Houston’s retail landlords work creatively but cautiously with vetted tenants to close the deal
Commentary By Hannah Tosch | Senior Associate
As COVID-19 continues to press on, tenants and landlords are working on their real estate strategy for the future. Many months later, we must all now accept the fact that COVID-19 has made its permanent imprint on the real estate decision-making process. As a result of this impact, we see a discrepancy between landlord and tenant expectations for new leases. To state the obvious, the active tenants in today’s market are looking for deals. Deals can come in many forms, whether it be percentage rent, step rent, flexible commencement dates, more substantial landlord concessions, etc. While it certainly is a tenant’s market right now, the tenant does not necessarily hold all the cards. Based on what Colliers sees in the Houston market, there is a misconception that the tenant is entirely in the driver’s seat. What is not evident is that most landlords are not desperate for just any deal put in front of them. In fact, their approach proves to be far from that.
The majority of the real panic around COVID-19 has mostly settled, and landlords are no longer making rushed decisions to keep their centers full. In fact, many landlords are becoming extra cautious about which tenants they allow in their centers. We see stronger landlord involvement in vetting and interviewing prospective tenants. Landlords want to know a tenant’s marketing plan, how they intend to achieve success and how their other locations are performing. Of course, these are all boxes they have always checked, but not quite to this degree. They need to know that a prospective tenant is substantial and qualified.
Not only are landlords becoming more methodical on who they allow in, but many are actually more interested in short-term leases to give themselves more flexibility for the future. Brokers are getting creative in structuring deals right now, especially when talking about rent for the beginning of the term. Of late, we have often seen percentage rent at the beginning of the lease term in order to get tenants comfortable enough to move forward. While this structure is often bridging the gap to make deals, this is not something a landlord would want to entertain long-term.
A landlord wants to feel 100% confident that their tenant will succeed before signing a lease. There is little room for error right now after what landlords have been dealing with over the past eight months. The landlord cannot afford to invest capital and resources into a new tenant space, only for them to fail in a few years. Therefore, the new deals that are being made are happening with strong vetted tenants. Ultimately, this will allow for an unprecedentedly sustainable retail market with fewer closures, stable tenants with robust business plans, and eventually fewer vacancies, which might drive rents up again in the coming years
Vacancy & Availability
Houston’s average retail vacancy rate rose 20 basis points from 5.9% in Q2 2020 to 6.1% in Q3 2020. At the end of the third quarter, Houston had 18.2M SF of vacant retail space on the market. Among the major property types, Theme/Entertainment, Single-Tenant retail and Malls had the lowest vacancy rates of 1.0%, 2.2% and 2.8%, respectively, followed by Lifestyle Centers at 3.6% and Power Centers at 5.1%. Neighborhood centers have the highest vacancy rate of 10.6%, followed by strip centers with a vacancy rate of 9.7%.
Approximately 393,500 SF of new inventory delivered during the third quarter and currently there is 1.6M SF of retail space under construction, of which 58% is pre-leased. One of the larger projects under construction is a Life Time Fitness located at 9000 Six Pines Drive in the Montgomery County submarket. The development is expected to deliver in April 2021.
According to CoStar, our data provider, Houston’s citywide average quoted retail rental rate for all property types dropped from $17.36 per SF NNN in Q2 2020 to $16.78 per SF NNN in Q3 2020. These average rental rates are typically much lower than actual deal rates since they include all retail property types and classes, the majority of those properties are not well leased and are listed with discounted asking rates. According to Colliers’ internal data, Class A in-line retail rental rates can vary widely from $20.00 to $85.00 per SF, depending on location and property type.
Absorption & Demand
Houston’s retail market posted 80,417 SF of positive net absorption in the third quarter. The retail sector posting the largest amount of positive absorption in Q3 2020 was Power Centers, with 190,160 SF of positive net absorption. Neighborhood Centers recorded the largest amount of negative absorption posting 237,600 SF of negative net absorption. Neighborhood centers usually have one anchor and the balance of the center is occupied by smaller retailers offering services from nail salons to casual dining.
Houston’s retail leasing activity, which includes renewals, rose 4.3% over the quarter from 1.0M SF in Q2 2020 to 1.1M SF in Q3 2020. Looking forward, we expect leasing activity to remain flat through year-end. Some of the tenants that signed leases during the third quarter are listed in the table below.