Houston’s retail sector negatively impacted by COVID-19 in Q2 and through the near-term
Commentary By Hannah Tosch and Kim Lenardson
It is no secret that retail has taken one of the hardest hits by the economy’s shutdown, surpassed only by hospitality. A closer look at the restaurant industry, in particular, reveals this sector is doing what they can but are hanging by a thread. COVID-19 is causing a ‘survival of the fittest’ effect in our restaurant community, restaurants are making changes to stay afloat, and we are finally seeing a shift to favor tenants here in Houston.
In today’s environment, it is not a matter of making profits for most restaurants; it is merely a matter of minimizing losses. New data from Yelp shows that just over 50% of U.S. restaurants that closed during COVID-19 are now permanently closed. As we make our way through Q3, we see more restaurants shutter here in Houston as PPP loans dry up. Both one-off concepts, as well as larger restaurant groups, are disappearing, proving the more prominent players are not immune to COVID-19’s impact. Pappa’s, Houstonbased family of restaurants, announced the closure of 5 long-time locations throughout Houston.
With many of the big box soft-good users and fitness concepts filing Chapter 11 (JC Penny, Neiman Marcus, Stage Stores, 24 Hour Fitness, to name a few), more (40k+) SF boxes are going to come to market. This poses another challenge to owners as soft-good users are downsizing their business models moving forward, even the ones that come out of Chapter 11. Some larger users, (50k+), are already revamping their model to be able to fit into the (20k) box, which brings their costs down.
Active tenants, restaurants and traditional retail, which can expand during these conditions, are set up for success as a tenant in today’s environment have more negotiation leverage than we have seen in over ten years. Houston retail rents have been at an all time high and absorption is negative for the first time since 2012. We believe that there will be a softening of rents as the markets adjust to higher vacancy and lower top-line volume for retailers. Landlords, highly motivated to sign deals, will be much more flexible if they can ink a deal.
Many landlords will be offering more free rent and are amenable to a “moving target” commencement date dependent on traffic returning. We are seeing landlords negotiate percentage rent based on capacity allowed or revenue. Many credit tenants are holding firm on requiring some form of force majeure language to be included in the leases that will cover them should another shutdown ensue. Smaller, local owners are struggling to accept that this type of language will likely be covered in all contracts moving forward.
As the market continues to change through the Fall, owners, retailers and consumers alike will need to adapt to the shift in retail and restaurant life to keep the economy going.
Vacancy & Availability
Houston’s average retail vacancy rate rose 50 basis points from 5.3% in Q1 2020 to 5.8% in Q2 2020. At the end of the second quarter, Houston had 17.5M SF of vacant retail space on the market. Among the major property types, Theme/Entertainment and Single-Tenant retail had the lowest vacancy rate of 1.0% and 2.1%, respectively, followed by Lifestyle Centers at 2.7% and Malls at 3.3%. Neighborhood centers have the highest vacancy rate of 9.9%, followed by strip centers with a vacancy rate of 9.4%.
Approximately 450,000 SF of new inventory delivered during the second quarter and currently there is 1.6M SF of retail space under construction, of which 64% is pre-leased. One of the larger projects under construction is Brookhollow Marketplace located on a former Exxon campus in northwest Houston. The Fidelis owned development is approximately 190,000 SF and 100% pre-leased. Some of the tenants that will occupy space in the center include Burlington, Michael’s, Ross, T.J. Max, Old Navy, Ulta, Five Below, Rack Room Shoes and Bath & Body Works. Brookhollow Marketplace is expected to deliver in September 2020.
According to CoStar, our data provider, Houston’s citywide average quoted retail rental rate for all property types increased from $16.71 per SF NNN in Q1 2020 to $17.33 per SF NNN in Q2 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 1.25M SF of negative net absorption in the second quarter, which is the first time Houston’s retail market has posted negative absorption since 2012. The retail sector posting the largest amount of negative absorption in Q2 2020 was Neighborhood Centers, with 535,450 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, decreased 28.6% over the quarter from 1.4M SF in Q1 2020 to 1.0M SF in Q2 2020. Looking forward, we expect leasing activity to decline during Q3 due to COVID-19.