The return of strong job growth to the Houston area along with formidable rates of population growth and a reviving residential sector are laying the groundwork for the next upcycle in retailing and retail real estate. “For local retail property owners,” states Marcus & Millichap in its second quarter report on the local market, “these trends will translate into strengthening occupancy, as the bulk of new retail supply this year is either build-to-suit or substantially pre-leased.” Demand aside, there is perhaps no stronger indication of the market’s revival and its renewed optimism than the return of construction, which will bear its first fruits next year as newly started and currently planned projects begin to deliver. While the vacancy rate in the community-neighborhood shopping center market remains elevated, a residual effect of earlier construction despite recent high absorption numbers, its direction is downward. Conversely but favorable nonetheless, the vacancy rate in the power center market has shown recent increases but remains relatively low. Moderate positive rent growth is a factor for both market segments.
Developers confident in demand for their product provided Houston with its active development profile over the years. Elevated community-neighborhood shopping center market vacancy, accordingly, was seldom a deterrent. Indeed, while the slowdown in consumer and retailer demand for goods and space brought on by the recession resulted in higher vacancy rates, the rate had been increasing since 2004. Moreover, vacancy rates were notably higher in the middle 1990s than any produced by the latest recession. The latest peak, in any case, was first quarter 2010’s 13.4% vacancy rate. A descent soon began. By the end of the second quarter of 2012 the rate had decreased to 12.6%, down 10 basis points for the quarter, down 20 year-over-year, yet still notably higher than the 10.8% second quarter national rate for this product category. Additional declines are expected for the local rate for year-end and after, as the downward trend continues.
Despite recent increases, comparison with national vacancy rates is more favorable for the local power center market, which remains tight. Reis put the second quarter rate at 5.2%, up 70 basis points for the period, up 40 year-over-year, yet still below the 6.3% second quarter national power center rate. For retail generally, Marcus & Millichap expects “tighter conditions,” particularly in choice submarkets such as northwest suburban Montgomery County and southwest suburban Fort Bend County to “allow owners to pare concessions.”
SUPPLY AND DEMAND
The local community-neighborhood shopping center market passed through the recession’s slowdown period and its sluggish aftermath without suffering a single instance of annual negative net absorption (2006 provided the market with its last sub-zero total). From 2004 through 2009, however, demand trailed new supply as vacancies rose and rents, eventually (beginning in 2008), softened. Construction, accordingly, slowed as well. Following the delivery of 635,000 square feet of community-neighborhood sector space in 2011, only 19,000 square feet delivered through the first half of 2012, in a single project in the River Oaks/Innerloop NW submarket in February (see Submarkets). Net absorption through the first half of the year, regaining the lead following a minor setback in 2011, ran substantially ahead at 340,000 square feet. Demand should maintain the advantage.
The 156,000 square feet of product in this category expected to deliver all told in three projects in 2012 will be accompanied by net absorption at 724,000 square feet, which would be the largest net absorption total recorded by Reis for this market since 2007. Moreover, the excess of net absorption over same-year new supply projected for 2012 would be the largest since 1999. Per the date of this report, only one project in this category, a 203,100-square-foot neighborhood center in Katy, was underway for delivery in 2013. Others, however, are likely as well. Meanwhile, Reis reports approximately 1.3 million square feet of community-neighborhood shopping center space in the planning-proposal pipeline.
Interestingly, construction totals for other product categories, including large-format projects, are small, despite the buoyant local economy and the strength of retail underpinnings. Marcus & Millichap refers to a “dearth of new construction.” “An expanding development pipeline,” however, “points to further acceleration in 2013 and beyond.” As noted in the Submarkets section of this report, a number of substantial developments, particularly in the suburbs, have recently started or soon will be underway, including the 350,000-square-foot Tanger Factory Outlets development in far southeast suburban Texas City, which broke ground in the third quarter of 2011, and 360,000 square feet of retail in two mixed-use developments in west suburban Katy, which started in July 2012. Included, are at least four major master-planned developments with substantial retail components now making their way through planning phases. Power center development, despite the favorable occupancy profile in that sector, remains subdued. Only 137,900 square feet in two power center expansions were underway per report date. A third, at 32,500 square feet, completed in July 2012.
Positive growth, albeit in modest proportion, has returned to average community-neighborhood shopping center lease rates. At $15.95 psf and $13.69 psf, average asking and effective rents were each up 0.3% for the period, following gains of 0.4% the quarter before, thereby exceeding the 0.6% and 0.5% increases recorded, respectively, for all of 2011. The gains in the vicinity of 1.5% projected for each, for the year as a whole, would stand as the greatest since 2007. Reflecting favorable occupancy and the recent backfilling of spaces emptied earlier, the $22.59 psf average asking lease rate for non-anchor power center space for the second quarter was unchanged from the quarter before but was up 0.8% year-over-year. The ongoing tightening of retail generally should allow landlords to “pare” rental concessions in the period ahead, comments Marcus & Millichap.