By Taylor Williams
HOUSTON — High occupancy rates paired with low volumes of new construction have been the prevailing narratives in many major U.S. retail markets over the past couple years, and Houston is no exception. And while that dynamic ensures healthy rent growth within stabilized properties, when paired with high construction costs and higher interest rates, the result can be growth that feels rather sluggish.
According to second-quarter data from Colliers, the Houston retail market currently has a vacancy rate of 5.2 percent, a mark that has held steady for the past year. The market added about 1.1 million square feet of new product through the first six months of 2024 to go with roughly 732,000 square feet of positive absorption. The average asking rent stands at $20.38 per square foot, which represents a 3.8 percent increase relative to the second quarter of 2023.
Rosy as these figures appear on the surface, they do not tell the full story of the market. Most owners cannot afford to simply sit back and let the deals come to them at rents they dictate. For although demand exceeds supply of quality space, the aforementioned macroeconomic factors are squeezing owners’ profit margins, meaning they can ill-afford to deliver underwhelming projects or do deals with the wrong tenants.
At the inaugural InterFace Houston Retail conference in early August, a group of local owners and developers identified these and other touches of gray that exist within the market’s many silver linings. Hosted by InterFace Conference Group, a division of Atlanta-based France Media Inc., the event drew more than 150 local real estate professionals to the Houston Racquet Club in its debut.
First the Good
The panelists unanimously agreed that demand was about as healthy as could be desired.
“While this may not apply to all categories [of retailers], from the standpoint of contemporary and luxury tenants, I’ve never seen so many tenants interested in the Houston market,” said Lacee Jacobs, senior managing director of retail leasing at Parkway, the office owner-operator that partnered with retail developer Midway in 2023. She later added that due to the strong demand for infill spaces, her company is also seeing more tenants target suburban sites — a strategy many had shied away from in the past.
“There are still issues in terms of getting the mix right with some of the smaller tenants in suburban markets, but the demand is there,” agreed Guillo Machado, vice president of development at Read King Commercial Real Estate. “COVID happened; people shifted their lifestyles, and growth happened in the suburbs. Now they need places to shop, eat and get services. We’re reaching the end of that development wave, and regardless of the economic environment, there’s a lot of underserved markets in the suburbs.”
Dean Lane, partner at developer NewQuest Properties, also noted that the demand side of the market has been marked by stiff competition among users.
“We’re seeing huge demand for retail space in every arena, whether it’s ground leases for restaurants or space for medical users or [interest in] big boxes,” said Lane. “We’re seeing competition within some of our boxes because we’re somewhat limited on what we can provide for those spaces. And with renewals, we’ve been adamant about rent increases.”
Lane added that with some big box renewals within the NewQuest portfolio, the company has been willing to take the space back. This willingness to temporarily forego rent collection and shell out fresh dollars to re-tenant the space stemmed from confidence that new leases would carry serious premiums — in some cases as much as 50 percent, according to Lane.
Now the Challenges
Nathaliah Naipaul, CEO and partner of owner-operator XAG Group, noted that one of the foremost challenges facing landlords involved getting tenants — particularly mom-and-pops — to better understand and more accurately underwrite rents in this market. The issue reflects the reality that higher rents are not just a factor of healthy demand, but also of the combination of high interest rates and inflation.
“Tenants are facing real challenges in securing financing, so encouraging them to underwrite [deals] at higher rental rates is a process that we have to sit down and explain,” she said. “We’re also facing delays in permitting in some cases, dealing with little issues going back and forth for no reason, so that’s another challenge for us.”
Arsean Maqami, co-president of development and investment firm DC Partners, noted that as the post-COVID era has ushered in a shift in preferred tenant profiles, landlords have struggled to apply appropriate rents and allowances for those users.
“I don’t know if we’ve ever seen price escalation like we have in the last five years,” he said. “Having tenant prototypes change as a result and not having the base rents and allowance expectations adjust to capture the yield that’s needed in this new interest rate environment — everybody’s trying to negotiate that perfect deal.”
Jacobs concurred with landlords’ struggles to expedite new tenant openings and to adjust rents such that they comfortably cover higher operating costs — for both sides — while adhering to principles of profit maximization.
“Across our portfolio, we’ve probably got a dozen tenants that should’ve opened months ago,” said Jacobs. “We’ve had several renewals with restaurants lately, and they’ve been very open book on showing their costs, and they’re not making more money. Restaurants tend to be our anchors, and having to do those deals first on new developments can cripple the rest of the pro-forma. We have to give huge tenant improvement [allowances] and cut big checks to get these tenants, but the sales and rent aren’t growing in the same capacity as these other costs.”