The confluence of sobering economic conditions has officially reached the retail sector. So much so, that it has become difficult to track the steady flow of dismal news over the past few months. Whose stock is plummeting? Who’s filing for bankruptcy? Who’s closing stores? Energy and commodity prices; consumer spending and confidence; the value of the dollar have all taken their toll on the retail sector, in particular.

The almighty consumer has been pushing retail to new heights over the past decade. New concepts and stores opened and expanded at a rapid pace, even at the expense of diluting the brand and quality of product or service. Both venture capital firms and Wall Street are significant contributors to this excessive “over-expansion,” which became most apparent on July 1 of this year when Starbucks announced 600 store closings and approximately 1,200 non-store job cuts. It is an unprecedented shift for such a well-known brand and seemingly recession-proof category such as coffee.

A short-sighted view on quarterly earnings and profitability significantly eroded the concept of long-term growth and perspective on re-tailing – and the result is evident. In the past year, companies such as Ann Taylor, Foot Locker, Children’s Place, Pier 1 Imports, The Gap and Massachusetts’s own Talbots have announced substantial retail store closings in the wake of considerable increases in retail rents, cost of goods, transportation of those goods, and labor. Other household “big box retailers” such as Circuit City and Linens ‘n’ Things that had flourished over the past decade recently announced significant store closings and cutbacks on expansion.

Is Hub Still The Hub?

So how does the current economic condition affect Boston retail real estate? For one thing, retailers are more cautious than ever when considering and selecting new locations. A domino effect from the stagnant debt markets and housing slump is now being felt – whereby retailers are experiencing difficulty financing their expansion plans and must cut back and adjust their balance sheet to meet profit expectations. Naturally, store closings will follow, most of which will be in underperforming or overlapping stores in tertiary markets across the country.

Many retailers have depended on a customer base that was living above their financial means for the past few years. In a recessionary period, those retailers products or services could become expendable. For high-end retailers such as Valentino and Gucci, sales may be less affected in a market like this because those consumers have an abundance of disposable income.

Many middle-income consumers spent the past five years buying, selling and upgrading their home furnishings, and likely extracted equity from their home to do so. With that trend coming to an abrupt end in 2008, there is less disposable income with which to buy many of the goods and services that these retailers provide. Consequently, home furnishings companies like Domain, In-Home Furnishings and Dovetail have all closed retail locations in the Boston area in the past year.

Corporate Strategies

It is prudent, however, to differentiate the effect of macroeconomic trends from isolated corporate decision-making. Prior to current economic conditions, Massachusetts-based retailer Tweeter was well on its way to shutting down its retail operations due to “Category Killer” competition from Best Buy and Circuit City. Another local brand – Cambridge Soundworks consolidated its retail locations in high rent / high traffic areas in favor of online operations, while maintaining one retail store in Newton. Both concepts made strategic decisions based on the retail electronics sector’s evolution rather than larger consumer-driven reasons.

The recent Chapter 7 filing of Bennigan’s and Steak & Ale, which will result in almost 300 restaurant closings, illustrates more about the concept than the economy. Starbucks, one could argue, is as much at fault for its strategic over-expansion as consumers for dropping that daily $ 4 cup of coffee from their budget. There are also concepts that just didn’t take off – like Steve & Barry’s, a company that started out selling low-cost items targeted at teenagers and college students. Since its opening in 2005, Steve & Barry’s leased 3.5 million square feet of space in shopping centers across the country, including eight Massachusetts locations. Just three years later, the company has defaulted on its loans to General Electric’s Commercial Lending unit and filed for Chapter 11 Bankruptcy protection, laying off almost 200 employees. In a more conservative retail market, it is difficult to surmise how a retailer with no product in its stores in excess of $10 could fall from grace so quickly. Interestingly, a significant portion of reported profit early on was due to considerable cash payments made in the form of tenant improvement allowances and rent abatements from landlords desperate to fill large vacancies in their shopping centers. Unfortunately, once the dust settled, profit margins shrunk as sales floundered – and the bankruptcy filing fol-lowed.

Building Owner Blues

Landlord consolidation has yet to contribute to the problem – but that time may be approaching. Over the past few years, institutional investors have spent heavily on completed retail projects in the Boston area. Some over-inflated purchase prices were based on projected retail rents that were assumed for revenue projections but are no longer achievable in this market.

It is extremely difficult for any retail operation to be successful when sales activity is slow and real estate, gasoline and labor costs are skyrocketing. This “disconnect” between what landlords must achieve and what tenants can afford to pay is evident in the slowdown in retail leasing activity, even in downtown Boston. Large mixed-use projects with planned first floor retail are having a difficult time pre-leasing their space in this environment – even for service-amenity type tenants. As vacancy and store closings rise, landlords will become wiser with respect to a tenant’s brand viability and credit rather than the base rent.

While there may not be further excessive expansions in Boston like Starbucks and Steve and Barry’s anytime soon, the area’s retail landscape will keep plugging along, adapting to ever-changing economic conditions.

There are several reasons for the resiliency of Boston’s retail market. First, retail development is extremely difficult to re-zone, permit and build in Massachusetts, let alone Boston. Further, the area’s physical limitations, topography and environmental issues keep over-expansion of retail at bay when compared with other major metropolitan cities such as Chicago and Los Angeles

Even in the challenging economic environment, new projects are still being permitted and are under construction. Construction began recently at W/S Development’s Legacy Place in Dedham and the project is almost 100 percent pre-leased. Whole Foods, Ruth Chris Steakhouse, and Apple, who have all committed to Legacy Place, continue their expansion plans for dense, wealthy submarkets undeterred by shaky economic conditions. Nordstrom opened two of its four planned locations in the Boston area – Natick and Burlington — in the past year. Those opportunities originated from the Federated/May consolidation in 2006 and are also in conjunction with overall up-grades in mall tenancy.

Apple recently opened its flagship store on Boylston Street in Boston’s Back Bay to complement its suburban locations. The three-level glass structure is the largest Apple location in the country, where sales are projected to be $100 million annually. Newbury Street rents continue to increase with national tenants such as Best Buy and international boutique retailers such as Zara flocking to the Back Bay.

In summary, there has been an extraordinary amount of negative news for retailers in 2008. Many economists and real estate experts are unsure as to when things will get better. There are positive signs that metropolitan Boston, with its strong foundation of educational institutions that attract hundreds of thousands of young student-shoppers every year, is to some extent isolated from the uncertainty across the country. More and more students and visitors are coming from abroad, where the weak U.S. dollar has inflated their buying power.

Tourism is major component of the area’s resiliency – which grows into the tens of millions of visitors each year. With that being said, Massachusetts tends not to over-build even in times of economic prosperity and thus the area has not yet reached its potential for high-quality retail. And while those retailers and restaurants are still looking to expand in the Boston metro area, continued instability in the credit markets and macro economy could mean that some larger projects get pushed back months, even years.