RetailResearch

M A R K E T
Houston Metro Area

O V E R V I E W
Second Quarter 2012

Investors Broaden Search as Competition Intensies

Strong energy markets, rising trade activity, and increased demand for professional and business services will drive outsized job growth in Houston this year. Metrowide, employment growth is forecast to reach 3.6 percent, more than two times the national average, which will renew interest in local residential development and encourage retailer expansion. For local retail property owners, these trends will translate into strengthening occupancy, as the bulk of new retail supply this year is either build-to-suit or substantially pre-leased. Nonetheless, rent growth will be minimal at the metro level in the near term as owners maintain their focus on lling vacancies, though performance will vary by property type and location. For example, quality shopping centers in tight submarkets such as the Outer Loop West, along with areas experiencing resurgent economic growth, such as Montgomery County and parts of Fort Bend County, should see above-average rent growth and reduced concessions this year. Improving fundamentals will bring several retail owners back to break-even levels on properties purchased near the markets peak. This will likely prompt increased listing activity as owners who carried these assets through the downturn opt to sell and redeploy capital into less-management-intensive investments. The market for performing Class B/C deals has lagged in recent quarters as REITs and institutions focus on Class A deals in core locations and local, private investors target value-add plays. Demand should begin to shift, however, as sti competition at the far ends of the quality spectrum pressure prices and yields, drawing investors back to the mid-tier market. On average, cap rates for well-located Class A anchored centers range from the mid- to high-7 percent range, while performing Class B assets tend to sell at cap rates more than 150 basis points higher. Similar to 2011, single-tenant transaction velocity will remain at reduced levels this year due to limited inventory, which can be attributed largely to a dearth of new construction in recent years. The development pipeline has expanded in recent months, though, with numerous fast-food restaurants and a handful of drugstores slated to come online in 2012 and 2013, suggesting increased single-tenant opportunities ahead.

2012 Annual Retail Forecast

3.6% increase in total employment

Employment: Houston employment will rise 3.6 percent in 2012 with the addition of 93,000 new jobs. In 2011, payrolls grew 3 percent as 76,700 positions were created. Similar to last year, the education and health services and trade, transportation and utilities sectors will lead growth.

1.2 million square feet will be completed

Construction: In 2012, approximately 1.2 million square feet of retail space will come online in the Houston metro, up from 826,000 square feet last year. An expanding development pipeline points to further acceleration in 2013 and beyond.

70 basis point decrease in vacancy

Vacancy: Overall retail vacancy in Houston will decline 70 basis points in 2012 to 9.8 percent, its lowest level on record since late 2005. During 2011, the metros retail market posted an 80-basis point reduction in vacancy.

1.6% increase in asking rents

Rents: Asking rents in the metro will rise 1.6 percent in 2012 to an average of $15.57 per square foot. Eective rents will rise at a faster clip of 2 percent, to $13.36 per square foot, as tighter conditions allow owners to pare concessions.

Economy

Employment Trends
Metro United States

Employment growth in Houston accelerated signicantly over the past 12 months to 3.3 percent with the addition of 85,100 jobs. During the prior 12-month period, payrolls grew by 59,200 positions. Nearly all major private sectors expanded over the past year, led by the education and health services, and professional and business services sectors. Government and construction payrolls, on the other hand, contracted. The latter should start to recover this year amid renewed commercial and residential development. Payrolls in the trade, transportation and utilities sector exceed pre-recession levels by a wide margin, driven largely by gains in retail trade. At the same time, the manufacturing sector is within 1.5 percent of pre-recession levels thanks to rising demand for mining-related supplies and machinery. Outlook: Employment in Houston will rise 3.6 percent in 2012 with the addition of 93,000 jobs. In 2011, payrolls grew 3 percent as 76,700 jobs were created.

6%
Year-Over-Year Change

3% 0% -3% -6%

08

09

10

11

12*

Construction

Retail Completions
8
Square Feet Completed (millions)

Approximately 840,000 square feet of retail space was delivered to the Houston metro over the past 12 months, up from 249,000 square feet in the previous period. During the rst quarter, developers completed 116,000 square feet, which was already more than 80 percent leased as of early May. Last year, major projects brought to market included a 185,000-square foot Walmart in the Northwest submarket, and H-E-B and Kroger stores in Montgomery County. In 2012, the largest build-to-suit projects include a Sams Club in Pearland and a new Kroger in Katy. The largest retail center slated for completion in 2012 is an outlet mall in Texas City. The project should benet from renewed residential developments in the immediate area and will also draw shoppers from closer-in southern submarkets. Outlook: In 2012, 1.2 million square feet of retail space will come online in the Houston metro, up from 826,000 square feet last year. An expanding development pipeline points to further acceleration in 2013 and beyond.

08

09

10

11

12*

Vacancy
Vacancy Rate Trends
Metro United States

Metrowide retail vacancy ended the rst quarter at 10.6 percent, up 10 basis points from late 2011 but still 40 basis points below year-earlier levels. Over the past 12 months, the Montgomery County and I-10 Far West submarkets posted the most improvement. At the same time, the Southwest, I-10 West, Inner Loop West and Outer Loop West submarkets softened, though they all continue to boast vacancy rates below the metro average. Vacancy among neighborhood/community centers declined 20 basis points over the past year to 12.7 percent. Performance varies within this segment, though, with community centers posting vacancy of 9.8 percent, while smaller neighborhood properties report vacancy in excess of 15 percent. Outlook: Overall retail vacancy in the Houston metro will decline 70 basis points in 2012 to 9.8 percent, its lowest level on record since late 2005. During 2011, the metros retail market posted an 80-basis point reduction in vacancy.
Marcus & Millichap

14% 12%
Vacancy Rate

10% 8% 6%

08

09

10

11

12*

* Forecast

page 2

Retail Research Report

Rents

Houston asking rents rose 0.8 percent over the past 12 months to $15.39 per square foot, while eective rents ticked up 0.9 percent to $13.15 per square foot. The strongest asking rent growth over the past year occurred in the Outer Loop West submarket, where the average climbed 3.2 percent to $12.83 per square foot. With the exception of the Southeast, where asking rents slipped 1.3 percent, all submarkets recorded gains over the past year. Eective rents for neighborhood/community centers rose 0.9 percent over the past 12 months. The average for neighborhood properties increased to $12.45 per square foot, while community centers commanded $15.11 per square foot. On average, concessions in this segment average 14 percent of asking rents. Outlook: Asking rents in the metro will rise 1.6 percent in 2012 to an average of $15.57 per square foot. Eective rents will rise at a faster clip of 2 percent, to $13.36 per square foot, as tighter conditions allow owners to pare concessions.
6%
Year-Over-Year Change

Rent Trends
Asking Rent Effective Rent

3% 0% -3% -6%

08

09

10

11

12*

Single-Tenant Sales Trends**

Despite healthy demand for credit-tenant properties, transaction velocity remained minimal over the past year due to limited inventory. The shortage of listings can be attributed to a dramatic slowdown in development during the downturn. The shortage of top-tier single-tenant deals has driven cap rates for national bank branches and top drugstore chains to the 5 percent range. Cap rates for fast-food assets vary, starting around 7.5 percent for corporate stores and pushing upwards of 8 percent for franchised locations. Some investors have begun to move down the quality chain due to the lack of available credit-tenant deals, resulting in cap rate compression. Assets with local or regional tenants often sell at cap rates in the 9 to 10 percent range. Outlook: Sales velocity will rise over the next few years as national chains increase store counts, particularly in strong markets such as Houston. The development pipeline already includes several fast-food properties and a handful of drugstores.
Median Price Per Square Foot

Single-Tenant Sales Trends

$250

$200

$150

$100

$50

08

09

10

11

12**

Multi-Tenant Sales Trends**

Shopping center investors remained focused on either end of the quality spectrum over the past year, with REITs, syndicators and private equity targeting high-quality anchored properties and private buyers competing for value-add deals. Smaller centers with elevated vacancy tend to trade at cap rates between 9 and 10 percent. At this stage of the cycle, investors stand to capture outsized returns as economic growth intensies and occupancy builds. Cap rates for well-located, anchored Class A shopping centers with a mix of national chains have compressed to the 7 percent range. Cap rates are likely to remain at reduced levels this year as demand outpaces for-sale inventory. Outlook: Listing activity will rise in 2012 as owners who purchased ahead of the downturn raise NOIs through occupancy growth, bringing values back near break-even levels. After several years of carrying these assets, many investors have expressed their intent to sell soon after their properties are re-stabilized.
Median Price Per Square Foot

Multi-Tenant Sales Trends

$140

$120

$100

$80

$60

08

09

10

11

12**

* Forecast ** Trailing 12-Month Period Sources: Marcus & Millichap Research Services, CoStar Group, Inc., Real Capital Analytics page 3

Marcus & Millichap

Retail Research Report

Capital Markets
By WILLIAM E. HUGHES, Senior Vice President, Marcus & Millichap Capital Corporation

The yield on the 10-year Treasury hovers below 2 percent as political uncertainty in the eurozone has investors ocking to the safety of U.S. bonds. In response, lenders have pushed out loan spreads by approximately 250 basis points to 300 basis points, with CMBS lenders pushing wider. Mortgage originations were up 46 percent in the second half of 2011 when compared with the same period the previous year, driven by higher activity among commercial banks and life insurance companies. Funding for single-tenant assets with credit tenants will remain plentiful this year. All-in lending rates for drugstore assets currently fall in the high-4 to mid-5 percent range, while loans for fast-food and restaurant properties price 50 to 100 basis points higher. In the multi-tenant sector, lenders are loosening criteria on anchored Class B centers and Class A strip centers. Deals under $10 million will be dominated by local and regional banks, which offer three- to seven-year, xed-rate recourse loans. In the $10 million to $20 million range, CMBS lenders and nance companies step into the picture, while deals over $20 million typically have access to a full spectrum of sources. On average, debt yields will hover in the 9.5 to 10.5 percent range, translating into LTVs of 65 percent to as high as 75 percent.

Visit www.NationalRetailGroup.com or call: Bill Rose National Director National Retail Group Tel: (858) 373-3100 bill.rose@marcusmillichap.com

Submarket Overview

Strip properties within the loop remain in particularly high demand, even aging centers with local tenants. The area, though, has a high concentration of long-time owners with little debt on their properties, restricting listings. Given limited availability, owners who do sell this year stand to achieve strong pricing. The rst phase of Tanger Outlet Center located southeast of Houston will open in the fourth quarter. The project consists of 350,000 square feet and is already 85 percent leased. The developer expects the center to be almost fully occupied when opened. Higher-growth and/or auent areas, such as Sugarland, Spring, Woodlands and Cinco Ranch, remain popular among expanding grocery chains, creating a more competitive climate for food dollars. H-E-B purchased land for a store in Spring, while Kroger will open a 100,000-square foot location at Cinco Ranch late this year. Smaller chains, such Trader Joes, are also targeting these areas for growth.

Prepared and edited by

Erica Linn Senior Analyst

Research Services For information on national retail trends, contact

John Chang
Vice President, Research Services Tel: (602) 687-6700 john.chang@marcusmillichap.com Houston Oce:

Submarket Vacancy Ranking

Rank
1 2 3 4 5 6 7 8 9 10

David Luther
Regional Manager dluther@marcusmillichap.com 777 Post Oak Boulevard Suite 900 Houston, Texas 77056 Tel: (713) 452-4200 Fax: (713) 452-4210

Submarket
Inner Loop West I-10 West Outer Loop West Southwest Southeast I-10 Far West I-10 East Montgomery County Fort Bend County Northeast

Vacancy Rate
6.6% 7.3% 8.1% 8.3% 9.7% 10.7% 10.8% 10.9% 11.0% 13.4%

Y-O-Y Basis Point Change

70 90 90 20 -120 -180 -160 -90 -60

Effective Rents
$19.17 $14.45 $11.19 $16.17 $11.29 $12.76 $10.51 $14.45 $11.87 $10.13

Y-O-Y % Change
-0.1% 0.6% 2.9% 0.4% -1.0% 0.4% 0.5% 1.5% 1.8% 1.8%

Price: $150

Marcus & Millichap 2012 www.MarcusMillichap.com

The information contained in this report was obtained from sources deemed to be reliable. Every eort was made to obtain accurate and complete information; however, no representation, warranty or guarantee, express or implied, may be made as to the accuracy or reliability of the information contained herein. Note: Metro-level employment growth is calculated using seasonally adjusted quarterly averages. Sales data includes transactions valued at $500,000 and greater unless otherwise noted. Sources: Marcus & Millichap Research Services, Bureau of Labor Statistics, CoStar Group, Inc., Economy.com, National Association of Realtors, Real Capital Analytics, Real Estate Center at Texas A&M University, Reis, TWR/Dodge Pipeline, U.S. Census Bureau.