That retail is overbuilt is obvious to anyone who has driven 20 miles in America. Less obvious is the why of over-building.
By John E. McNellis, Principal at McNellis Partners, for The Registry:
“The fault, dear Brutus, is not in our stars, but in ourselves” — Julius Caesar
As it happens, Shakespeare was writing about retail in America today when he penned those memorable lines in 1599. Our woes stem not from the internet, but from our building permits. Forbes notes that, “Since 1995, the number of shopping centers in the U.S. has grown by more than 23 percent and the total gross leasable area by almost 30 percent, while the population has grown by less than 14 percent.”
In short, retail is overbuilt. But not quite everywhere. This is where the old saw about real estate being the most local of endeavors cuts sharp. While the recession is a fraying memory for the country as a whole, five states—Arizona, Connecticut, Mississippi, Nevada and Wyoming—have yet to hit their pre-recession GDP levels and, according to Bloomberg, eight are below their former employment peaks and fifteen have yet to scale their former housing heights.
Where is it hot? The usual suspects: where land is scarce, zoning hard and everyone wants to live. Basically, ocean-view cities.
But back to the losers. Citing CoStar Group, Inc.’s research, Bloomberg picks on poor Cleveland to demonstrate how wildly developers have been over-building. 21 million feet of new retail in Northeast Ohio have been thrown up since 2000, while buying power—a jobs/income formula—declined by 26 percent. This is among the quickest expressways to the bankruptcy court.
You don’t need me to tell you any of this. That retail is overbuilt is obvious to anyone who has ever driven twenty miles in any direction in America. Less obvious is the why of over-building. This is worth considering.
Putting aside a crude joke about dogs that illustrates the point perfectly, developers build in sagging areas because they can. That is, away from the coasts, all towns great and small are begging for development, for investment in their communities. We approached one town on the knife-edge of nowhere and inquired as to whether we could build a supermarket. “When can you start construction?” came the official response and permits were issued forthwith. We built the market almost overnight, put it up for sale and six months later without a single offer we were reminded of the downside of ignoring location.
To borrow from a little-known primer on development, Making it in Real Estate, “…But if what you [develop] doesn’t matter that much, where you do it is huge…I’d rather be a mediocre developer in a brilliant city, than a brilliant developer in Lancaster, California. My advice? If you’re stuck in my hometown or any other city with Lancaster’s dim prospects, move.”
Upon reflection, several other reasons for mis-developing come to mind. The first applies to that class of developers known as merchant builders, the second is more applicable to the naïve, young or amateur developers and the third to the retailers themselves.
Merchant builders are those who build to sell, those who get in and out of a project as swiftly as possible, often using other people’s money to do so. If the merchants are large enough, they avail themselves of the public markets and use their stockholders’ equity. If not, they tend to be funded by aggressive “hot money” sources that want out of deals even faster than the merchants themselves. Thus, merchants will build in Northeast Ohio or Lancaster—ok, maybe not Lancaster—if they can simply convince themselves that someone will buy their project on completion. Their bar is practically on the ground: Will their project hold up for 18 months? With such a stunted horizon, merchants care little about an area’s longer-term prospects or whether they might be adding kindling to retail that’s already ablaze.
The inexperienced may build in the wrong places for less cynical reasons but ultimately to the same effect. How many times have you heard a homeowner airily dismiss comparable sales that undercut his view of his own home’s value? “Yes, but mine has a hot tub.” Or some such. Just as the homeowner blinds himself to the reality that, on average, houses sell at a surprisingly efficient price per foot, naïve or amateur developers tell themselves that, yes, the market may be over-built, but their project’s amenities are unique (they’re not), their line-up of tenants is special (it’s not) and that, whatever slings and arrows may befall them, their project will thrive (it won’t).
And, finally, the retailers, the spark atop all of that kindling the developers are busy erecting. Enslaved to Wall Street, the majority of retailers must grow or die. It’s that simple. The moment a company’s growth falters, the private equity guys turn off the lights and unsheathe their blades. The company will be bought (stolen may be the more accurate verb), the CEO and his cronies will lose their jobs, and the real estate managers will wave aloha to their bonuses. To avoid this fate, all too many retailers force their growth into saturated areas like Northeast Ohio or where they should never have been in the first place.
Groucho Marx famously remarked he would refuse to join a club that would have him as a member. If you’re thinking of developing in an area that has scant prospects for growth, you might ignore the charming surface contradiction of Groucho’s comment and ponder his underlying point. By John E. McNellis, McNellis Partners, author of Making It in Real Estate: Starting Out as a Developer. The article was first published on The Registry.
Retail landlords are reading the memo, but it may be too late. Read… Will Plunging Store Rents Slow the Retail Doom-and-Gloom?
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.
I recall this pundit on television, Davidovitch, who said there was “xx amount” of retail store space per American, way up, and it was unsustainable. However, he said this about ten-fifteen years ago! Just shows you that in a massively complex world, it takes considerable time for some trends to become consequences.
I live in New York State where population flows from cities and small towns alike have been negative
However over the past decade, various chains, (retail, restaurants, etc) have been building constantly, which has always left me scratching my head asking “Why? The population isn’t growing, all your doing is dividing the pie smaller and smaller…”
Needless to say, I’d estimate 80% of these chains are out of business within 3 years.
Too much free money, too little growth….stay lean and mean.
Private equity has purchased a lot of those chains and expanded in order to have a great IPO and exit with a profit.
A variant of the classic pump-and-dump operation.
It is the same as shale – why keep pumping, if you keep losing money.
The US market economy no longer seems rational. Lots of capital has been spent on projects of dubious value. It is probably worse than China and most of it borrowed. It will have to blow up at some point, except that that point is yet some time away.
Citing your dog joke, because they can, retailing is taking on a direct hit from Wall Street, particularly from hedge funds. There are so few profitable businesses, even marginally, that they are overpaying to acquire many of them. Since the margins hedge funds demand are by definition unreasonable, they are killing off retailing as a consequence. The hit on commercial real estate development is just a byproduct of Wall Street’s parasitic practices.
As an example, my favorite supermarket in town is Fresh Market. I can only afford to shop there occasionally, but I manage to go once a month, for the good stuff. I noticed a significant decline in it’s offerings about 3 months ago. I am not talking about price, I expect to spend more there, but in availability of quality items. The decline continues which sparked my interest. I discovered that last year they had been purchased by a hedge fund. I am glad the original owners where able to cash out, but now I know that it will never again be what it was. My expectation is that Wall Street will destroy yet another viable going concern and another once productive location will be empty.
If you want to develop successfully, you need to build small, away from the eye of the parasites. You need to attract businesses that thrive on a small scale. You need to downscale on your own before it is done for you. Many of us already seek out smaller businesses to support.
Hedge funds are like parasites; they live off the host until they kill it.
Why? Simple. Create the false recovery narrative. “Overstoring” creates demand for goods to go in those stores, jobs for people to work in them, and demand for builders, land, and all the admin that is required to turn dirt into a mall.
Not that complicated, someone as smart as Wolf surely knows this. Close to 5 million retail clerk jobs exist due to this bubble, staggering number. Those jobs soaked up many who formerly had “real” jobs, and stopped a total collapse of the market. But now that collapse will commence.
Those 5 million low paying clerk jobs will be replaced by a few hundred thousand highly paid tech positions needed to develop and maintain checkout software, like what is employed in the Amazon grocery store.
Society is quickly transforming to a winner take all format. Wealth disparities are rising rapidly.
“replaced by a few hundred thousand highly paid tech positions”
You might have a few tech positions in the U.S. but not many. Most of the hardware is outsourced to companies that already service hardware with the same engineering resources. A couple of guys can cover a state like Texas. Developers and support are usually out of India. ITs a bummer for U.S. employment.
The supply of money is the wild card in the development and lending businesses. Banks and other lenders with too much underdeployed capital have to answer to boards asking why they are not lending more. That translates into relaxed credit standards, even with the accompanying denials. Lenders have admitted that, just as developers have said that they would build even if the project didn’t pencil out, because there was all that money being pushed on them.
The same dynamic has played out several times in America. Witness the recycling of petro-dollars some years back with that led to the 1980s MBA problem, the Mexico-Brazil-Argentina sovereign debt crises. Each time there is a tidal wave of new money, whether through recycling or QE or some other asset inflation cause, the lenders jump at the chance to say This Time It’s Different.
There are too many lenders, not enough regulation and way too easy a path to bankruptcy to wash away the recurring sins. Lending excesses, and now the latest incarnation in private equity, are only a few symptoms of a monetary system that benefits a few to the detriment of the world. Instead, we get politicians like Bill Clinton who gut Glass-Steagall, and Phil Gramm and his ilk. Gee, thanks, guys.
Glass stegal was put there for a reason and we are going to find out why it was put there the hard way AGAIN thanks Bill but no thanks dam you
The last GOP platform called for a reinstatement of Glass Steagall. I’m sure the Republicans will keep that promise any minute now.
The three co-sponsors of the Gramm-Leach-Bliley Act were:
Sen. Phil Gramm – R
Rep. Jim Leach – R
Rep. Thomas J. Bliley, Jr. – R
In 1999, the Republicans held a majority in both the Senate and the House of Representatives.
The final version of the Gramm-Leach-Bliley Act passed the House by a vote of 362-57 and the Senate by a vote of 90-8. This made the bill “veto proof”, meaning that if Clinton had decided to veto, the bill would have been passed anyways. Having said that, if Clinton truly didn’t want the bill to become law, he could have vetoed the bill in a symbolic gesture, but this did not happen.
Yeah, that’s laughable.
Trump & Co. talk about a “Modern day Glass Steagall” which has nothing to do with Glass Steagall at all.
It’s propaganda, at best. Don’t believe me? Just listen to Steven Mnuchin debate with Elizabeth Warren.
WARREN: I have to try this one more time. What does it mean to be in favor of 21st Century Glass-Steagall if it does not mean breaking apart these two functions in banking?
MNUCHIN: You know what, I’d be more than happy to come and see you and follow up—
WARREN: Just tell me what it means!
MNUCHIN: Had we – we never came out and said separate banks from investment—
WARREN: Just tell me what 21st Century Glass-Steagall means if it doesn’t mean breaking apart those two functions. It’s an easy question – or an impossible question.
MNUCHIN: It’s actually a complicated question because there’s many aspects of it, OK?
WARREN: This is just bizarre, the idea that you could say we are in favor of Glass-Steagall but not breaking up the banks.
MNUCHIN: We never said we were in favor of Glass-Steagall, we said we were in favor of a 21st Century Glass-Steagall. It couldn’t be clearer!
There you have it. It couldn’t be clearer! They’re in favor of a “21st Century Glass-Steagall” which actually has nothing to do with Glass-Steagall at all. It couldn’t be clearer!
Yup, couldn’t be clearer… they want to use the name to fool people into thinking they are actually doing something that will help regulate the banks and too-big-to-fail, without actually doing anything at all.
Glad we have so many Goldman guys in the White House.
I recently saw a comparison of retail space per capita in the USA to Europe and the USA had 6x the amount of retail space. In Colorado, the thing cities want most is retail as sales tax it is the backbone of their tax base. In order to garner as much of that as possible they are willing to condemn agricultural property on the urban edge and declare that it is under an urban renewal authority so that they can finance all of the infrastructure needed to support new large scale retail developments. The result is that they misuse this law which was intended to make blighted urban core areas competitive with the (cheaper to develop) urban edge by subsidizing development on the urban edge with their urban renewal authorities. The cities are willing to rob the tax base of all other authorities in order to finance the goose that lays their golden eggs. In Colorado, distant, sometimes failing, communities are backfilling education budgets in large urban areas where these “urban renewal” districts are set up to subsidize retail development. That which you subsidize you get more of. The grand irony of all of this will be that they have built more retail than can be supported and it will eventually fail causing urban blight which will need to be renewed. By the way the average life of a shopping center is about 22 years but these urban renewal plans are set up for 25 years.
Actually the long term prospects for Lancaster are pretty good, lots of flat available land with water. Close proximity with rapid transit to LA. I also understand that LA county houses a number of HUD candidates in the area. Sure US birthrates are down, but immigrant groups have large families, and Hispanics are living three generations in a single family home in many cases. Today’s retail space built on the edge of communities like Lancaster is tomorrows higher value residential property. If you want an idea how fast things can move when the infrastructure (I15 corridor) is built consider the Rancho California area in So Riverside county. What triggers this new development is a recession, where prices for labor and material come down and permits are fast tracked. The problem in CA is that we haven’t had a recession like that in a long time.
The empty mall and mostly empty giant strip mall I grew up near were thriving 15 years ago, but then they built a new mall ten miles away, with many big box stores and restaurants nearby. The 1950’s era mall I grew up with couldn’t compete, and is now sitting empty, awaiting demolition. That may count as retail space in the statistics, but in reality it’s just waiting for someone to come up with the money to tear it down.
“21 million feet of new retail in Northeast Ohio have been thrown up since 2000, while buying power—a jobs/income formula—declined by 26 percent. This is among the quickest expressways to the bankruptcy court.”
How can buying power decline by 26% when we have been at peak employment for 3-4 years? According to the government data, we are at peak employment, and employers can’t get enough people.
The patient’s hair is on fire, feet in a bucket of icewater, but the patient’s average temperature is ‘normal’. You find “Help Wanted” signs all around the Bay Area (California) but those jobs pay $10/hr, maybe a bit more, and you have to live with your parents, or you cannot eat. $1000 per month in a shared apartment is typical lowest rent possible. If you get 40 x 4 hours per month (typical, 168 hours x $10 hour, and 60% after taxes =$1000 a month…nothing for food etc!). That explains why employers cannot get enough people. Not enough employees get the “free rent” of living with parents.
Yep! I’m making just about exactly $1000 a month and it only works for me because I’m not paying rent. I also don’t have a car, the diet I’m following pretty much precludes eating at restaurants*, and I’m a pretty thrifty person anyway.
If I lose this place, one possibility is that I rent a small office and “nap” in there during much of the day, and go out and play music or something during the night.
Otherwise, you can find rooms for $600 or so a month here (office can be half that) but you’ll probably find yourself living with the McNosey family.
This chimera of “peak employment” actually fails to account for 16 million “missing” workers, as Jeffrey Snider explains.
“The mainstream always interprets “hard to find workers” as a shortage situation, when that is only one possible interpretation. Since the price of labor over the past decade has barely risen, it isn’t, can’t be, the most likely one.
Instead, there is an unspoken stipulation that is never explicitly stipulated. Businesses are surely finding it difficult to hire good workers at the rate they today want to pay. Obviously, that rate is insufficient so as to clear market demand for supply. Why don’t they pay that market-clearing rate?
Simple. Because unlike how the economy is talked about in the media, the one always derived from the unemployment rate, actual business is sluggish and uncertain at best. There is no rush to find qualified workers because in reality the economy is tight – not favorably tight as in no slack in the labor market, but more so tight in that there is little margin for addition.”
Yup– Jeffrey Snider is EXCELLENT, by the way, in explaining a lot of the confusing economic situation we’ve found ourselves in post-2007.
He has a better grasp on the markets and the economy than 99% of the talking heads out there.
For starters, check out anything he’s written regarding Eurodollar futures– it’s something that is never talked about, but is a better indicator of global financial health / trade than virtually anything else out there.
He did not say wages. he said buying power. increased cost of housing, medical, insurance etc can create less buying power, even with higher wages.
I’ll explain in short how buying power declines by 26%.
With the ACA (obama care) employers have incentive to hire part-time workers pushing those workers to the exchanges. Plus even if these part-timers are renting (not living at home) their costs continue to rise.
So even if Walmart and competitors raise wages to $10 from $8.50.
The employer takes three to five positions with hours 35 + and creates
eight to eleven part-time 5 – 25 hr, 3 – 5 days per week positions. Lowering unemployment, increasing wages and decimating purchasing (buying power).
These young employees are happy to have a job until they have to get insurance and realize their “career” experience and purchasing power is irrelevant. Irregardless of educational level, cause the CEO states that Millennials and younger workers are entering the workforce less educated than the previous generation.
Meanwhile the long term seniority employees can’t figure why there is such high churn of fresh faces while their hours are slowly shaved with a thirty cent increase change from every six months just two years ago to ONE raise of a quarter every year.
But MGT keeps their raises & bonuses rolling in!
To Wall Street and investors: “See our store and company are competitive and profitable.”
Please continue to ignore the fact that the company borrowed more at close to zero interest to pay back previous loans and lines of credit in the ranges of 7 – 16 % interest.
Another reason for so much mall construction- it’s cheap.
Unlike a typical 1000 square foot townhouse, the typical new 1000 square foot lease unit comes with no kitchen, bathroom, windows or doors. It may have no interior walls and if leased new, may have just the concrete foundation as a floor.
In the busiest mall in my city the monthly lease payments are more than the rent of the townhouse, and with few of the residential tenant hassles and tenant friendly law.
The other side of the coin: clean residential units around here can always be rented, even when in not so great areas.
The failing mall in town is half empty and I’ve heard that you can get six months free rent.
“No inventory” retail is what fills vacant commercial space. Typically, nail salons and haircutters, from my un-scientific observation.
My son’s favorite barber shop just closed down. It was a 3 chair storefront. His barber is now cutting hair once a week in a pop up in some tee shirt place and another 2 days in a barber shop in some other town.
fascinating this pop up thing. i was even considering doing a “pop up” garage sale with my stuff because i’m so close to the main drag here, but i’m onto something more epic that i hope to have a story of LATER.
Old Farmer… if you’re here, thank you for that about your $6 soap that you could easily sell for $18 in san francisco as local olive oil soap. everytime i think there’s no santa anymore (i mean COSBY? come ON!), then a few santas pop right up and i must laugh at my faithlessness and cynicism showing like a slip.
Petunia’s right about people tiring of being hustled and wanting to go back to shopping where they TRUST the folks and the food, etcetera.
(she’s the oracle, man and old farmer’s another santa… tell me this site is just about MONEY, people. TELL ME! ha. no writer could make this stuff up that happens here. secrets in plain site/sight.)
Residential construction requires services. Schools, police, ambulance, etc. Retail requires a lot less.
When will it end?
When most big chain stores go bankrupt or get bought by companies wanting to imitate Amazon model. But people won’t like surge prizing so online buying will rise even more.
New York has tons of bubbles, restaurants is one of those, they are so many they barely make any profit. As soon as the crisis hits many will close down.
due diligence for a developer “can I get a loan”
yes it,s all online shopping only the ones in great locations like in florida or duty free places shopping mall with luxury brands or brands outlets will stay in business.brick and mortar is going to do better then shopping malls brands on great shoppings streets or tourist places with a great boardwalk will do great business
The same business model seems to be taking place in the larger towns outside of Bangkok.
All is not lost –
A shopping mall is a brilliant piece of real estate – it has massive parking capability – parking is matter from heaven.
“Our appointment is at 1.pm & we are still driving round looking for a parking spot.”
“How far away are you from our office?”
” We can re-book that appointment for you for next month.”
“But we waited a month to get in today.”
How multi faceted can a shopping mall become ?
The sky is the limit man.
What ever you do do not pull down these complexes – they are for real brilliant.
They can be used for lots of things. It doesn’t take much imagination to figure out how to repurpose a mall into a livable space. The problem is many of these malls are out in suburbia where space isn’t the issue.
They can be used for lots of things. It doesn’t take much imagination to figure out how to repurpose a mall into a livable space. The problem is many of these malls are out in suburbia where space isn’t the issue.”
Detention centers are normally where there is lots of space.
It would be very expensive to convert a typical mall to apartments that met codes and market expectations. There is a reason older hotels, rooming houses etc. had shared bathrooms.
To plumb a mall for individual units you would have to jack hammer a mile of floor. Cheaper to tear it down and then you can add stories.
Converting to an educational institution would be relatively easy.
I live in a small rural community. We have acquired 2 auto part stores beside each other (Advanced and O’Riley’s). A weird trend here is Dollar General and Family Dollar stores are being built in tiny hamlets and towns with very small populations. My hubby and I question whether they will ever recoup the building cost let alone ever get into the black with all of these stores. What in the heck are they doing?
The chains all grown on stock market money. It doesn’t matter if the stores make money or not, they keep expanding until they can’t. The investors think expansion means profits, but it doesn’t, it means more investors.
Destroying all your local family business, that possibly employ some people at a reasonable wage.
When they move out not only will you have no other service providers or suppliers, you will have much higher unemployment as they will destroy all the local business by undercutting in their quest to stay alive, longest.
PA MOM ” A weird trend here is Dollar General and Family Dollar stores are being built in tiny hamlets and towns with very small populations.”
We have this very strange thing happening in our itty bitty town. NEW really big buildings in the middle of no where. One across from a high school, with a cross walk over to it, and nothing else around. Twilight-zone-ish. And the parking lot is huge, with only one or two cars in it….
And there are too many Tractor Supply stores around too…..
One thing missed in this discussion is the growth model of companies that own their stores outright – either the building and land or the building on a long term land lease. Businesses like Walgreens and Rite Aid with thousands of stores are generating much of the growth in their balance sheets not from retail profits, but from inflation of the asset value of their real estate and lease holdings.
Balance sheets improve nicely as the booked value of store property increases. Who cares if the stores themselves are short on business and profits if they can make “money” in real estate. The recent stalled merger of these two bloated corporations involved the closing of a reported minimum of 1,000 stores. It is also reported that the planners of this merger included the revenue to be realized from the sale of the closed stores in their calculations. Whether there is enough future business to support all of this is a big question.
And then there is Amazon. We can be sure that our prescriptions in the future will be ordered by computer and delivered by UPS. As far as the rest of the crap they sell – you can get it all at WalMart or the grocery store cheaper.
Property value on the balance sheet does not increase if its market value increases. The opposite. The value of buildings is depreciated over time to zero. Land is carried at cost and left alone with no change in value.
To book a gain on a property (land and building), the company would need to sell it for a profit.
Most retailers do not own their stores. They lease them from mall landlords. Some chains own some of their stores (Macy’s, Sears, Dillard’s, etc.) and lease the remaining stores.
The activists are really on the case of HBC. Its own valuation of its RE is about $34 a share and the stock is at 11 and change.
So it’s understandable that the activist sees the retail use as secondary. Among other things, the activist wants HBC to add condos to its Saks 5th Avenue location.
The population of china is over 4 times that of America.
china builds Ghost Cities.
America builds Ghost Malls.
They are both fueling a huge segment of their debt funded, bubble economy’s, by building and tearing down, things they simply do not need.
This is simply a variation of the states bridges to nowhere. Japan and Europe (Particularly Spain and Italy) engage and engaged in.
It will end unhappily in America and catastrophically in china. Which will again, as is has many times in the past offload the pain on the rest of the trading economies of the planet.
Right now, the United States has the highest amount of retail space per capita, at about 23. Next-highest on the list is Canada, with about 14. Both of these countries are large land masses with pockets of population density.
Next on the list are England and Australia. But these have closer to 10-11 retail square feet per person. If any of these four nations are normal, then I would expect the rest to move toward that point.
Therefore, either the United States will have to shed plenty more retail space, or the other nations will have to build up.
Guess which way would be the more logical direction?