SOUTHEAST SNAPSHOT, NOVEMBER 2008

Orlando Retail Market

Recent Wall Street woes and weakness in the global financial system has worsened the credit crunch, further limiting the availability of credit to private and institutional real estate investors, businesses and consumers in Orlando. The Fed’s recent plan to infuse $250 billion into the nation’s largest financial institutions — including Citigroup, Morgan Stanley, Goldman Sachs and J.P. Morgan Chase & Co. — could spur a faster economic recovery by providing more liquidity into the nation’s banking system. As a result, borrowers seeking loans may be able to access acquisition financing for real estate transactions sooner than anticipated.

Despite ever-tightening lending standards, best-of-class retail assets are able to garner financing at around 300 basis points over the 10-year Treasury. Lending rates are up roughly 40 basis points from before the Lehman Brothers and Merrill Lynch announcements for less-desirable retail properties, with the average currently around 345 basis points over the 10-year Treasury.

Long-term projections for significant population and employment growth in the Orlando metro area remain unchanged, although retail property fundamentals are softening due to sluggishness in the housing and employment markets. Retailer closures and fewer new store openings produced a subdued level of space absorption during the first 6 months of the year. New properties also continue to come online, typically with large amounts of space unoccupied. Clearly, retailers are adjusting space requirements in response to slower consumer spending than only a few quarters ago. This more muted spending will likely persist over the remainder of the year due to the adverse effect of sub-par job creation on incomes, and space demand will wane as a result. Spending by tourists, however, will help sustain customer traffic at local restaurants, shopping centers and other properties.

Below-trend employment growth will persist in the near term. This year, employers in Orlando are forecast to add 2,000 jobs, a 0.2 percent gain, but this is still down from the creation of 11,200 positions in 2007. Developers are expected to complete 2.9 million square feet of new retail space in 2008, compared with 3.8 million square feet last year. Looking ahead, 2.4 million square feet is under construction and slated for delivery during the next 2 years. Sluggish demand and slower leasing activity will underpin a 170 basis point increase in vacancy this year to 9.8 percent. In 2007, the average rate rose 160 basis points. This year, asking rents are forecast to inch up 0.8 percent to $18.79 per square foot, and effective rents will drop 0.7 percent to $16.57 per square foot, due to easing demand.

As buyers and sellers continue to adjust to new standards affecting acquisition financing, investment activity has slowed. Although deal flow is down, new shopping centers in emerging trade areas are generating investor interest, listing at cap rates in the 7 percent range. Older multi-tenant properties are still trading, but closer attention is being devoted to near-term vacancy rates and demographics. The median price of multi-tenant properties sold in the last year was $124 per square foot. Since attaining a peak of $147 per square foot 2 years ago, the median price has fallen 16 percent. On the single-tenant side, out-of-state buyers are active in deals involving drugstores and freestanding assets leased to national-credit tenants. The median price of single-tenant assets sold in the past year was $281 per square foot, down 5 percent from the previous stretch. During the most recent span, the median price of restaurants remained unchanged at $311 per square foot. Sales of bank branches have also gained traction during the past few quarters. In the months ahead, investors may want to seek restaurants or convenience stores located near limited-service hotels. With cost-conscious travelers trading down to lower-priced accommodations that often do not offer food service, nearby retail properties may post strong operating results.

The current real estate environment is marked by a flight to safety, constrained capital and economic weakness, which combined are putting pressure on property values. Lenders are increasing equity requirements as concerns regarding defaults and declining property values increase, adding further pressure to the commercial real estate market. However, when setting price expectations in today’s market, investors would be well served to consider the difference between true distressed assets, such as those being disposed of by struggling financial institutions, and Main Street assets that continue to generate relatively healthy cash flows. With this new infusion of capital into the banking system, an economic and real estate recovery might occur faster than many pundits expect, which is good news for both out-of-state and local real estate investors.

— Nicholas E. Ledvora is a senior associate in the Orlando office of Marcus & Millichap Real Estate Investment Services.

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