Retail properties dressed for distress

NEW YORK (Reuters)- For David Simon, chief executive of Simon Property Group (SPG.N), the largest U.S. owner of malls and shopping centers, retail property may be less about dress this year and more about distress.

The credit crisis has made the cost of new loans expensive or impossible for commercial real estate buyers and developers. That could leave some with short-term debt scrambling for loans to complete their projects or hold onto new ones.

"There's a lot of broken projects out there," Simon, who heads Simon Property Group, said during a recent conference call.

Soaring gasoline and food prices and the U.S. housing crisis have forced the U.S. consumer to cut other spending and retailers to reel in expansion plans. Those who own shopping centers are likely to feel a double punch: less demand for space and falling prices of their centers due to higher financing costs for buyers.

Amid the tougher times, thousands of developers, retailers, shopping center owners, bankers and brokers this week will descend upon Las Vegas for an annual convention sponsored by the International Council of Shopping Centers. For two days at RECon they will meet, talk and make new contacts they hope will lead to deals for new shopping centers they plan and tenants they hope to land.

Last year a record of nearly 50,000 people came to the events. But this year, attendance could fall.

So far, commercial real estate has seen vacancies rise mildly and loan default rates have generally been low. But the sector lags the general economy, and many investors and other experts believe the sector will see prices fall about 15 percent to 20 percent from their highs of last year.

"My view of the world is that the markets typically correct from most liquid to least liquid," said Spencer Haber, chief executive of H2 Capital Partners, an alternative investment firm specializing in commercial real estate securities.

Those securities, such as commercial mortgage-backed bonds, first felt the pain because they're most liquid, meaning they can be bought and sold quickly. Loans follow, and finally properties themselves.

"The least liquid thing in the real estate capital markets is the actual property," Haber said.

The retail sector is expected to soften through 2009, according to a report by real estate brokerage Marcus & Millichap. The report, obtained by Reuters, forecasts the overall retail real estate vacancy rate will rise 1.4 percentage points this year to 11.1 percent, after a 0.9 percentage-point increase last year.

Marcus & Millichap sees a 1.9 percent increase in asking retail real estate rents this year to about $20 per square foot, compared with 2.9 percent in 2007. Owners are expected to increase concessions such as periods of free rent, limiting effective rent growth to 0.9 percent.

While demand slows, the supply of new shopping centers is expected to continue to grow, albeit at a slower pace. Marcus & Millichap forecasts about 131 million square feet of new shopping centers should be completed this year, down from 145 million square feet in 2007.

The location and type of shopping center plays a significant part in the expectations for its performance. For example, grocery- or drugstore-anchored shopping centers have an overall vacancy rate of 7.7 percent, well below the overall retail average. Because the stores at these centers carry necessities, they are seen as a defensive real estate investment during an economic slowdown.

HOUSING TO HAMMER SOME CENTERS

Real estate experts said they do not expect to see an overall fallout in retail real estate. But new construction and shopping centers that were either a part of a new residential development or were built to support one may not fare well. Properties in once-hot residential markets of southwest Florida; the California's Inland Empire areas, such as Riverside and San Bernardino; Phoenix; and Las Vegas are of particular concern.

"In some of those markets, what you saw were properties that were built to service a consumer base that never materialized," Haber said.

The big-box retail-anchored power centers, and the open air "lifestyle" centers featuring restaurants and small, trendy shops are expected to come under stress, said Michael Giliberto, JPMorgan Investment Management real estate portfolio manager.

Meanwhile, Simon and other large, well-capitalized shopping center owners could see great deals for new properties appear, as owners of new projects find it hard to lease space at a time when tenants are curbing expansion plans and the values of the centers are falling because of tighter lending.

"There's more lifestyle centers out there for sale than we've seen in the past," David Simon said. "I think the floodgates of that is just going to begin to open ... We're going to end up dealing with the construction lender."

(Editing by Gerald E. McCormick)