Retail Market Steady but Slowing, Continues to Feel Impact of Housing Slump

• Retail absorption dropped from year end, but a huge increase is expected in the second half as 2.12 million square feet is delivered—most of it pre-leased
• Big-box retailers are still aggressively looking for sites but scrutinizing deals more carefully
• Small-shop demand in outlying markets is slowing due to the residential slowdown
• To fill existing small space, landlords may begin to get more creative 

The Twin Cities retail market remains strong, reporting 5.8% vacancy (6.6% with sublease space). The metro’s vacancy is considerably lower than the national average, which is estimated to rise to 8.6% by fourth quarter from 8.1% at year-end 2006, according to the National Association of Realtors.

While absorption dropped to 741,334 sq. ft. from an impressive 2.2 million square feet at year end, that drop is primarily a function of typical construction cycles. More than 2.12 million square feet is underway, with the majority being delivered in the second half. Much of the space is pre-leased. Absorption is expected to bounce back with full force by year end. Due to the strong development pipeline, 2007 should be another healthy year for construction and absorption. Rental rates edged up to an average of $28.60 per square foot.

Market Affected by Housing Slowdown

While big-box retailers—like Target and Wal-Mart—are still aggressively looking to expand, they are moving more cautiously than six to 12 months ago and are more selective as they realign their expansion strategies in light of the residential slowdown.

Small-shop space is being hit the hardest by the housing slump because small, independent retailers typically follow rooftops. In the future, developers will likely build significantly less speculative side-shop space and wait for demand. To fill existing small space, landlords are having to get more creative with deal structures. Landlords also are starting fill small spaces with professional service concepts, such as chiropractic, dental, financial and accounting businesses.

Also impacting small-shop space are the big-box “superstore” concepts. Inside every superstore are full lines of groceries, optical shops, delis and sometimes even services like nail salons. It’s one-stop shopping. Also, these big boxes are being built closer together and squeezing out many small retailers.

Gas Prices Taking Toll

National retail sales were down in April, suggesting that the deteriorating housing market and skyrocketing gas prices are taking a toll on consumer confidence and spending. These circumstances are affecting spending on entertainment items, apparel, home-related goods like furniture and appliances, coffee/sandwich shops and meal preparation and luxury concepts like nails and massage. Those consumers hit hardest are the low- to median-income households. This is apparent in sales at Wal-Mart, which caters to these customers. The retailer reported a 3.5% drop in same-store sales in April.

Fewer New Concepts Coming

The metro is seeing fewer new retail/restaurant and franchise concepts than in past years. One reason might be that the economy is relatively stable and fewer people are “buying” themselves jobs by opening franchises.

Community Centers Are ‘Darling’ of Retail

Of the 2.12 million square feet of retail space underway, 2.1 million square feet is community center space. The community center vacancy is tight at 3.6%. The closing of two large retail chains in the Twin Cities, CompUSA and Wickes, will impact this category during the second half of 2007 and into 2008. Community centers will also see a battle of the full-service health clubs, as L.A. Fitness International goes head-to-head with Life Time Fitness. L.A. Fitness opened its first metro-area location in Apple Valley and has identified sites in Blaine, Brooklyn Center and Roseville.

Neighborhood Centers Undergoing Renovations

Many older centers are undergoing renovations and repositionings to stay competitive. Retailers have to consider redevelopment as a way to enter highly sought-after markets. The redevelopment at Penn and Lowry Avenues North in Minneapolis breathed new life into an aging property by adding Aldi and improving the existing Family Dollar building.

Meanwhile, sit-down restaurant concepts—like Chili’s, Applebee’s and TGI Friday’s—are trying to compete with quick-serve, fast-casual concepts by changing menus, lowering prices and adding take-out items and curbside delivery.

Specialty Centers Performing Well

Most specialty centers are performing well with high-end centers like the Galleria and 50th & France reporting little or no vacancy. The Galleria is opening a two-level Crate & Barrel store, and 50th & France landed new high-end retailers Sur La Table and Cos Bar. However, Calhoun Square in Minneapolis’ Uptown struggles. BlackRock Inc. acquired the center and is rumored to be interested in redeveloping the property.

Regionals See New Tenants

Regional malls experienced significant leasing activity with JC Penney opening at Eden Prairie Center and Home Depot opening at Northtown Mall. Simon Property Group is looking to acquire Southdale Center and likely will undertake a long-awaited repositioning/renovation. Nordstrom will continue to scout for a second Twin Cities location. Possible markets include Minnetonka/Ridgedale, Edina/Southdale, Maple Grove and Woodbury.

Minneapolis CBD Is Mixed Bag

The condo slowdown is impacting downtown retailers. While three grocery stores were planned to serve the growing population, only one was built. Also, downtown is seeing store closings: Nicollet Mall’s Polo Ralph Lauren store will close in July, and Chevy’s Fresh Mex closed on Hennepin. Meanwhile, several developments are proposed, including one at 12th Street and Hennepin Avenue to be anchored by Whole Foods and possibly Best Buy. Also, developer Bob Lux obtained control of a block across from the Orpheum and is looking at its development potential, which could include retail and a hotel. Good news for downtown includes an improving office market, new hotels and the approved Twins stadium—all of which will bring people downtown.

The Outlook

The market will remain steady and see hefty absorption by year end. Concessions will likely creep in for small-shop space in centers that have struggled to fill vacant spaces. This will be interesting to watch since this has not happened in the Twin Cities retail market in nearly two decades. There will be more creative deals and retooling of how retailers do business. Big boxes will still be hungry for sites, but they will be more selective. A correction in land prices in the outer-ring areas will continue. High-profile centers like Calhoun Square and Southdale will likely undergo much-needed makeovers. Neighborhood centers will continue to see renovations in an effort to stay competitive. Regional malls need to stay fresh and will continue to look for ways to reinvent themselves and find interesting tenant mixes to attract customers.