Despite General Real Estate Rebound, Outlook for Retail Properties Off

Though rapid economic growth has propelled demand for all kinds of real estate, the prospects for some properties are radically different.

The multifamily sector is in solid shape, and the office market is full of opportunity.

But supply and demand are still out of balance in the retail sector, market experts said at the Mortgage Bankers Association's commercial real estate finance and multifamily conference here this week.

Industry leaders stressed that economic forces that have fueled real estate growth are bound to contract in the near term. Therefore, lenders should carefully examine the varying supply-demand dynamics across property types, they said.

"Over the last five years growth has been well dispersed around the U.S., and most markets have participated in the real estate recovery," said Tony Pierson, managing director of research for Cigna investment management, Hartford, Conn.

"Over the next five years it's going to be very difficult to replicate that growth," he said.

But there is still room for lenders to finance new construction, especially in the office market, said Jeanette Rice, vice president of research at Amresco Inc. of Dallas. She said she expects occupancy rates to rise 1.5% in the near term and rents to climb by 5% on office properties.

"It has been the most exciting story for the last two years and will continue to be for the next two," Ms. Rice said.

Demand for office space is spilling from the suburbs into downtown areas, she added. But Ms. Rice urged lenders to proceed with caution.

"Pent-up demand provides good opportunity now, and there is still room to play market recovery," Ms. Rice said. "The first round of office development will see good absorption, but the subsequent building may produce oversupply."

Retail properties, on the other hand, face what Mr. Pierson called a "different and difficult situation."

Construction started on 250 million square feet of new retail space in 1997, though the market is already 30% "over-stored," he said.

With vacancy rates flat and rising, and the Asian population shifting its spending habits, the outlook is not good.

Indeed, J.C. Penney recently announced it would close 79 stores.

And Egghead Software said it would shutter all its stores and sell its product exclusively on the Internet.

But real estate adviser Paul Sack, president of Paul Sack Properties, San Francisco, said there are opportunities for new retail space.

Class A regional malls, where sales are rising faster than inflation, are still an excellent investment, Mr. Sack said. In class B malls, however, vacancy rates are at 15%, and owners are competing for tenants and having difficulty getting rents up. Class C malls, where vacancies have reached 25%, are a "terrific problem," he said.

In the group of "big-box power centers," which house tenants such as KMart and Circuit City, "we are starting to see a shake-up," Mr. Sack said. If those companies experience problems and go out of business, their spaces will be difficult to convert for other uses.

The multifamily sector has had steady, stable growth in the face of adverse demographic trends. On the supply side, construction risk has risen steadily since 1992, and "it is a concern going forward because it doesn't take a lot to overbuild," Mr. Pierson said. On the demand side, the number of renters ages 25 to 35 has continued to decline every year since 1992.

Nevertheless, vacancy rates have held steady in the multifamily sector, partly due to the growth of lifestyle renters and single-family households resulting from divorce.

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