By Taylor Williams
DALLAS — It’s an exceptionally challenging time to be developing retail space in the metroplex.
Pick your poison: Interest rates that have tripled in two years, restricted proceeds from lenders, longer entitlement and permitting times, limited land for new projects. Between all these barriers to growth, the deck is seemingly stacked against brick-and-mortar retail developers these days, despite the fact that in Dallas-Fort Worth (DFW), occupancy is very high and population growth shows little sign of slowing.
Of course, each of those factors is exacerbated with large-scale developments. More land and rentable square footage require the raising of more debt and equity, which translates to heftier interest and dividend payments, respectively. If the site is an assemblage, then predevelopment is more time-consuming, and with the push outward to new suburban paths of growth, those sites may not already be zoned for retail. If rents aren’t trending upward, those factors alone can kill a project in its infancy.
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For all these reasons, some owner-operators see opportunity in building smaller product, specifically unanchored strip centers that still possess the visibility, traffic patterns and surrounding population density to attract national credit tenants. That’s according to developers who spoke at the InterFace DFW & North Texas Retail conference on Aug. 27, an event that took place at the Renaissance Dallas Hotel.
In guiding the discussion, moderator Shams Merchant, senior attorney at M&W Law, pointed out that the current environment represents the first time since 1990 that the DFW retail market has exceeded 95 percent occupancy. While owners clearly recognize that figure as an open invitation to develop more space, delivering that product to market is so much easier said than done.
Herb Weitzman, executive chairman of Dallas-based Weitzman, said that prolonged negotiations with anchor tenants represent another obstacle to delivering new supply. In doing so, he indirectly endorsed smaller centers as viable undertakings in the current economic environment. Weitzman owns shopping centers and leases/manages others on a third-party basis.
“The time it takes to put a deal together is getting much longer, primarily due to negotiations with anchor [tenants],” said Weitzman. “Your anchor will drive you into the ground if you’re not an experienced developer. So that category [of retail development] has become very high-risk and expensive, so the real opportunity exists in small neighborhood centers of about 10,000 to 15,000 square feet.”
“With those projects, you don’t have to deal with anchors,” Weitzman continued. “You deal with local credit and service tenants, and you maybe do a strip or ground lease or something that’s just smaller. And those deals are very successful.”
Weitzman also noted that within the spectrum of retail users, small operators have historically comprised the majority of the base, and even more so since numerous big box chains began declaring bankruptcy in the runup to and aftermath of COVID-19. And while seasoned developers may have the capital markets relationships and track records to go big, smaller developers looking to break into the market would be well-advised to target these types of smaller projects, he concluded.
“If you’re just starting out, stay with the neighborhood center,” he said. “Buy your site that’s an acre and a half, maybe two, add some stores and build the base [of your portfolio] from that position.”
Panelist Vipin Nambiar, managing partner at HN Capital Partners, noted that retail owners whose centers are established and producing steady income levels have significant advantages in the credit markets as well.
“If you have a neighborhood center with steady cash flows, the CMBS market is open to you,” he said. “Maybe five years [of term], 3.7 [percent interest rate] — you can probably borrow at 250 [basis points] over that and have a sub-6-percent interest rate in the fixed-rate market. So it really depends on the risk profiles and cash flows you’re looking to leverage.”
Panelist Robert Dorazil, CEO and co-founder of United Commercial Development, circled back to the high occupancy rate in expressing his endorsement of smaller centers.
“I think across our entire portfolio, we have one vacancy right now,” said Dorazil. “Everything is very full, but the problem is that not a lot [of product] is getting built. And while we haven’t focused much on doing the 10,000- to 15,000-square-foot retail centers, sometimes I wonder if that’s where we should be spending our time.”
Dorazil then gave some anecdotal evidence to support his analysis. His company developed a center in the northern Dallas suburb of Frisco that is anchored by grocer H-E-B. Although the deal with the grocer was inked in 2016, the store only recently opened, although it’s unclear how much of that progress was delayed by the pandemic. Regardless, Dorazil noted, the company isn’t going to celebrate just because the grocer is now up and running.
“It’s hard to make a project work these days,” he said. “The real estate guy from H-E-B called me after they opened and said I should take him to lunch because they’re now open. But the reality is that we won’t make money on this deal for another two or three years. We’ve been carrying that land for eight or nine years and had preferred returns with our investors click for eight or nine years, and it just kills you.”
Dorazil added that strong rent growth — particularly with ground-leased pad sites that abut the grocery building — have been crucial in keeping the project above water.
“In some cases, we’ve gotten more money for those pads than people get in other parts of the country just because we’re in Texas and everyone wants to be in front of an H-E-B,” he concluded. “But there are a lot of [large-scale] projects that are being planned in areas like Celina and markets up north, and we know those projects are going [to happen], but we talk to those developers, and they’re not making any money.”