After declines in 2001 and 2002, construction starts for stores and shopping centers turned positive in 2003 with a 10 percent rebound. In 2004, starts gained another 4 percent to reach 293 million-sq.-ft. Despite the general strength of the 2005 economy, however, this year's retail construction starts will not continue the rally. Instead, retail starts will ease back 1 percent to 290 million-sq.-ft. While this is only a modest decline, and the level of activity remains quite robust by historical standards, it is not the usual events that are leading to this year's deterioration. Rather, it is the tight concentration of construction activity among just a few of the largest U.S. retailers that is causing concern. Because these retailers are—or will be—increasingly facing pressure to slow their expansion, construction too is expected to feel that stress and will ease in response.



Construction activity too concentrated?

In 2004, the retailer with the largest amount of new construction starts was—to no one's surprise—Wal-Mart. According to hand calculations from the McGraw-Hill Construction database of starts, Wal-Mart broke ground on 364 projects, and added 52.3 million-sq.-ft. of space at a construction cost of nearly $2.2 billion. No other retailer came close to this amazing amount of activity. Of course, with $228 billion in revenue during 2004, only Wal-Mart could afford such a spending spree.

In second and third place among retailers were arch rivals Lowe's and Home Depot. Lowe's started 139 projects, adding 21.5 million-sq.-ft. of space at a cost of $810.4 million. Not to be outdone, Home Depot started 138 projects, which added 13.8 million-sq.-ft. of new space at a construction cost of $720.4 million.

Rounding out the top five were Wal-Mart competitors Target and Kohl's. Target started 71 construction projects, which added 7.4 million-sq.-ft. of space at a cost of $445 million. Kohl's broke ground on 55 construction projects, which added a combined 4.4 million-sq.-ft. and totaled $298 million in construction costs. (Note that all of these projects include some amount of alteration work, which does not add net, new square footage. As a result, you cannot compute cost per square foot measure from these figures.)

Combined, these retailers were responsible for nearly 100 million-sq.-ft. of space added—or fully one-third of total retail construction activity in 2004. Because activity is so concentrated among only a few of the largest U.S. retailers, retail construction lies in a precarious position. If any of these three to five retailers significantly cut construction activity, total retail construction would slump sharply. And, for the top three retailers, that eventuality is not out of the realm of possibility.



Wal-Mart under pressure

Wal-Mart, for example, is under considerable pressure in California and elsewhere where local communities are fighting hard to keep out the retailer. These communities are concerned that Wal-Mart's lower wages (relative to what competitors are often paying) could drive the competition out of business, inhibiting the local community's economic growth. As Wal-Mart saturates the most lucrative markets in other parts of the country, it may face difficulties in finding new locations that both meet its needs and don't restrict entry. That could slow its pace of expansion in the United States, and/or force it to look more to foreign markets for its expansion needs.

And, despite the fact that it remains the largest U.S. corporation (in terms of revenue), Wal-Mart is facing increased pressure from higher expenses, slower growth and profit that is increasingly coming from non-core activities (such as MoneyGram, its check-cashing service). Some Wall Street analysts are increasingly concerned that Wal-Mart may not be able to maintain its pace of growth due to operating expense pressures such as higher wage and utility costs and rising healthcare expenses.



Home Depot and Lowe's at their peaks?

The second tier of retailers expanding and renovating stores in the United States (Lowe's and Home Depot) are also facing more troubling times ahead. Both retailers have dominated in growth largely because of the historically low interest rates that have encouraged extraordinary levels of housing starts and home sales. Even where homes do not change hands, cash-out refinancing has enabled homeowners to upgrade and remodel their homes at an unprecedented rate, generating a considerable amount of business for these two retailers.

But interest rates are now rising—and are expected to climb through 2005. Moreover, housing starts and home sales have reached new historic levels for two consecutive years—and may not have much more room to grow. Higher interest rates could significantly curtail the growth prospects of these retailers. If that occurs, expansion plans may inevitably slow along with softening home sales and remodeling activity.

On the positive side, one of the more interesting aspects of the retail industry is that change—with all the chaos that it can create—often ends up as a good thing for construction activity. Change can mean that old formats no longer work and must be replaced with new ones. Change can mean that two competitors are now one, and must look like one. Change can mean that retailers are always looking for a new concept to drive sales. And ultimately change will mean that, even if construction levels fall from the currently robust activity, they will not fall far.