Retail Check: Manhattan Besting Boroughs For Now
We recently had a reader inquiry about the New York City retail market and its impact on building revenue in co-ops. Back in February, Crain's ran an article about how rising maintenance charges were impacting Coop and Condo owners. According to the Crain's article "Income derived from renting retail space and levying charges on unit sales is plummeting, and the number of owners defaulting is starting to rise". Faith Hope Consolo of Prudential Elliman, a dean of New York City retail leasing was quoted in the article commenting on the big spike in retail vacancy rates in Manhattan residential buildings, so I decided to catch up with her as well as Cushman Wakefield's Gene Spiegelman to get an update.
First let's go through some macro statistics:
According to Marcus Millichap's recent 2009 National Retail Report, New York City ranked 6th among major MSAs down from 4th in 2008, in their National Retail Index, which ranks cities by 12-month forward looking supply and demand indicators. These factors include forecast employment growth, vacancy, construction, household formation, retail sales, rent growth and an analysis of local housing market conditions. San Diego (1), San Francisco (2) and Portland (5) are reported to be long-time supply constrained markets. New York has likewise been considered a supply constrained market for time immemorial. It is for this reason that Marcus Millichap believes that New York City will experience less draconian rent declines than most other markets nationally. Specifically, Marcus & Millichap writes "Job cuts in banking and finance will weigh on property performance in New York City (#6), but supply constraints continue to restrict construction keeping vacancy in check and supporting one of the more modest rent declines in the country this year".
CoStar Group just put out their national Q1 retail real estate trends report. Trends across the country are somewhat bleak, with negative absorption (net move outs) of 23.8 million square feet, versus positive absorption (net move ins) of 22.9 million square feet in Q1 of last year. According to CoStar, 60.3 million square feet of new retail space is under construction nationwide. The average total vacancy rate is 7.2% at the end of the first quarter, the highest since CoStar started tracking data in 2000. The vacancy rate rose 50 basis points quarter-to-quarter and 100 basis points year-to-year. As far as New York City goes, it was cited as the city with the lowest average retail vacancy rate nationally at 2.4%. Further, New York City was one of only 5 markets that notched a decline in vacancy rate in Q1, down 22 basis points. However, New York City did make last place in the top ten rankings for markets with new retail space coming to market with 1.49 million new square feet. Unfortunately for New York City, Northern New Jersey and Westchester/Southern Connecticut, with which the city vies for retail dollars, ranked numbers two and three for new retail space additions at 5.4 million square feet ad 3.6 million square feet respectively. Interestingly, a recent Real Deal article cites a Prudential Douglas Elliman estimate of retail vacancies citywide hitting 12.4 percent this year, versus 8.7 percent in 2008. I confirmed with Faith Hope Consolo that those numbers are for the five boroughs, with Manhattan being below 10% (still reflecting a healthy market, though weaker than what CoStar is implying). With regard to the weaker retail trends in the boroughs, a recent survey by Congressman Anthony Weiner's office found a 14.1% vacancy rate in Brooklyn, a 12.2% vacancy rate in Queens, a 9.7% vacancy rate in Staten island and a 9.1% vacancy rate in the Bronx.
Considering, Manhattan's relatively better retail performance than much of the nation thus far in the economic downturn, it is not surprising that I found both Consolo and Spiegelman in the glass half full camp on Manhattan retail. Much more importantly to Urban Digs readers, neither believed that retail rent declines, however severe, would be a significant burden to significant numbers of coop and condo owners in Manhattan, for several reasons.
According to Consolo, the old 20% rule, which limited the income of cooperatively owned real estate corporations to 20% from non-residential real estate activities - if they wanted to be able to deduct property taxes and mortgage interest from their taxes like other residential real estate owners - had a couple of impacts on retail real estate in coop buildings. The first is that some buildings made the choice to turn their retail units into condops and sell the units to outsiders, thus relieving themselves of the issue and bringing in a one-time cash injection. The number of buildings that did this was said to have been small, but they had good market timing - better lucky than smart. Future maneuvers of this nature were rendered unnecessary recently due to the Mortgage Forgiveness Debt Relief Act of 2007, which created several ways for coop buildings to get around the 20% rule (read here). The second and more important impact was that for many years coops signed long-term leases of 20 - 30 years in duration at below market rents and often without significant annual inflation adjustments. Many of these leases are now coming up for renewal. It is true that the timing of the expiration of many of these leases could be worse for the retail tenants (like 18 months ago). Consolo recently saw one expiration where the coop was charging $50 per square foot in a $300 per square foot market. In this situation, current softness in the market seems beside the point.
Away from the market distorting impact of the 20% rule, retail around Manhattan though soft, is by no means dead. Gene Spiegelman, of Cushman Wakefield, believes that we are too early in the cycle for retail to really make a firm judgment on how low rents will go. According to Spiegelman, "retail rents actually held up well through 2008, but since New Years, you have seen a big decline in leasing velocity". He thinks it's still hard to say exactly where rents settle out, with most transactions he is seeing still in the proposal phase. Spiegleman makes an important point regarding the difference between the office and retail asset classes. Office space is much more of a commodity so when space comes back on the market through sublets deals pricing gets hammered across the board. In retail, location is critical and product is by no means a commodity, additionally since landlords often participate in the success of tenants businesses through percentage rents (a piece of the revenue driven by the retailer), the leases have very specific limitations on use, requirements for signage etc. As a result, although about 25% of the space currently available is for assignment or sublease, it does not have anywhere near the corrosive effect on rents that subleased space has on the office market.
Spiegelman notes that retail south of 96th Street remains supply constrained and that there is significant contrast between various Manhattan neighborhoods and even more so the boroughs. Spiegelman offers that 3rd Ave between 57 - 79th street has seen availability tick up, but it's still at a somewhat reasonable 7 to 9%. Fifth Avenue is still very supply constrained and one of a couple of locations worldwide where retailers feel they have to be to be an international brand. However, where this drove rents to $2,300 per square foot at the peak, they may settle back to $1,500 to $1,700....still incredible numbers, but I would note a near 35% decline on the lower end of the range. Broadway between 59th and 86th Streets, is still holding at a 5 - 6% availability rate, and SoHo still holding at 7 - 8% despite a speedy turnover rate in that boutique driven market. Surprisingly, the posh Madison Ave shopping district, famous for shishi designer brands saw availability hit 13% in mid 2007 and stay there, versus a normal 6% to 7%. Apparently, as with apartment prices, luxury retail seems to be taking on the chin harder as people trade down. Some have attributed this in part to a Madoff effect.
Consolo also commented on the "trading down" phenomenon, but noted that lower rental rates are enabling lower price point retailers to get into New York City for the first time. As a result she sees a dozen new openings for every chain store closure. Sure Circuit City and Virgin MegaStores are closing, but the likes of youth retailer Forever 21, who is replacing Virgin in Times Square, are coming into these sought after slots. She sites the opening of the city's first JC Penney in the moderate price category as another example. Teen retailing, which remains a relative bright spot has kept Hollister (recently took down 20,000 square feet at Houston and Canal), Zara and Mangos (new Lower east side unit) rolling out new stores in the city. Newcomers like Topshop of the UK are absorbing large blocks of space including 40,000 square feet of space in SoHo for 1 of 3 new stores planned this year.
The Wall Street Journal had a piece yesterday on the Chicago's Magnificent Mile, discussing the increasing vacancy rate on Chicago's major retailing thoroughfare. One longtime retailer was quoted as saying "The stores that had declining sales but wanted to keep a presence for marketing purposes are rethinking their strategy". Fortunately for New York City, the conflict between the need to have a marketing presence in the "world's capital" is not in conflict with the need to generate profits. According to Consolo, New York stands apart from Rodeo Drive, Worth Ave and the Magnificent Mile, in that the sheer density of the New York City population drives sales per square foot much higher than in any other area of the country and allows profits to be generated even in a poor economy. For this reason she believes it is even more recession resistant than any other prime retail location in the country.
Even the retail banking industry appears to be pulling back somewhat less than expected in New York City. Spiegelman offered a couple of comments on bank branch consolidation fears which he sees as having been a bit overblown. According to Spiegelman, banks had been consolidating space for the past 2 years and the combinations that have happened are less negative than some that were contemplated. My piece on potential bank branch blight which considered the impact of a Citi/Wachovia deal and Chase/Wamu marriage was a bit premature. With Wachovia going to Wells Fargo instead of Citibank, there will likely continue to be branch growth in that system, versus overlaps and closures. While JP Morgan is closing some Wamu branches, many of those will actually be mid-block locations and not the coveted corner spots. Meanwhile, Citi, TD and Doral Bank continue to expand, he even goes so far as to say that the banks are being careful not to give the public the perception that they are widely shuttering branches.
So at the current time, while a lot has been made of the "missing teeth" that darkening retail windows resemble in some buildings, the market does not seem to be in a complete meltdown, like office, hotel and new build residential. I admit to leaning towards the pessimistic in most cases of late (which I think has served my prognosticating well thus far) due to my overall concerns with the economy.
That said, although retail is normally supply constrained in New York City making it a "demand driven" market as it is in the hotel, office and residential market. We know that weak demand can still cause significant downturns even in the "greatest city on earth". To wit, here is a little reference to history in the form of some text from a New York Times article circa mid-1988, after the last Wall Street debacle gave unemployment a big boost.
AFTER almost a decade of heady growth, store rents in many Manhattan neighborhoods are beginning to decline as landlords sitting with large blocks of space grow nervous.The leading broker of retail space in Manhattan, Garrick-Aug Associates Store Leasing, reported a 24 percent drop in average negotiated rents between the second half of 1986 and the same period in 1987. Since then, average rents have continued to slide - especially along such trendy stretches as West Broadway and Columbus Avenue - despite stability within a few retail districts.
''Landlords today are concession minded,'' said Charles Aug, president of Garrick-Aug, ''whereas a couple years ago their attitude was: You better rent the space now, without any concessions, because it'll be more expensive tomorrow.''
The jury is still out on just how bad retail in Manhattan will get. At this point the impact on coop and condo cash flows seems to be minimal. Retail is certainly worse in the boroughs and will undoubtedly have some impact on mixed use properties there.
From the Blogosphere:
Help for Atlantic Avenue Retailers To Keep Storefronts Open
Brooklyn Stores Hit Hardest By Retail Slump
Comments (7)
" in that the sheer density of the New York City population drives sales per square foot much higher than in any other area of the country and allows profits to be generated even in a poor economy. For this reason she believes it is even more recession resistant than any other prime retail location in the country."
Isn't amazing that you buy into this logic about reatil space, but when it comes to residential space, "the sky is falling" mantality prevails.
Posted by j scott | April 10, 2009 2:14 PM
It's supposed to be a nice weekend. Go take a stroll on Broadway on the UWS. Start north of Fairway and walk up to the 100's. Observe the gaping chasms left by Circuit City, Morris Bros. Ruby Foo's, and Docks; the small retail wipeout between 87th and 88th; the total vacancy of the Greystone redevelopmentat 91st; the never-occupied retail at the Melar at 93rd; the newly-vacant corner WAMU at 96th; the small retail wipeouts between 98th and 99th and 100th and 101st, etc. Then ask who are you going to believe? A broker report? Or your own lyin' eyes?
Posted by BD | April 10, 2009 6:51 PM
Thanks for the update.
I think I was the one who submitted the query back in early March (or was it Feb?). Anyway, I appreciate the work.
Btw, your analysis of the other boroughs could use an update - particularly w/regards to Queens. Is
it just my imagination or have Manhattan retailers fled the island for Astoria, Flushing, Elmhurst,
and Jackson Heights? Business is certainly booming there.
But a caveat is that these are mostly in recent immigrant communities where supply and demand are bound by geography as opposed to the more luxe
environment of Manhattan (but even then in Manhattan you can see Chinatown expanding to parts of Tribeca and Soho).
Posted by In Debt We Trust | April 11, 2009 7:59 PM
Jeff, doesn't retail movements (particularly for larger operations) occur a bit more slowly than other commercial activity?
Bankruptcies will obviously clear out some major space, but it seems to me that in some cases it is just a case of lease timing. There is alot more office leasing space, so change shows up faster there. For retail, the smaller entities may have shorter-term leasing or just go belly up, but the banks and big boxes seem to me to be less liquid, being able to exit usually only when leases expire. If the economy improves, they may have dodged a bullet, but if it doesn't it seems to me as though over time you'd see many companies reduce locations (there will, after all, be plenty of space in the next few years).
I don't know if I'd call Consolo an objective observer. An expert certainly, but not without an agenda.
Posted by brenda | April 12, 2009 9:41 AM
Brenda, et al
I do believe that because of the more unique aspects of retail properties and the consequent structure of leases, the price transmission mechanism is much slower than in office. So while as I noted, I am a pessimist generally, and retail is no exception....I don't think things will play out that differently than the 1988 historical flashback i included. But Brenda is right, if the economy turns around, retail rents could dodge the bullet. As far as residential goes, I view it as half way between retail and office. Residential is definitely not a commodity, so price comparison is less direct than in office. Since 75% of the housing stock is coop and sub lets are restricted/tenant quality is higher there is less price transmission through distressed renting/selling.
Posted by jeff | April 12, 2009 3:50 PM
Brenda,
I think normally you are right. I have some friends who are major owners of commercial space in flushing and chinatown -- and you wouldn't believe the number of restaurants that are having trouble paying the rent, negotiating lower rents, folding, etc.
Posted by RegularAnon | April 12, 2009 8:45 PM
RegularAnon,
Yes, I wasn't intending to be particularly optimistic. Actually the opposite, I think that the nature of retail leases means that retail both occurs during and lags an economic downturn. I think that some locations will survive merely because they are owned by companies that can't walk away and are not going bankrupt. If a company can reduce locations, I think they will. So many of the banks/drugstores opened in the last three years, however. So timing may keep those locations open.
But the little people, that's a different story. At some point you just can't pay the bills.
As an aside, I was at Crossgates Mall in Albany this weekend. The vacancies were obvious, but not overly extreme. What WAS amazing, however, was the reduction in the quality of many of the smaller stores. This is a Macy's/J. Crew/Pottery Barn type of mall, and now there are TWO dollar stores, and numerous locations selling items that can be generously deemed cheap(particularly quality).
Posted by brenda | April 13, 2009 9:33 AM