zoned land sites.

Recognize the need for a sufficient inventory of these sites at all times within each community’s UGB, to meet the always-present demand for land parcels that will surely grow as the economy turns upward.

Commit financial resources to providing urban services (utilities, streets, etc.) to make these land sites “ready to go” for each expanding or new company.

An Update on Commercial Real Estate

The retail sector may be suffering, but some opportunities do exist for small business

JJ Unger and Debi Rosenbaum, Real Estate Brokers, NAI NBS

Struggling retailers have been dominating the news this fall, and big-box retailers from Linens ‘n Things to Circuit City to Mervyns have filed for bankruptcy. Though Black Friday sales were better than expected, industry insiders are forecasting disappointing retail sales this holiday season.

But a glimmer of hope in this recession is an opportunity for small businesses that have funding and good business plans to gain space not previously available to them.

Retailers today have a lot to be worried about. November’s retail spending was the weakest in more than three decades, according to the International Council of Shopping Centers. Consumers are spending more carefully than in the past, and though consumer confidence has recovered a bit from its steep drop in October, the mood remains tenuous. So many retailers are drastically cutting prices in order to move product, but their profits may suffer.

Third quarter retail vacancy in the Portland metropolitan area was 6.0 percent, and that number is expected to rise in coming months, though it may take time for the numbers to reflect what landlords and tenants are experiencing. Some businesses are leaving space that sits vacant for months, while others are downsizing, potentially subleasing space they are not using.

In these difficult times, certain retailers are getting along better than others. In general, consumers are looking to get more bang for their buck. Grocery stores are doing well as Americans eat out less and opt for prepared foods at the grocery store over restaurants. Thus many restaurants are experiencing tough times, with the exception of fast food. Stores focused on value, like discount stores, thrift stores, and pawn shops, are in a good position, but today even stores like Target and Costco are seeing diminished profits.

There is a possible bright spot: small and local businesses may be in a position to benefit from the stagnant market. Oregon is said to be an incubator of small business, and aside from the state’s many successful smaller homegrown enterprises, major companies like Nike and Columbia Sportswear have prospered in the state and gone national and international.

Landlords try to attract tenants with strong credit, and in the past, that meant established big-box and chain retailers. Now, with many of those retailers having financial problems, landlords may be willing to give small businesses of all types a chance.

For entrepreneurs who have financing, a fresh idea and a strong business plan, an attractive lease could be in the cards. Landlords don’t want to have retail space sitting empty, so rates and terms may be negotiable, with some landlords willing to give concessions like free rent or more money for tenant improvements. Landlords are also getting creative in marketing space, especially during the holidays; for instance, some are displaying local art in vacant store windows to fill the space and attract potential tenants.

In addition, existing small business tenants may have an opportunity to upgrade into a higher quality space than they could previously afford. With lower rates and concessions, those in Class B space may now be able to move up to Class A.

Rather than signing a long-term lease on a new business that hasn’t been tested, some small business owners are opting to enter the market through subleasing. They can get a smaller space and test their concept for a year or two, then relocate, expand or sign a longer lease if the enterprise proves successful.

Another opportunity for certain small businesses to gain space is through a trade show atmosphere. For instance, HomeShow America recently leased nearly 28,000 square feet in Vancouver for a new location. A home-related vendor can set up a display at this location for a fraction of the price of a space of their own. The home show is open daily, so it’s convenient for consumers to access many businesses in one location and it can provide vendors with exposure.

Though much of the focus in the news today is on struggling businesses, landlords are also feeling the economic crunch. General Growth Properties, which owns more than 200 malls around the nation, including the Portland area’s Pioneer Place and Clackamas Town Center, has considered filing for Chapter 11 bankruptcy. So though some landlords are providing incentives like free rent, others may be financially unable to do so.

As is the trend throughout commercial real estate, many retailers of all types and sizes are taking a wait-and-see approach to expanding or opening new enterprises. Though the much-anticipated presidential election is over, the impact of the new administration’s policies and actions on retail will not have an immediate effect, so for many the wait continues.

No one knows quite when this recession, which began in December 2007, will end. While hoping for a quick turnaround, experts are predicting that retail will see tough times through 2009, and potentially into 2010. In the meantime, retailers are doing everything they can to attract consumers and maintain profits.

City’s Core Possesses Potential Aplenty

As businesses and residents return to greater downtown area, new retail investment possibilities emerge

Denis O'Neill, Associate Vice President, NAI NBS

Tired of doom and gloom in the real estate world? We are clearly in a down cycle driven by the implosion of the financial markets. However, if you are not inclined to spend 2009 searching the globe, do solid retail real-estate-investment opportunities exist right here in Portland? Here’s a tip: Follow the money.

Since the late 1970s, civic and business leaders have pursued a strategy to stop the suburban flight of retail and office businesses. Through the Portland Development Commission, public resources were channeled back into the core, initially through the establishment of the urban renewal districts, and later through substantial infrastructure investment in light rail and the streetcar. Propelled by the city’s desire to increase residential density around mass transit and fueled by property tax subsidies, we saw an explosion of condominium units.

New commercial investment followed residential growth and continues throughout the Central Business District and Northwest Portland. The Pearl District’s success is flowing both across Burnside to the west side of downtown and up Burnside toward Northwest 23rd Avenue.

On the south end of downtown, Portland State University and Oregon Health Science University’s ambitious expansion plans are linked both by the streetcar and the tram to Portland’s newest neighborhood, the South Waterfront District. South Waterfront boasts multiple high-rise apartment and condominium buildings, such as the John Ross and Meriwether, and a growing number of retailers, from a bank and restaurants to a neighborhood market and dry cleaner.

Dead zones are disappearing and districts are growing together. For years, talk of a 24-hour downtown was a planner’s mantra and little more. A city where people lived, worked and played seemed futuristic. Are we at a tipping point?

Two demographic trends appear irreversible. First, no one wants to commute. The rebirth of neighborhoods and commercial corridors near downtown, such as Southeast Belmont, Southeast Hawthorne, Northeast 28th Avenue and now, North Mississippi, were early indicators that an increasing percentage of people were rejecting the suburban lifestyle.

People are seeking a more diverse, urban lifestyle, minimizing the need for a car for work and play. An estimated 11 percent of the Portland metro area’s workforce walks, bikes or rides mass transit to get to work. The increase in gas prices has only encouraged this trend, and TriMet ridership continues to rise.

Portland’s unique neighborhoods and downtown are heralded by travelers and national publications alike. For instance, Travel + Leisure’s America’s Favorite Cities 2008 ranked Portland No. 1 for public transportation and pedestrian friendliness, safety, cleanliness, public parks and environmental awareness.

Second, young professionals and creative types want to work close to downtown. Leasing agents consistently report that companies are now trying to relocate from suburbia to the core, and recruitment and retention of talent are the drivers. This is a fundamental business shift.

So where are the investment opportunities? If you believe the lure of working and living near the core is going to only grow stronger, downtown real-estate values will surely benefit.

For the last year we have been dealing with a wide gap in the “ask” and “bid” resulting in a nationwide drop in the number of investment sales. Though buyers were quick to price in new financing costs, sellers were not ready to accept lower prices. Prices are now falling as available financing shrinks. The average cap rate for core office and retail properties is now about 7.5 percent, up from the low 6-percent level in early 2007. In addition to a rollback in rental rates, credit restrictions have finally forced sellers to acknowledge the new financing realities.

In emerging commercial areas like South Waterfront, the ground-floor retail space is being built as an amenity to attract condominium buyers. Until a critical mass of retail is reached, the retail components are being offered for lease and sale at subsidized rates. Rents are in the $25 NNN per-square-foot range, 10 to 20 percent below the market for established spaces. This translates to sale values in the low $300 per-square-foot range, well below construction cost for a Class A building.

However, South Waterfront has distinct advantages over earlier urban renewal areas. For the initial retail developments to be successful they must generate customers besides neighborhood residents. OHSU, Portland’s largest employer, is an engine that will continue to deliver research and medical space to South Waterfront and its 35-acre Schnitzer campus.

Plus, the sheer scale of the density and construction is unprecedented. Despite the downturn, South Waterfront will deliver more residential units, office and retail in five years than seen in the first 10 years in the Pearl.

South Waterfront may be the obvious example of where public and private investment creates opportunities for investors. But years of investment in Portland’s core, ever-increasing density, lifestyle and demographic trends make solid purchases in all of Portland’s areas near downtown a very good bet.

Differentiate Yourself and Your Service

Jennifer Medak, Vice President, NAI NBS

Today's shifting economy provides a great opportunity for brokers to truly focus on client interests, being aggressive and creative in weathering the storm. Forget you are a broker and put yourself in the shoes of your client. The empathy, struggles and challenges they face are as real as yours, so by solving their problems you will be solving your own. Spend more time with your owner clientele to make sure their needs are being met with market updates, competitive analyses or by taking them on a tour of their competitor's properties. Sublet their spaces or portions of them to alleviate financial burden. On the tenant side, focus efforts within your area of expertise to ensure that you have the leading market share. Move tenants into more appropriate space, if applicable. In all transactions, negotiate with more detailed market information on renewals. Demonstrate that your knowledge of construction costs, operating expenses and motivation are critical to your client's success, and be prepared to go well beyond the sticker price quoted on your marketing materials. Lastly, believe in your expertise and use it, because this (market) too shall pass.

If You Build It, They Will Come

Developers bank on demand for Class A office space in Central Business District

Sean Turley, Vice President, NAI NBS

If you build it, will they come? The popular answer to this question is yes. Developers are building new office space to meet demand and fill the limited supply in Portland’s Central Business District. First & Main will be the first CBD building to be delivered, providing approximately 350,000 square feet in 2010, followed by Park Avenue West adding an additional 330,000 square feet of Class A office space.

So why are developers pouring hundreds of millions into new construction, while tenants remain jittery about cash flow and may be tightening belts rather than loosening them? The answer is simple: supply and demand economics. Single-digit Class A vacancy, rising rental rates and diminishing supply of larger blocks of office space suggest that Portland’s CBD isn’t experiencing the economic doom and gloom of other markets in the nation. Sure, downtown has had to navigate its fair share of slow periods, and the meltdown in the credit markets didn’t help, but overall the CBD remains healthy for development.

Tripwire’s recent 36,000-square-foot lease at One Main Place has further diminished the availability of large blocks of space, and larger users are feeling the squeeze. With One Main out, now KOIN Center and Crown Plaza are the only existing Class A buildings that can accommodate a tenant seeking more than 30,000 contiguous square feet – just two buildings to choose from in the entire CBD. Developers are paying attention, and as a result, cranes are in the air.

It is clear that the limited supply points favorably toward development, but the concern has always been demand. Several signals suggest that demand will be there, but only time will tell.

The first signal is renewed interest in downtown. Blame it on high gas prices, but the CBD is seeing a resurgence from suburban tenants interested in relocating downtown. This is a fundamental shift, since for years the CBD lost tenants seeking abundant free parking and a more favorable tax situation offered in suburban markets. The ability to draw from a deeper employment pool, central location and easy public transportation options are helping drive this shift.

Another factor helping drive demand in the CBD is sustainability. Firms are feeling increased pressure to be environmentally conscious and provide a healthy work environment for their employees. Most new construction is being developed to some level of LEED (Leadership in Energy and Environmental Design) standard while most existing buildings have few to zero sustainable elements. LEED-certified construction is in demand as it helps companies recruit and retain employees, especially in environmentally conscious Oregon. Further, “green” is arguably the new growth industry coming to town, as wind, solar and other sustainable industries are growing and expanding across the metropolitan area.

Lastly, demand could come from outside Oregon. Even though rents are on the rise, Portland is still the low-cost leader when it comes to West Coast options. It is not out of the question for demand to start coming from growing or relocating firms from the San Francisco and Seattle areas. Although Portland is courting business from other markets, historically absorption in the CBD occurs from organic growth. Typical lease up for new construction comes from existing tenants looking for newer and more efficient office space. This usually leaves a sizable hole to fill in the tenant’s former building and will create some opportunity for tenants in the Class B and C markets. Landlords with this product still have to compete for deals, but even these rates will eventually be pulled up by the limited supply in the Class A market.

The health of Portland business needs to be strong as it will clearly have to absorb higher rental rates in the coming years. Contributing to these increased rates are rising costs for both new construction and those to provide tenant improvements. Institutional buyers looking for opportunity in Portland are also adding to higher rents. These buyers have concluded that they can press rental rates in Portland easier than other areas of the nation. As a result, institutional buyers have paid top dollar for Portland assets and immediately pressed rates to justify their purchase price.

With limited supply, clear projections that rental rates are on the rise, and reasonable assurance that demand is healthy, developers are feeling confident that if they build it, tenants will come.