| COVER STORY, DECEMBER 2011
BROKERS OUTLOOK 2012
Brokers (and one lender) offer their insights into specific Texas markets for the new year.
Compiled by John Nelson
Texas has been quickly recovering from the recession with booms in the energy sector and job growth in general. According to the U.S. Bureau of Labor Statistics, Texas has gained 248,500 jobs from September 2010 to September 2011.
In addition to the job gains, Texas has been active in commercial real estate with high-profile acquisitions and healthy leasing in several markets. Likely the biggest commercial real estate news out of Texas in 2011 is the construction of ExxonMobil’s new campus in The Woodlands. Although the approximately 3 million-square-foot campus won’t be delivered or occupied until 2015, the development has been the talk of the commerical real estate office market since the announcement.
While in the process of recovering from the recession, Texas has garnered national attention for its economic potential. Site Selection magazine named Texas the state with the best business climate in 2011. Also, CNBC ranked The Lone Star State as the Number 2 state to do business.
One of the bigger honors the state received was having four cities named in the “Top 20 Markets to Watch” in Urban Land Institute and PricewaterhouseCoopers’ 2011 Emerging Trends in Real Estate report.Austin, Houston, Dallas and San Antonio were included in the Top 20 as both commercial real estate investment prospects and development prospects.
With 2011 being such an impressive year for the state, industry professionals have decided to look ahead to 2012 and all of the exciting opportunities it has to offer. Leaders from Marcus & Millichap, Beech Street Capital, Jones Lang LaSalle and Grubb & Ellis Co. have given their analysis of different markets in which to watch out for in the new year.
Broker Outlook: Texas Hospitality
A strong statewide economy is stimulating greater business and leisure travel, placing the Texas hospitality market firmly on track for a sizable gain in hotel occupancy this year. The projected increase and modest gains in key profitability measures will occur primarily as a result of the positive effects of substantial job growth on room demand. Approximately one in seven new jobs created nationwide during the first three quarters were in Texas, with the Dallas and Houston markets combining to add more than 120,000 positions year to date. As a result, weekday occupancy continues to rise in Dallas and Houston as employers’ travel budgets loosen and additional business meetings and trips occur. Weekend occupancy is also up in the state’s major markets, reflecting an increase in leisure travel. Additional gains in occupancy loom in 2012 as employers throughout the state expand. Potential improvement in the national housing market may also strengthen relocation-related room demand. Relocations from other areas of the country to Texas typically require the use of hotels as temporary or transitional housing.
Employment gains are forecasted for Texas through the end of the year and into 2012. The Dallas and Houston markets will add 70,000 and 87,000 positions, respectively, by year’s end, and more than 170,000 combined positions next year. Statewide occupancy year to date through September was 60.4 percent, representing an increase of 440 basis points from the corresponding period in 2010, and the highest level in three years. Nationwide, the occupancy rate was 61.6 percent in the 9 months ending in September, a gain of 270 basis points from 1 year earlier.
Year-to-date, room demand in the state has increased 9.7 percent, due partly to a 10.9 percent jump in the large Houston market. Over the same period, nationwide room demand surged 5.3 percent. Developers are building in Texas, however, as available rooms (supply) rose 1.7 percent year to date, more than the 0.7 percent increase nationally.
Dallas and Houston posted strong year-over-year daily occupancy increases during the third quarter. Occupancy during the Tuesday-to-Thursday period in Dallas, for example was nearly 63 percent during the third quarter this year, up from less than 60 percent last year. Houston also posted strong occupancy growth in the midweek period, and averaged nearly 53 percent occupancy on Fridays and Saturdays. In the third quarter last year, occupancy on those days slightly exceeded 50 percent.
Strong room demand is improving profitability measures in Texas. Through September, room revenue increased 13.1 percent statewide, compared with an increase of 9.1 percent for the entire country. Texas was one of only two states to record double-digit year-over-year increases in room revenue in each of the first 9 months of 2011. Thus far in 2011, the statewide average daily rate(ADR) has climbed 3.1 percent to $86.33. Property owners in the state have not leveraged a significant increase in room demand, resulting in a smaller increase in the state than has been recorded nationally. Nationwide, the year-to-date ADR of $101.45 was 3.6 percent more than 1 year ago.
The rise in room revenue far exceeded the increase in available rooms, yielding an 11.2 percent jump in statewide RevPAR to $52.15 so far this year. The national RevPAR rose 8.3 percent over the same period. Within the state, RevPAR in Dallas and Houston climbed 13.3 percent and 11 percent year to date, respectively.
Recovery in Operations Spurs Investment Sales
The investment market in the state also continues to gain momentum as the recovery in property operations improves and access to acquisition financing widens. Pricing trends, however, remain challenging to discern due to the state’s nondisclosure status. Texas offers plentiful opportunities to prospective investors, including a deep stock of properties in major metros and assets in other locales that benefit from strong local demand generators such as major employers or colleges. Hotels on interstate highways are also numerous, as Texas has more miles of interstate highways than any other state. Investors will continue to carefully assess the recent performance of potential acquisitions, focusing on the strength of the property’s demand generators and revenue trends. Global events have encouraged buyers to move more deliberately over the past 90 days, and investors will focus on assets with strong brand affiliations in solid locations. Distressed assets will also provide opportunities to purchase properties at less than replacement cost. Lenders are increasingly acting to dispose of troubled properties due to the continuing resurgence of buyer interest.
— David Luther, national director of the National Hospitality Group (NHG), Marcus & Millichap Real Estate Investment Services
Broker Outlook: San Antonio Retail
San Antonio’s retail market remained relatively stable in 2011 amid uncertainty in the economy and a softening in consumer confidence.
As of November, the 45.5 million-square-foot retail inventory in San Antonio had an occupancy rate of approximately 89 percent. In the first three quarters of 2011, the retail market experienced roughly 216,000 square feet of positive net absorption, CoStar’s data shows. The underlying stability of the local economy eased retailers’ trepidations and gave them enough confidence to move forward with expansion decisions. Some anchor and free-standing buildings that had been sitting vacant for some time are now being occupied and witnessing positive absorption. Examples include RoomStore, which took occupancy of two anchor spaces previously vacated by Lack’s Furniture, and Staples, now occupying the former Academy Sports + Outdoors at 7555 N.W. Loop 410. The dominant local grocer H-E-B built three new stores and have at least one additional store slated for completion in 2012. Additionally, Ross Dress for Less opened a new location, and Baskins Western Wear has entered the San Antonio market with a store in The Forum at Olympia Parkway. Restaurants active in the market include Cheddar’s Casual Cafe, Logan’s Roadhouse, Saltgrass Steak House, and LongHorn Steakhouse. Several fast food restaurants have also expanded their local presence by adding new restaurants.
New shopping center construction is primarily anchor driven. Few developments are under way and active projects include Terrell Plaza, a 228,000-square-foot redevelopment. Set to deliver in 2012, the project will feature a new 138,000-square-foot space occupied by Target and 90,000 square feet of additional small shop space. Bulverde Marketplace, a 150,000-square-foot center located at the intersection of Loop 1604 and Bulverde Road, is under construction and is projected to open in 2012.
Asking rents for retail space in San Antonio have begun to stabilize, averaging $18.20 per square foot, but tenants still have the upper hand in negotiations. The only exception is in well-located, Class A projects, which continue to garner significant interest. A large percentage of Class B and C properties are targeting mom-and-pop type tenants, who still hold quite a bit of bargaining power due to the abundance of available small space. Looking ahead, San Antonio’s continued influx of residents, the deleveraging of consumer debt and limited new construction will continue to benefit the local retail market, which is shifting towards a better balance between landlords and tenants.
— Cynthia Ellison, CCIM, senior vice president, Retail Group, Grubb & Ellis Co.
Broker Outlook: Dallas data centers
In 2011, the U.S. and international data center markets witnessed tremendous growth as a result of increased consumer and business demand. Growth in capital markets activity allowed businesses to make real estate decisions, which released years of pent-up demand at a higher volume than we have seen in years. With the new and existing capacity expected to open doors for consolidations, relocations and technology overhauls, shifts in both the public and private sectors will continue in 2012.
Estimates show that before January 2012, more than half of the Fortune 1000 companies will have increased total IT spendings by at least 5 percent. Specific spending falls into various infrastructure components, including servers, software, support cloud and virtualization. As power consumption and IT investments continue rising in 2012, energy will become one of the biggest market drivers because today’s users are increasingly concerned with power redundancy, capacity and cost.
Regional highlights
According to Jones Lang LaSalle research, Dallas-Fort Worth’s strong business climate, robust infrastructure and low power costs (among other factors) all contribute to why the market ranks among the top six on the list of U.S. Data Center markets. Demand in Dallas-Fort Worth is projected to grow at an average rate of 13 percent through 2014, tightening an already constrained market. Additionally, as landlords competed for tenants prior to the opening of new data center facilities, rental rates softened in the first few months of 2011. Transactions in the market today could seriously impact the 2012 deliverables, but demand is expected to continue to outpace supply until a wave of new construction is completed in mid-2012.
Dallas-Fort Worth will see approximately 16 megawatts (critical load) of retail co-location in 2012, while wholesale providers have approximately 22 megawatts under construction for 2012 delivery. The market’s construction activity is attributable to a lack of inventory available at the end of 2011.
The Future of Data Centers
Several companies have made major real estate site selections based on economic incentives. However, future incentive packages from large data center projects are currently in limbo due to their contingency on state budgets, meaning location searches and selections will no longer have an obvious answer.
During the next 5 years, we expect businesses to consider and adopt more remote areas, such as the Pacific Northwest, North Carolina and the upper Midwest, as ideal locations. Thanks to their low energy costs, tax implications and favorable economic incentives, these regions are poised for growth in the data center market.
Another driving factor of the data center market is the appetite for faster, better and more efficient technology. This growing need in the coming year will bring with it the need for increased space to house it. An abundance of real estate developers, or one-off owners of real estate, are getting into the game with minimal marketplace experience.
With insatiable global demand for technology and innovation, as well as speculative development across the market, we will witness a new crop of both winners and losers in the data center arena.
— Bo Bond is Managing Director of Jones Lang LaSalle’s Dallas office and Co-Lead of Jones Lang LaSalle’s Data Center Solutions Global Practice
Broker Outlook: Houston Healthcare
The biggest issue, past and present, affecting the healthcare industry is the Patient Protection and Affordable Care Act commonly referred to as the Healthcare Reform Bill. A survey of 105 healthcare investment organizations conducted by Grubb & Ellis’ Healthcare Properties Group in October listed this issue as having the greatest impact on the healthcare investment market. The shadow of uncertainty that this law has cast upon the industry since its inception in March 2010 has greatly influenced decisions by large healthcare organizations and private physicians. Since the bill became the law of the land, many healthcare systems, healthcare specialty groups and individual physicians have either put expansion plans or any general long-term plans on hold. Surely, many physician investors that were traditionally in the acquisition market are not there now.
The uncertainty and high level concern of the consequences of this legislation is further highlighted by the numerous legal challenges that have been filed. To date, more than 28 states have challenged the law and the U.S. Supreme Court has agreed to rule on the legality of some of its provisions, especially the mandate requiring all Americans to buy insurance. The Supreme Court arguments most likely will take place in February or March 2012 with a ruling expected in June 2012.
The second largest impact on the healthcare investment market expressed in the Grubb & Ellis survey is the movement of doctors leaving private practices to become affiliated with large healthcare systems. This trend has been very active in 2011 and is expected to continue in 2012. These affiliations impact space utilization because the doctors will typically move into offices owned by the healthcare system, thus creating vacancy in medical office buildings where they previously leased space. Physician practices will likely continue to affiliate with healthcare systems in 2012, negatively affecting medical office building occupancy in related areas.
REITs remain the dominate investor of high quality and well located healthcare properties. Sellers like to work with REIT investors because they typically make very attractive offers for the properties and generally offer to buy the property without a financing contingency. During the next year, capitalization rates should remain consistent with those in 2010, ranging from 6 to 6.5 percent for healthcare system sponsored leased properties with strong credit to 8.5 to 9 percent for off-campus multi-tenant properties in secondary markets.
Although there is financing available for development, the underwriting criteria is very strict — marginal deals need not apply. In 2012, medical office building multi-tenant developments will likely require 60 to 80 percent preleasing to satisfy requirements.
The most notable healthcare development has been completed by some of the largest healthcare systems in the area. Texas Children’s Hospital and The Methodist Hospital System recently opened hospitals in the new Texas Medical Center-West in Katy. This is one of the fastest growing areas in the Houston area.
Memorial Hermann Healthcare System built a towering new hospital and medical office building in their Memorial City Campus. The St. Luke’s Hospital at the Vintage in northwest Houston is also newly constructed.
The impact of these new suburban developments is multi-faceted. Each of these hospitals has been strategically located in high growth areas of the Houston region and do have an impact on existing, more centrally-located hospitals. While some might say that these developments are a little premature based solely on start-up demand, thought leaders believe that these were built primarily for the future needs of an aging population and to strategically garner market share and presence in these proven growth areas. Secondly, each of these hospitals or campuses have a medical office building component which do have an impact on existing properties that do not have the same location advantages.
Looking forward into 2012, rental rates and occupancy will likely remain flat due to limited new supply. Investment activity will keep pace with 2011, but demand will continue to exceed supply. The confusion surrounding healthcare reform should be settled in 2012, providing sustained direction to healthcare practitioners and owners/investors in healthcare properties. Hospital consolidations are expected to continue but have little effect on existing real estate. The surgery center concept should continue to strengthen where there are strong physician teams in place with strong referral networks.
— Henry Hagendorf, CCIM, LEED AP, vice president, Healthcare Properties Group and Beth Young, CCIM, LEED AP, vice president, Healthcare Properties Group – Grubb & Ellis Co.
Lender Outlook: Texas Multifamily
Texas Real Estate Business magazine recently spoke with Larry Sneathern, senior vice president of Beech Street Capital’s Dallas office, about his outlook on multifamily properties in Texas.
TREB: What is the current status of multifamily development activity in Texas markets? What areas are hot — and why?
Sneathern: Multifamily permits nationwide are close to record levels, and four of the top 10 markets for multifamily growth are in Texas: Austin, Dallas, San Antonio, and Houston. MPF Research now reports 8,800 units under construction in Dallas/Fort Worth right now. With new construction locations getting harder to find, you see most new construction happening in the suburbs where more infill sites are available.
Many factors are contributing to the favorable outlook for the multifamily sector in Texas. Between September 2010 and September 2011, the state gained 248,500 jobs. Our unemployment level is at 8.5 percent, which is unchanged from last month, but well below the national average. Incomes are rising. And more people are choosing rental housing in lieu of ownership.
That’s the demand side. On the supply side, there is a lot of ground to make up. During the past few years, most of the larger banks weren’t making construction loans, and when they were, the terms were pretty onerous. That is now opening up a little bit because of increased demand for new construction.
The result is higher occupancy rates and higher rents. Occupancy levels in our major markets are approaching 93 percent and above, except for Houston which is just below 90 percent. It has been reported that rents in Dallas are now over $800 a month, which is a new high for multifamily, and you’re seeing the same growth in Austin and San Antonio. Houston is lagging those markets, but developers are building units there.
Even with the increase in supply, it will be at least 18 months before they change the market fundamentals.
TREB: What are the challenges you’re seeing with financing for multifamily properties — both for transactions and development?
Sneathern: We’re seeing a lot of properties being marketed, but the bid-to-ask is really tough. The biggest thing is that people want pretty high leverage, especially out-of-state investors. With actual sales prices below 6 caps on certain deals in major markets, it’s hard to get the leverage that they want. The investment looks so good, though, because right now we’re quoting below 4.5 percent for 10-year money, fully leveraged.
TREB: What’s the overall condition of properties in Texas?
Sneathern: We specialize in Class A and B products, so our view is necessarily restricted. Nonetheless, with Fannie Mae and Freddie Mac being primary lenders during the past 15 years, most of the products we’re seeing have been well-maintained. For our part, we set aside reserves so that we don’t have distressed properties in 5 to 7 years.
There’s always an ongoing reserve account, and this practice has been good for the industry. In addition, all DUS and Freddie Mac lenders monitor the accounts and make sure the properties are well-maintained. As a result, most second-cycle refinancing of Fannie Mae/DUS deals are in pretty good condition, which has helped the market.
TREB: What’s you feeling about the lending environment in Texas going forward for the next few years?
Sneathern: I’m optimistic. Texas is growing, and we’re growing in all sectors. Oil has once again crossed the $100-a-barrel mark, which is great for Texas. We’re gaining jobs, incomes are rising, and more people are choosing to rent. All of these factors are terrific for the future of Texas multifamily.
What’s been good for the refinance side of the multifamily market is that a lot of owners that have held on through the recession are now seeing rent growth. In lieu of selling their properties, owners are opting to refinance.
TREB: What are your biggest concerns?
Sneathern: With my 30 years of experience in Texas apartments, I know we have a propensity to get over-exuberant and to overbuild in our markets. What has helped mitigate my concern is that construction loans are harder to get now than they were in the past, so that the growth of supply will be measured.
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