June 30, 2009

By George Ratiu, Research Economist

The retail sector is trying to regain its footing due to the low level of consumer spending. During the first quarter 2009 consumer spending posted a 0.3 percent increase from the fourth quarter of 2008. However, compared with the first quarter 2008, spending was down 0.2 percent. Much of the first quarter 2009 spending was focused on motor vehicles and parts, electricity and gas, as well as gasoline and fuel oil.

At the same time, consumers continue to be wary of spending given the rising levels of job losses. Payroll employment declined 3.1 percent during May 2009, pushing the unemployment rate for the month to 9.4 percent. And while prices for certain goods have declined, gasoline prices have been rising steadily since the $40-per-barrel achieved in February 2009.

For the time being, consumers continue to be cautious about prospects for an upcoming recovery. Consumer confidence has been trending upward from the low of February 2009, when The Conference Board’s Consumer Confidence Index hit a low of 25. Yet, the University of Michigan index of consumer expectations dipped four points this month.

Considering the economic uncertainty and consumer reluctance to spend, retail businesses continue to scale back their operations, close stores and even go bankrupt. The latest bankruptcy filing by Eddie Bauer brought the issue to the forefront.

Demand for retail space, as measured by net absorption, is expected to drop by 9.4 million square feet during the second quarter 2009. On the supply side, completions of new retail space dropped during the first quarter of the year, but are expected to pick up slightly during the second quarter. Consequently, vacancy rates are rising and expected to hit 12.0 percent in the second quarter, 27 basis points higher than a year ago. The retail vacancy rate is estimated to jump to 13.3 percent by the end of the year.

Regionally, Midwestern cities are feeling the steep decline in the employment base. Detroit, Columbus, Indianapolis, Cincinnati and Cleveland are part of the top ten metro areas with the highest retail vacancy rates. With a couple of exceptions, coastal and Western markets are posting lower availability rates. For the second quarter 2009, Honolulu and San Jose are tied with the lowest vacancy rate, at 5.8 percent. San Francisco, Orange County, Salt Lake City and Long Island also post lower vacancies.

As a result of rising vacancies and store closings, average retail rent is declining. Rent growth is expected to decrease 0.6 percent in the second quarter 2009. For the year, rent growth will likely post a 2.1 percent drop.

Looking ahead to the second half of the year, the retail sector is likely to continue struggling through a difficult environment. Job losses are forecasted to increase. Faced with rising delinquencies, banks have been increasing their policies of reducing or eliminating revolving consumer credit. A sustained improvement in residential housing could provide a much-needed boost to consumer confidence, which in turn, may bolster retail spending.