Value Retailing Puts the Squeeze on Regional Shopping Centers

Although retail market indicators and retail sales have improved steadily in the past several years, many underlying conditions could dampen the retail market's prospects for continued improvement. In the majority of regions, retail market conditions are solid. Paradoxically, the performance of the retail markets does not mirror that of individual retailers. Since the late 1980s, a paradigm shift in national shopping patterns toward value-oriented retailing has squeezed retailers' profits. In fact, earnings for many types of retailers, such as apparel stores, have been negligible or negative in the past several years because of intense price competition. Many chains have been forced to slash margins in order to remain competitive. The number of bankruptcies for regional and national retail chains has remained high in the past several years from the price competition. In fact, retail business failures increased by 2.8 percent from 1994 to 1995. This has led to a major shakeout of retailers that will continue for the next several years.

Prior to the paradigm shift, the retail market was segmented by the following hierarchy: super regional malls, regional malls, community shopping centers, and neighborhood shopping centers. Although neighborhood, community, and regional shopping centers had modest product overlaps, each type had a specific function that did not threaten the viability of the other categories.

However, during the late 1980s, the large-scale introduction of power centers along with the proliferation of large discount-oriented retailers, such as Wal-Mart and Target, upset the retail hierarchy's competitive balance. In fact, most new retail space added during the 1990s has consisted of power centers or individual big-box stores. They upset the competitive balance by offering product lines in direct competition with community, regional, and super regional shopping centers.

Historically, general merchandise tenants have paid premium lease rates to be located in regional and super regional malls in order to draw from the traffic that department store anchor tenants generated. High construction costs and common area expenses of large enclosed malls mandated the higher lease rates. These premium lease rates serve as a de facto subsidy to the anchor tenants, who pay much lower rates. This arrangement made economic sense for the general merchandise stores (in-line tenants) because of the high sales volume generated at regional and super regional malls. Because general merchandise stores cannot compete against the power centers on price and cannot compete with department stores on service, sales volume of some stores in regional and super regional malls declined overall between 1993 and 1995. However, during that period, the rental rate increase of 8.1 percent eclipsed the sales volume increase of 5.2 percent for in-line tenants of regional shopping centers. Subsequently, the failure rate of in-line tenants has increased dramatically. Even when new tenants are found quickly, high turnover weakens the financial performance of regional and super regional malls because of costly build-out expenses and leasing commissions for new tenants.

Because many general merchandise chains no longer receive sales volumes commensurate to the lease rates charged by regional and super regional centers, some are locating new stores in community shopping centers that have much lower lease rates. Community shopping centers are able to offer lower lease rates because their rates do not have to reflect the high common area maintenance fees and construction costs associated with enclosed malls. In other cases, in-line tenants are negotiating for lower lease rates that will enable them to remain in regional and super regional malls. These trends indicate that regional and super regional malls will require aggressive and creative marketing to maintain their tenant base, or they will face high turnover.

Another worrisome trend for retailers is the spiraling level of consumer installment credit. From the beginning of 1994 through July 1996, consumer installment credit increased to $1.2 trillion from $849 billion. Escalating consumer installment credit was a major factor in pushing personal bankruptcy filings in 1996 to more than one million for the first time. More important to the retail market, high levels of consumer installment credit moderate consumer spending growth. The slowdown in projected retail sales growth to 3.6 percent in 1997 from 5.5 percent in 1996 supports this.

During 1997 and 1998, the majority of new retail construction will be concentrated in power centers and community centers. Although competitive pressures have severely squeezed the earnings of a large number of retailers, the individual supply-and-demand conditions within the product categories of each market dictate the level of new product that can be absorbed.

In the next several years, the level of improvement will vary significantly by retail product category. Regional and super regional malls will struggle to keep in-line tenants who are being hurt by the big-box retailers. Market conditions for community shopping centers will improve because of increased demand from general merchandise stores. Well-placed power centers will continue to thrive. Neighborhood shopping centers will continue to improve because the major shakeout in grocery store anchors has ended. However, retail centers in trade areas that are experiencing rapid population and income growth will continue to prosper regardless of retail category.

George Green

George Green is a policy representative/senior economist for investment real estate at the National Association of Realtors in Washington, D.C.