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US housing drop saps retail landlords' strength

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A common real estate maxim states that retail development follows new housing. These days, though, retail real estate may be following the home market off a cliff.

Sparked by the housing boom across the country, shopping-center and mall developers have gone on a tear in recent years, delivering millions of square feet of new space in Phoenix, San Antonio, Cleveland, Tampa, Fla., and numerous other markets. Since 2005, developers in the U.S. have produced more retail space than office space, rental apartments, warehouse space or any other commercial real estate category.

But just as that new space is hitting the market, demand is declining. Mounting home foreclosures have sapped the strength of previously hot markets like Phoenix and California's Inland Empire near Los Angeles, leaving retail-property owners with rising vacancies and slower leasing rates for new space. And anemic sales gains in the just-completed holiday season fell short even of the retail industry's tepid preseason forecast.

More shopping centers are suffering defections such as those faced by Phoenix's Paradise Valley Mall, which was built in 1979 and renovated in 1990. Though the mall has a healthy roster of tenants, an anchor slot vacated by a predecessor of Macy's Inc. has been vacant for two years. Among the empty storefronts in the otherwise vibrant venue: one left behind by bankrupt Bombay Co.

Analysts expect that more bankruptcies and liquidations of second-tier retailers are likely this year. Some retailers, such as Talbots Inc., are closing weak stores. Projected retail demand will justify only 43 percent of the new space delivered this year and last, predicts market-research firm Property & Portfolio Research Inc.

Retail development is "basically at a three-year high," says Steven Marks, chief of research on real estate investment trusts at Fitch Ratings Inc. "And that three-year high is at a point in the economic cycle where it's probably not the best time to be developing right now."

If consumer spending falls off much more, the retail-property market faces a bloodbath, some say. "In a recessionary scenario, retail gets killed, absolutely killed," says Suzanne Mulvee, senior economist at Property & Portfolio Research.

If the market holds steady, current trends will still translate into varying degrees of stress for owners of retail property. Most of the country's largest malls are owned by huge public companies that are financially equipped to survive a downturn, but the stocks of many of them are trading near their 52-week lows.

And smaller owners that bought or developed property at the top of the market expecting high occupancy and high rents may face problems with their lenders. Some are already scrapping or delaying projects that are scheduled to be delivered this year.

Even landlords with relatively stable properties aren't assured of escaping the credit crunch. Australian REIT Centro Properties Group, which has amassed a big U.S. retail portfolio in recent years, is scrounging to find an equity partner or a buyer because it can't pay off looming debt maturities. And the market is closely watching mall operator General Growth Properties Inc., which has $2.8 billion in debt coming due this year.

Meanwhile, for consumers, retail woes could mean more empty space in shopping centers and, in extreme cases, more failed projects, leaving suburban landscapes blighted with dark buildings set back on vast, empty parking lots. Property & Portfolio Research foresees retail vacancies jumping to nearly 12 percent by the end of this year in the top 54 U.S. markets, up from 10.4 percent in last year's third quarter.

Retail real estate is more closely tied to the housing market than other commercial-property types. As a result, retail landlords feasted in recent years on rapidly expanding tenants and easy financing as carefree shoppers spent their home equity with abandon. Some 145 million square feet of new shopping-center, mall and other retail space was built in the top 54 markets last year, with another 123 million square feet in the pipeline this year, according to Property & Portfolio Research. In comparison, the annual average between 2000 and 2006 was 118 million square feet.

Few markets have taken as sharp a turn as the Phoenix metro area, which has nearly doubled its population since 1990. With easy credit for homebuyers now gone, the number of homes listed for resale in Phoenix fell 24 percent from November 2006 to November 2007, according to housing-data provider Metrostudy Inc. Median resale prices are down 8.7 percent in the same period. In the Phoenix area's Pinal and Maricopa counties, home loans are in default at a rate of 6.1 percent and 3 percent, respectively, of the existing housing stock, according to Foreclosures.com.

Despite Phoenix's housing slowdown, 9.3 million square feet of new retail space was added last year and another seven million is expected this year. As a result, Phoenix's retail vacancy rate is expected to double by the middle of next year, climbing to 10 percent from 4.8 percent at last year's midpoint, according to Property & Portfolio Research. Retail property values, which rose 12 percent in 2005, are expected to decline over the next three years.

The Phoenix area's outlook has developers retrenching. Simon Property Group Inc., a mall REIT, recently wrote off its $26 million early investment to co-develop a mall in suburban Phoenix. Glimcher Realty Trust last year dropped an option to co-develop a mall on 100 acres in the suburb of Surprise. Among the projects whose openings have been pushed back by a year or more at the insistence of anchor tenants are a DeBartolo Development LLC shopping center anchored by a SuperTarget and a Wal-Mart-anchored project. Both retailers say they will hold off on those projects until the surrounding area's population growth justifies them.

The story is similar in California's Inland Empire, another fast-growing market now besieged by foreclosures. The area, which includes San Bernardino and Riverside, is expected to have construction totaling more than 11 million square feet over this year and last, the most there since the late 1980s. Retail vacancies, now at 12.8 percent, are forecast to hit 15.5 percent by the end of 2011, according to Property & Portfolio Research.

Wal-Mart Stores Inc. recently dropped talks to move and expand one of its stores to a proposed 300,000-square-foot, mixed-use project in San Bernardino. Developer Hopkins Real Estate Group is mulling scaling back the retail part of the project and replacing it with a less volatile use, such as industrial space.

There is also an impending surplus of retail space in markets not known as hot spots. Take Cleveland, an industrial city with negligible job growth in the past year. Retail projects under construction there total 6.5 percent of the area's existing base, or nearly twice the national average, according to Grubb & Ellis Co. At Bridgeview Crossing, a 550,000-square-foot shopping center being built in the suburb of Garfield Heights, 75 percent of the space is already leased to tenants like Target Corp., Lowe's Cos. and J.C. Penney Co. Renting the remainder will be more challenging. "We are talking to a variety of national, small-shop and apparel tenants who are saying to us, 'We may reduce the velocity of our expansion for a period,'" says David Mrachko, leasing director for developer Snider-Cannata Interests LLC of Cleveland.

In Omaha, Neb., a metro area of less than one million people, projects proposed along the 204th Street corridor on the city's west side stand to increase the retail-space inventory by a staggering 20 percent. Some observers doubt that all of the projects will be built soon, if ever. All told, they span 4.5 million square feet. "Many of these projects will fall by the wayside because some of these developers do not have holding power to wait a number of years until the area is ready," says Dave Lanoha, owner of Omaha-based Lanoha Development Co., which plans two shopping centers totaling 350,000 square feet along 204th Street.

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