Mall Vacancies Grow as Retailers Pack Up Shop

Shopping Venues See Uninhabited Rate Reach 8%, But Not All Is Bad in Commercial Sector as Apartment Rents Rise

Vacancy rates at U.S. malls and shopping centers continued their steep rise in the third quarter as slumping sales forced retailers to close stores.

Malls are seeing their highest vacancy rate since 2001, according to data released by real-estate-research firm Reis Inc. For shopping centers, the rate is the highest since 1994.

In contrast, the apartment market, particularly Philadelphia apartments, remained one of the most healthy real-estate markets in the third quarter, benefiting from the struggling home-sales market. Many would-be buyers, unable to get mortgages or worried about the darkening economy, are renting apartments instead.

In the top 79 U.S. markets, apartments posted a slight increase in the vacancy rate to 6.1%, up from 6% from the previous quarter, and a rise in rents of roughly half a percentage point, according to Reis.

Shopping centers and apartment buildings fall in the category of commercial real estate, which has fared better in the credit crisis than residential. Until recently, most commercial landlords had struggled with the financing drought, but the so-called "fundamentals" of their properties -- vacancy rate, rent and expenses -- remained healthy.

Now that is changing. In the retail sector, vacancy rates have climbed and rent increases have slowed for the past year. The vacancy rate at malls in the top 76 U.S. markets rose to 6.6% in the third quarter, up from 6.3% in the previous quarter, to its highest level since late 2001, according to Reis.

For strip centers and other open-air shopping venues, the vacancy rate climbed to 8.4% in the third quarter from 8.1% in the second quarter. That marks the highest rate since 1994, according to Reis. Meanwhile, retailers' closures outpaced new leases by 2.8 million square feet in U.S. strip centers in the third quarter, the third consecutive quarterly net decline. It is the first nine-month period of so-called negative net absorption since Reis started tracking the data in 1980.

The combined vacancy rate for malls and strip centers in the third quarter was 8%, up from 7.8% in the second quarter. Vacancy tends to be higher in strip centers during economic slowdowns because they have more independent, local tenants, which are more vulnerable to drops in sales than are the national retailers found in malls.

Still, the economic slump has taken its toll on national retailers. Among those that have closed stores in recent months are Starbucks Corp., Dillard's Inc. and Linens 'n Things Inc. More closures likely are on tap, as retailers such as Circuit City Stores Inc. struggle with dwindling sales.

"Almost every retailer has slowed their expansion by 50% to 70% for 2008," said David Brinbrey, chairman and chief executive of the Shopping Center Group, an Atlanta retail brokerage.

Retail landlords are hurt directly by slumping sales because many of them have leases that, in addition to base rent, give them a small portion of payments based on the tenant's sales growth. And retailers feeling the pinch from the shopping slowdown increasingly are asking for rent concessions.

Landlords have little choice but to give breaks to solid tenants. "Chances are, if they're a good merchant, we're going to work with them to get them through this bad time. There's no reason to have an empty space," said Rick Caruso, chief executive of Caruso Affiliated, which owns 10 high-end shopping centers in Southern California.

Sam Chandan, Reis's chief economist, noted that the growing weakness of retailers can be seen in the decline of retail jobs, which have fallen by more than 250,000 nationally in the past year. "Apart from declines in automobile dealers and parts sellers, the last month's declines are broad-based, including department stores, food and beverage retailers, furniture, and electronic and appliance stores," Mr. Chandan said.In the apartment sector, the vacancy increase has been more gradual. But the scarcity of job opportunities for recent college graduates has sapped a primary customer base for apartments, analysts say. And some people who are losing their jobs are moving in with family and friends.

Some foresee rent increases stalling or declining in the coming months as other economic indicators sour. "As unemployment rises, it will be harder for these [apartment] companies to push rent in terms of renewals and new leases," said Michelle Ko, an analyst with UBS Securities LLC.

Analysts report strong apartment occupancy and rent growth in markets including San Francisco, Boston, San Diego and the Pacific Northwest. Rents and occupancy have suffered in boom-bust markets such as Phoenix and Orlando, Fla. But some previously strong apartment markets, namely New York and Charlotte, N.C., might suffer from the loss of financial jobs amid the banking shakeout.