Texas Real Estate Business

MAY 2016

Texas Real Estate Business magazine covers the multifamily, retail, office, healthcare, industrial and hospitality sectors in Texas.

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36 • May 2016 • Texas Real Estate Business www.REBusinessOnline.com THE RETAIL FORECAST Marcus & Millichap analyzes economic trends and their potential impact on retail capital markets. By Bill Rose T he retail property market this year will continue to mirror the U.S. economy's irregular growth pattern of the last six years, which has been characterized by moderate eco- nomic expansion ofset by headwinds such as softening international econo- mies and turbulence on Wall Street. This paradigm has led a 66-month ral- ly of continuous positive employment growth through March and added 14 million jobs to the labor force since the end of the Great Recession. Employ- ers in primary, secondary and tertiary markets will maintain a steady pace of broad-based hiring this year, creating approximately 2.5 million positions. This will support upward pressure on wage growth, which, along with low gas prices, will boost discretionary income levels and facilitate increased retail consumption. That said, wage growth could prove to be a double- edged sword if wages rise too quickly, which could result in rising infation. Developers will complete 46 mil- lion square feet of new retail space this year, representing a modest decline from last year and allowing demand to exceed additions once again. How- ever, metros vary in their phases in the construction cycle with developers in markets with tight vacancy ramp- ing up construction, while builders in other metros are easing back as growth pressures fade. In other markets, rents have not yet caught up with the cost of new construction, thereby limiting de- liveries to build-to-suit projects. Over- all, retail property demand remains ahead of post-recession trends, which will support stronger performance and greater competition, particularly for existing shopping centers, as new developments remain muted. Lagging construction may also cause property owners and investors to look toward expanding shopping centers to relieve unfulflled space demand, further en- hancing property values. This supply/ demand imbalance will also impact vacancy rates nationwide. Last year, national vacancy fell to 6.2 percent as retailers moved into 66 mil- lion square feet of new space. In 2016, insatiable demand for retail space will cause vacancy to contract by 30 basis points to 5.9 percent — the lowest year-end level in 11 years. This will propel rent growth. The retail rent outlook this year ap- pears bright as operators are projected to advance rents by 2.8 percent nation- ally, the strongest rent appreciation since 2007. For this reason, retail prop- erties will continue to be popular real estate investment vehicles. In addi- tion, signifcant competition for well- placed assets has advanced valuations in many primary markets, which is leading some buy- ers to consider higher-yield met- ros in secondary and tertiary mar- kets, multi-tenant shopping centers and/or value-add opportunities to generate elevated returns. Regardless, the retail property listing environment will be even more competitive this year than last. In 2015, strong property perfor- mance, equity fows and competitive debt markets converged to generate a modest increase in transaction veloc- ity. While sales of single-tenant assets accounted for more than half of all transactions, the proportion of multi- tenant deals rose, indicating greater ac- ceptance of operational and re-leasing risk among investors. The average cap rate across all transactions contracted about 20 basis points to roughly 6.5 percent as competition for assets in- creased. This year, positive market sentiment and afordable fnancing will continue to bolster buyer demand, and put ad- ditional downward pressure on cap rates. With frst-year returns for retail properties, nationally, below the prior cycle's trough, the search for yield, es- pecially among private investors, will intensify. Institutions will maintain a conservative position, targeting re- turns in the 6 percent range ofered by anchored shopping centers with long- term leases in place in major metros. Heightened investor confdence, along with limited construction, will support strategies to raise rents to augment NOIs, and will sustain a liquid invest- ment market. Retail assets in second- ary and tertiary markets will continue to be attractive investment vehicles as investors pursue yield and debt pro- viders compete for market share. The strong performance of retail properties in 2015 helped to maintain a steady fow of equity into the sec- tor and opened up new opportuni- ties for debt providers to participate. CMBS accounted for about 29 percent of debt-issuance volume last year to claim a larger market share than all other types of lenders. Greater discre- tion may be applied in the remaining year on loans involving unanchored or shadow-anchored shopping centers, however, as the maturing economic cycle could slow the pace of retail sales growth. In addition, changes are com- ing to the CMBS market in December, namely the imposition of the "risk-re- tention rule" that requires the issuer of CMBS debt to either keep a slice equal to 5 percent of the market value for fve years or designate a subordinate bond buyer to assume that risk. Life companies captured a greater piece of the market last year and came into 2016 with new capital to place. This group of lenders remains highly selective, focusing on large, well-locat- ed anchored assets in major markets. Bank lenders, meanwhile, have shored up balance sheets in recent years and are poised to compete for market share this year. The Federal Reserve's accom- modative monetary policy conferred a low cost of capital to these lenders, an advantage that could wane if the central bank raises its benchmark rate more aggressively than anticipated. Though consumer confdence in the U.S. economy is still shaky as evi- denced by the weaker-than-anticipat- ed retail sales fgures so far this year, the Federal Reserve's December 2015 rate hike still ofers the most unequiv- ocal expression to date of the central bank's confdence in the U.S. economy. As a result, the central bank has stated its intent to raise its short-term rate to 1 percent in 2016, but the risk of con- tagion from soft overseas economies and U.S. economic trends may require a reconsideration of that plan. Should wage pressure advance rapidly, it would also place upward pressure on infation and force the Federal Reserve to carefully consider its monetary policies. These factors are functions of where interest rates are headed, which is an important dialogue the retail in- dustry should be having, given the symbiotic relationship between debt and equity. n Bill Rose, CRX, is Vice President, National Director-National Retail Group, Net Leased Properties Group, Marcus & Millichap, and National Director, Institutional Property Advisors-Retail. Bill Rose Marcus & Millichap Retail Cap Rate Trends by Market Type Retail Construction & Vacancy

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