WESTERN SNAPSHOT, OCTOBER 2007

Sacramento Retail Market

Sacramento’s underlying retail strength, coupled with its likely long-term demand, will continue to entice investor interest. While much of the country is experiencing growing cap rates, Sacramento continues to see cap rates average in the low 6-percent range. The sustained rates can be attributed to the annual double-digit price appreciation during the last few years and the difficulty to build quality retail projects.

The Northern California retail region continues to keep developers and national retailers interested in the Sacramento market due to the incessant population growth and low unemployment rate. The four main growth areas that continue to dominate the leasing sector include Folsom, Laguna/Elk Grove, North Natomas and Roseville/Rocklin. The submarkets of Lincoln, West Sacramento, El Dorado Hills and Woodland have also experienced strong development activity.

On the flip side, the Sacramento retail market has felt an impact the last couple of months due to a downward shift in the CMBS (Commercial Mortgage Backed Securities) market. Consequently, it has been extremely difficult for buyers to obtain financing for new acquisitions. The pricier financing has translated to more properties available for sale, and buyers having more options from which to choose from, ultimately putting downward pressure on prices.

Compounding the problem is the impact that the residential subprime meltdown is having on consumers and, consequently, retailers. Particularly hard hit are newer projects with top-of-the-market rents, where tenants are struggling to squeeze out a profit with the high rent and common-area maintenance charges. Tenant defaults are up, and landlords are finding they must reduce rents to replace tenants.

Sacramento’s mid-year vacancy rate is 6.6 percent, up from the 6.1 percent in first quarter 2007. The increase in vacancy is directly related to the over-supply of new construction being delivered and the shrinking tenant demand. The Sacramento retail sector currently has 2.7 million square feet under construction and 3.3 million square feet in the planning stages. West Sacramento reported the lowest vacancy rate at 2 percent while Hwy. 50/Rancho Cordova had the highest vacancy rate at 15.5 percent.

Even with the increase in total market vacancy, average rents continue to increase and activity is steady in terms of total leasing volume. Average rental rates for newer centers in high-growth areas currently range from $2.25 to $2.75 per square foot, and in some cases reaching north of $3 per square foot, NNN. Infill centers in established areas averaged $1.75 to $2.25 per square foot, NNN.

Currently, 19 projects are under construction in the Sacramento area, totaling more than 2.7 million square feet, of which approximately 65 percent of the construction activity is pre-leased. The Lincoln submarket represents the most square footage with more than 740,000. A great bulk of that planned retail is Saca Development’s Lincoln Crossing, a 470,000-square-foot power center anchored by Target, The Home Depot, Staples, PetsMart, T.J. Maxx and Ross Dress For Less. The Roseville/Rocklin submarket follows Lincoln with 600,000 square feet under construction.

Several notable projects currently under development include Inter-Cal Real Estates’ The Fountains in Roseville. The locally based company is developing an approximately 390,000-square-foot lifestyle center on the corner of Galleria Boulevard and East Roseville Parkway, directly across from the Roseville Galleria. Tenants projected to lease space at the site include Whole Foods Marketplace, Z Gallery, Orvis and LL Bean.

Another significant development in Roseville includes Westfield Properties expansion of the Roseville Galleria, adding 400,000 square feet that will include an expanded Sears, Macy’s and JC Penney, as well as 100 new stores of higher-end retailers such as Burberry, Kate Spade and The Apple Store. Reports have been circulating that Neiman-Marcus, Louis Vuitton and Tiffany & Co. will also be joining the tenant list at the Galleria once completed.

In downtown Sacramento, there will be increased buyer interest as several high-end multifamily projects are either under construction or planned, increasing the population of affluent residents. National developer Thomas Enterprises Inc. plans to redevelop the old Southern Pacific yard north of downtown that will include as many as 10,000 new homes. The 240-acre “The Railyards” project will also include retail, offices, a hotel and an entertainment center.

Due to strong market performance fueled by residential growth and historically low financing options, the Sacramento market has experienced a large amount of investment capital targeting retail properties. In the past 5 years, more than $2.5 billion has been invested in the Sacramento retail market. Strong market fundamentals have attracted some of the nation’s most aggressive retail buyers, which include Kimco, Lahka Investments, Weingarten Realty, Donahue Schriber, RREEF, Westwood Financial and Regency Centers.

Doerken Properties, based in Santa Monica, Calif., recently acquired three shopping centers from Kimco Realty Group totaling $64 million. The properties include two shopping centers in Sacramento, a 132,630-square-foot Kmart Center on Stockton Blvd. and Glenbrook Shopping Center, a 69,230-square-foot center on La Riviera Drive. In Folsom, Commonwealth Square, the largest center, sold for approximately $38.5 million.

Saca Development’s Elk Grove Marketplace, a newly constructed 188,000-square-foot community center anchored by Toys “R” Us, Sport Chalet, Jo Ann Fabrics & Crafts, Grocery Outlet and Pet Club, recently sold for approximately $40 million to a private capital buyer.

The Sacramento retail market is projected to close out strong in 2007 and will continue to be a very diverse and competitive market for developers and national retailers in 2008. By year-end 2007, the delivery of new retail space will once again outpace absorption. Despite the rise in vacancy, delivery of new space will continue to push rents higher. Approximately 1.5 million square feet of retail development is projected to come online by the end of 2007.

Julia Danner Oberg, Jon Gianulias, John DuBois, Mark Denholm and Erik Litvinchuk are based in CB Richard Ellis’ Sacramento office.

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