COVER STORY, MAY 2008

TEXAS RETAIL UPDATE
What to expect in the major markets for the rest of 2008.

Texas Real Estate Business recently spoke with a number of retail experts throughout Texas to discuss the current trends in retail development, leasing and investment in the Lone Star State. From San Antonio all the way up to Dallas, the major markets are performing well with high demand for quality retail. And, if developers and investors stay smart and creative, Texas’ retail market should continue on a positive and active path throughout 2008.

Interviewees included: Eric DeJernett, CB Richard Ellis; Amanda Fox, Fox Properties; Michael Dee, Grubb & Ellis Company; Jeff Beard, The J. Beard Real Estate Company; Chad Knibbe, Marcus & Millichap; Harry Dean Lane Jr., NewQuest Properties; Chuck Siegel, Rohde Ottmers & Siegel Realty; Mark Reeder, Staubach Retail; Eric Drymalla, Tarantino Properties; Will Deane, WCF Development and Fox Properties; Herbert Weitzman, The Weitzman Group/Cencor Realty Services; and Tom Pagel, Yancey-Hausman Interest.

TREB: How would you characterize retail development activity in your area this year?

Dee: In Texas, the retail development activity has been very steady due to a continuing strong economy and job growth.

Lane: We are most active in Houston’s MSA, Austin and Dallas. Those areas are strong, active and very good.

Weitzman

Weitzman: Austin, Dallas, Fort Worth, Houston and San Antonio are seeing substantial, demand-based activity. In Dallas/Fort Worth, retailer demand for new space resulted in a 2007 construction total of 3.8 million square feet, down notably from 5 million square feet in 2006. For 2008, construction should jump, based on the large number of planned new projects, including two open-air malls.

Reeder: Retail development activity has remained strong in the Dallas/Fort Worth market for the past 12 months. Most shopping centers are substantially preleased with very little percentage of speculative development. When a developer has an anchor committed or a large number of specialty tenants the projects are getting done and coming out of the ground. This is still a good retail market with plenty of opportunity.

Pagel: The Austin area is coming off a super-heated retail development period and activity has slowed down relatively speaking, but it is still good, especially when compared to many other markets.

DeJernett: The Central Texas market is moving into 2008 with a strong tailwind from 2007. During the second half of 2007, approximately 2.5 million square feet of new construction was delivered and over 2.2 million square feet of retail square feet was absorbed, along with an overall increase in rental rates of approximately 5 percent. This year should continue to see a healthy transaction flow based on the momentum in the pipeline. However, we will see a noticeable slowdown in new projects over the next 12 to 18 months due to national issues affecting local retail expansion plans.

Siegel: In San Antonio and the Texas Valley, projects underway in 2006 and 2007 are being completed, but new projects have slowed down considerably.

Knibbe

Knibbe: Nationally, the brisk pace of retailer expansion has slowed and more local developers are implementing pre-leasing benchmarks for potential developments before breaking ground. This is in contrast to the past 12 to 18 months which saw dozens of projects delivered to the market on 100 percent speculation. This necessary slowdown in speculative development will hopefully bring supply and demand back together without significantly affecting rent growth. On the other hand, there is still an impressive amount of square footage under development across the city of San Antonio in major mixed-use and power center developments.

Drymalla: Retail development activity in the greater Houston market is projected to continue to remain strong with an anticipated upward growth estimated to be in the area of 5 million square feet.

Beard

Beard: Houston is strong on the west in higher growth corridors. It will be slow and steady for the near future; however, some markets are becoming saturated with more vacancies.

TREB: How would you characterize retail leasing activity in your area this year?

Dee: Leasing activity in Texas has slowed, but not nearly as bad as many parts of the country (such as California, Florida, Nevada and Arizona). The new retail developments continue to attract new tenants.

Weitzman: Texas’ retail market continues to be one of the strongest in the nation, thanks to a state economy that has not suffered the type of downturn that some other major markets have recently seen.

Lane: Major markets are still very strong. Due to the oil and gas market and the medical industry, Texas is looking good. Tenants are starting to slow down expansion and focus on where the demographics are strong. Most tenants will not accept housing growth numbers in their sales projections.

Pagel: Compared to the previous 2 years, retail leasing has slowed. But, those were banner years, and that pace of activity can’t realistically be expected to continue. The market is still strong with occupancy over 90 percent, and I expect the well-located retail centers to continue to attract tenants.

DeJernett

DeJernett: Leasing activity may be more modest than recent years given overall concerns in the national economy. Retailers are more discriminating on site selection and more demanding on lease terms. However, there is still a strong demand for quality retail locations in Austin due to strength in the local economy.

Siegel: Tenants want more concessions and many are putting a hold on 2007 new store openings.

Knibbe: Tenant demand from national brands will continue to be strong for well-located properties anchored by grocers or category killers. Class B and C centers may start to see higher tenant turnover and a slowdown in rent growth.

Drymalla: Houston’s retail activity experienced a positive absorption of 664,252 square feet at the end of the first quarter 2008, down from the approximately 2.08 million square feet in the fourth quarter of 2007. The vacancy rate remained unchanged at 8.8 percent in the current quarter. The quoted rental rates have decreased from fourth quarter 2007, ending at $16.54 per square foot per year.

Beard: Retail leasing activity is average. It is slow for national tenants, moderate for locals. I believe it will start to level out over the next 2 years.

TREB: How would you describe the investment sales activity in your area?

Dee

Dee: Steady. Retail investment continues to be one of the more desired product types, but lending requirements are definitely more stringent.

Lane: Cap rates are up 50 to 100 basis points, but there is still a lot of money looking for deals.

Pagel: Retail investment activity has slowed somewhat because of the tightening in the financing market, but investor interest in the Austin area remains very high, and when the right financing can be found, properties are trading. Lenders are looking favorably at Austin, and this helps.

DeJernett: Demand for retail investments continues to be strong in Austin. However, tightening of credit has slowed transaction volume and this will continue until lenders regain confidence and re-establish lending criteria the market can count on.

Knibbe: Interest for retail properties has not slowed. However, with the increasing cost of debt, there is a widening gap between Buyer and Seller expectations of market value.

Drymalla

Drymalla: The retail investment sales activity in the greater Houston area for centers with more than 15,000 square feet during 2007 increased as compared to 2006, with a total volume of approximately $648.47 million ($109.99/square foot) consisting of a total 87 reported sales transactions. The average cap rates for 2007 slightly increased to 7.72 percent compared to 7.70 percent in 2006.

TREB: What retail markets (or submarkets) have grown in the past year and which markets are poised for growth in 2008?

Weitzman: All of Texas major markets have grown over the past year, and all are poised to grow during 2008. Even though all of the markets have active construction, we’re seeing occupancy in each remain stable and even increase due to the fact that the majority of construction is demand-based. We’ll see very active building during 2008, but 2009 construction will probably slow somewhat due to the cutback of single-family starts in the more outlying suburban markets.

Fox

Fox: All suburban areas, as well as Houston inside the Loop and also Lakeway.

Deane: The Inner Loop will grow at a faster pace in 2008 in Houston.

Drymalla: At year-end 2007, the retail markets with the most growth were in south Houston with 1.1 million square feet of new construction underway; FM 1960 with 904,157 square feet of new construction underway, and downtown with 469,998 square feet of new construction underway.

Markets that are poised for growth in 2008 continue to be the South, FM 1960, Katy Freeway East and the central business district (CBD) due to new retail centers under construction.

Knibbe: 2007 saw immense growth in the Northwest and Far Northwest submarkets of San Antonio as well as the Highway 281 North and IH-35 North corridors. This growth should continue in 2008.

TREB: What retail trends do you think will emerge in 2008 and 2009?

Dee: Discount retailers (Kohl’s, TJ Maxx, Target, Wal-Mart, etc.) will continue to do better than the vast majority of retailers since most consumers want quality at bargain prices. Ethnic-oriented retailers also will continue to do well since the ethnic population in most cities continues to grow. Consolidation in the major department store segment will continue.

Pagel: In Austin, I think we will see more and more green buildings, and more mixed-use development, some of which will be transit-oriented as our commuter rail system comes on line and expands. I think developers are looking for infill opportunities to serve the growing intown population. In terms of kinds of retail, I think we will see more tenants geared toward the aging baby boomer crowd.

Beard: I see lease rates dropping and centers sold at a higher cap rates. I think it will slow down in North Harris and Montgomery County.

TREB: What retail markets (or submarkets) are struggling?

Weitzman: Texas is fortunate that none of its markets are struggling. From a submarket standpoint, the majority of submarkets within the major markets of Austin, Dallas/Fort Worth, Houston and San Antonio are seeing occupancy above 90 percent.

DeJernett: Market demand has been so strong in all segments of the market, it is too early to tell where any specific weaknesses may reside. More likely, it will be a general slowing of the overall market.

Lane: The smaller markets and high growth areas where the builders have stopped building new homes are struggling.

Fox: Older, unanchored centers.

Deane: Over-built markets.

Knibbe: Any submarket that does not have positive demographic or rent growth trends.

TREB: What retailers are most sought after?

Reeder

Reeder: We are seeing soft good-oriented discount stores such as Target and department stores that locate in off mall locations such as JC Penney, and perhaps Kohls, as still being in great demand. Key grocers such as Whole Foods, Kroger, with its 123,000-square-foot prototype, or Sprouts, with its 25,000-square-foot prototype, are making a comeback. The grocery stores drive customers to a shopping center two or three times a week and serve as the impetus for service retail, small shops and pad site users to locate in the same development.

Weitzman: The sought-after retailers depend on the center category. For example, many upper-end, mixed-use properties seek strong restaurant co-tenancy, since restaurants are often destinations and drive traffic several times a day.

DeJernett: Actively expanding tenants and retailers — such as restaurants and entertainment that create energy and drive traffic counts in existing centers — continue to be the most highly sought after.

Lane: Target, JC Penny, Kohl’s, and Wal-Mart, followed by any soft goods.

Fox: National tenants.

Deane: Discount credit.

TREB: What do you think needs to happen in order for the market to improve in 2008 or 2009?

Siegel

Siegel: Landlords need to be creative.

Dee: Number one, the housing crisis needs to improve as well as the related foreclosure rate. Also, the overall employment condition nationally needs to improve with new job growth in most major markets. Here in Texas, job growth continues to be very steady. I believe, once the election is over, the economy will improve too.

Beard: Better terms for financing for out of country investors and looser lending. The national economy needs to rebound in order to make investors feel safe, and recover with interest rate stabilization

Pagel: Currently, the economy in our country is being affected by problems that are global in nature — the high price of oil, the weak dollar, an election year in this country, and the fallout from the sub-prime financing fiasco to name a few. All of these things have an impact on business, and while some of these problems can be solved in the short term, others will take time. Texas and Austin are feeling the impact of these problems to some extent, but not to the same degree as some other parts of the country. The Texas economy is strong, and we continue to create jobs. We continue to see corporate relocations and/or expansions into Texas, and as long as people continue to move into our area, there will be demand for retail.

TREB: What types of retail properties are hottest in Texas?

DeJernett: Last year we saw a trend for large suburban retail projects. Additionally, we also saw the opening of several large, mixed-use lifestyle centers including the Hill Country Galleria in Bee Cave, additional phases of Southpark Meadows in far south Austin and 1890 Ranch in Cedar Park. This year, as suburban residential new construction slows, infill redevelopment in areas having established demographics will gain the attention of developers. The redevelopment of North Cross Mall by Lincoln Properties is a good example of this trend.

Lane: Mixed-use projects. Having a mixed development with retail, office and residential all in the same project seems to be working well in most major markets.

Fox: Anchored centers with national tenants. Also, mixed-use developments that combine retail with office and residential.

Weitzman: We’re seeing pretty strong activity in almost every category. Unlike some national markets, the mall market in Texas is booming. Austin opened a new mall in 2007, as did Dallas/Fort Worth. Major malls in markets like D/FW and San Antonio are expanding, and the mall market in all of the major Texas cities reports healthy occupancy. Community centers remain strong.

Knibbe: From the investment sales perspective, the hottest retail properties are well-located assets that are not operating at full potential.

TREB: What types of retail properties are struggling in Texas?

DeJernett: Rapid growth of new projects over the past few years could leave older B and C grade centers looking for new anchor tenants. This could pose challenges in the short term while national retailers slow expansion plans.

Lane: Freestanding unanchored strip centers. Not enough traffic is being generated to keep tenants and sales volumes aren’t high enough to sustain rents.

Weitzman: The only property type that may be on the verge of overbuilding is the small, unanchored neighborhood center. Due to active demand from restaurants and small retailers, many developers are coming on line at the same time with this property type. We expect neighborhood construction to slow in 2009 so these properties can catch up with demand.

TREB: What are your predictions for Texas retail in 2008 and 2009?

Pagel

Pagel: I think Texas will weather the current national economic slowdown. The Texas economy is strong with good job growth, and if we develop our communities in a thoughtful and environmentally friendly way, Texas will continue to be place that people want to live, run their businesses and raise their families.

Dee: Steady. Although leasing activity has slowed, new retail development continues and Texas continues to attract retailers that want to open new stores. Retailers who had previously focused on states like California, Nevada, Florida or Arizona for expansion, will now concentrate on Texas as a solid expansion market. Retail investment will continue to remain steady and lending requirements here will be easier than many parts of the country.

Siegel: It will slow down, but not as badly as most other areas.

TREB: How would you describe the lending environment for retail properties in Texas?

Pagel: Lenders like Texas and financing is available both for new construction and acquisitions, but lending practices are more conservative than they have been in the recent past, and that is forcing developers and buyers to be more conservative in their projections.

Dee: Lending is better than in most of the country. There are three prevalent trends right now in Texas: local market experience is a must for the buyer or developer; local money is the best source of equity capital right now; pre-sales and pre-leasing are very important in securing financing. Because the Texas economy is healthy with job growth and retailer expansion, lenders will look more favorably on retail properties than many parts of the country.

TREB: How do you think the current credit crunch will affect real estate in Texas?

Weitzman: The retail investment market in all of Texas’ major cities, while still somewhat active, has slowed considerably due to the current credit crunch. Many investors are also taking a wait-and-see attitude to determine if prices will fluctuate. But overall, Texas retail is still considered a strong investment.

Dee: Existing homes sales have slowed, as well as new homes, but the foreclosure rate is less than most cities. However, the overall residential lending environment needs to improve before the credit crunch will go away.

Beard: We are somewhat buoyed by energy, so it should not be as drastic as the Northeast. Eventually I think things will slow some, but Texas will continue to hold strong for the next few years

TREB: Are there any other comments you’d like to make regarding the real estate market in the coming year?

Weitzman: We are fortunate in Texas that we have not seen a significant economic downturn in our economies.

Dee: For the retail sector, it is certainly not all doom and gloom. 2008 will continue to be a challenging year for retail leasing activity and new store expansion, but I believe the environment will improve relatively quickly.

Fox: I think it will be a challenge, but well-positioned, well-managed properties with a good tenant mix will do fine. Marginal centers will suffer.

Siegel: There is uncertainty, and deals are harder to complete. Longer time is needed to execute leases or contracts. There are still opportunities, but you must be creative and think outside the box.

High Street at Stonebriar Mixes Work and Play Retail space within mixed-use projects, like High Street (above), is in high demand in Texas. High Street at Stonebriar, a 550,000-square-foot specialty retail center by The Ainbinder Company, will blend shopping and dining with office space and a boutique hotel on 35 acres in the Plano/Frisco submarket of North Dallas. “High Street at Stonebriar is going to be a unique, dynamic environment that will mix work and play, making it a nice respite to the retail clutter in the North Dallas area,” Bart Duckworth, president of The Ainbinder Company, says. “It’s not another power center.” The project will appeal to a general audience, though the line-up will skew toward the upscale, female patron, according to Duckworth. “In addition to the rapidly growing upper-middle class residential neighborhoods of Plano and Frisco, the daytime employment in the area is huge,” Duckworth says. “High Street at Stonebriar will be well-suited to reach those potential shoppers and diners.” High Street at Stonebriar Container Store, opening this summer, is one major national tenant that is set to lease the 200,000-square-foot first phase of the project. The second phase is scheduled to open in fall 2009 with 150,000 square feet of retail and restaurants. In 2010, the third phase will add another 150,000 square feet of retail and restaurants, 100,000 square feet of high-end loft/office space and potentially a boutique hotel. “The design of High Street is going to be timeless — a comfortable, yet remarkable, place you’ll want to visit or work,” Duckworth says. “The project will provide a collection of retailers and restaurants new to the trade area in a highly accessible and convenient environment.” — Lindsey Walker

High Street Brings Specialty Retail to Uptown Houston High Street Trademark Property Company — in a joint venture development with Coventry Real Estate Advisors — is bringing a $105 million urban, mixed-use village to Houston. The 400,000-square-foot project will combine specialty retail, restaurants, residential and office space. Located on Westheimer Road between the Galleria and Highland Village on the former site of the Central Ford Dealership, High Street will benefit from a very strategic location in Houston’s best and most active submarket. “Uptown Houston has a density comparable to downtown L.A. or Denver,” says Tommy Miller, senior partner for Trademark. Featuring 422 feet of frontage on Westheimer and pedestrian access to an emerging urban enclave to the north, High Street is being designed to promote a pedestrian-friendly atmosphere. “We will weave High Street into this neighborhood and create crosswalks to encourage neighbors in Afton Oaks and other neighborhoods to walk to and from the project,” Miller says. “Our design is the right scale for the area — mid-rise, not high-rise — and has a warm, contemporary design vernacular that Houston will be drawn to.” Comprising 100,000 square feet of retail space, the development will feature an eclectic mix of fashion, home furnishings, restaurants and cafes and wellness uses, according to Miller. In addition, High Street, which is seeking LEED certification, will have 80,000 square feet of office space and 233 multifamily residences. Construction currently is underway, and High Street is slated to open in late fall 2009. Kosene & Kosene is the residential development partner. Page Partners is leasing the retail component, and CB Richard Ellis leads the office leasing effort. — Lindsey Walker

RETAIL LENDING SHOULD STAY THE COURSE The financing situation is affecting business, but the overall market will remain steady. Lindsey Walker Wernick In light of the unpredictable financing outlook for commercial real estate, Texas Real Estate Business recently asked Stuart Wernick, president of Quantum First Capital in Dallas, what he foresaw for the rest of the year in terms of retail lending. See his responses below. TREB: What is the lending climate for retail in your area and how does it compare with the other Texas markets? Nationally? Wernick: There is really no significant difference in the lending climate from the Dallas/Fort Worth retail market as compared to other major cities in Texas or even in the rest of the country. The current financing situation is affecting the way business is being done in all markets and all real estate products equally. With the disappearance of the CMBS market over the past 6 months, much of the commercial lending has forced the commercial banks and life companies back into to the forefront of the capital supply. However, the banks and life companies are not able at this point to digest the additional servings placed on their plates. Therefore, the banks and life companies have become more selective with the type of product they are choosing to execute. TREB: How is your company approaching the current credit crunch? Wernick: With the limitation of capital for permanent loans (typical 10-year term), the bridge and construction loans are what we are actively processing now. Value-added opportunities and new development plays are the transactions that are keeping the retail activity moving forward. Therefore, we not only are assisting in providing the senior debt stack, but we also are executing the equity component and, in some cases, modifying a structure with the current lender to complete the process. TREB: What type of retail projects, properties or retailers are lenders interested in? Wernick: Obviously, assets that are well tenanted in good locations and have strong operating history are at the top of the list for the permanent lenders. Sales of the retailers are a major component at the center. Additionally, lenders also are drilling into the retailer’s current growth strategy. What was once a strong pitch about the retailers’ search for more site locations is not a positive view in the lender’s eyes. They want to see that the retailers are paying attention to their core business. With respect to property types, the neighborhood and community centers are at the top of the list due to their average loan sizes. There are only a select few lenders interested in the regional malls or single loans over $75 million. The larger transactions are getting more securitized and take up too much of the lender’s limited allocation dollars. TREB: What do you foresee in the near future for the retail market in your area? Wernick: The retail market will remain stable as a whole. The good news is that many of the owners have taken advantage of the favorable debt that was available over the last few years. Those owners that financed with mid-5 percent fixed-rate money have created additional value and can demand a favorable price if they opt to sell due to the assumable feature of the debt. For those that are seeking financing on their properties this year, they should act quickly and execute. ¬Additionally, the lending market will have changed by the time this goes to print. — Stuart Wernick is president of Dallas-based Quantum First Capital.

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