After last year's boom, retail development in the Southwest is enduring the inevitable growing pains that follow the introduction of 20 million sq. ft. of new space. Easing the discomfort of rising vacancies and flat rents is the promise of a steadily growing consumer base.

According to the U.S. Census Bureau, the populations in three Southwestern states — Arizona, Nevada and Texas — are outpacing the national average of 1.2% per year. From April 2000 to July 2001, Arizona grew 3.4%, Nevada grew 5.4% and Texas grew 2.3%. Each of these states is projected to double its population in the next 36 years. New Mexico trails with 0.6% population growth.

What's more, the housing units in four of the five Southwest states grew by double digits in the past decade — 37% in Nevada, 24% in Arizona, 19% in New Mexico, and 14% in Texas.

New industry, lower housing costs and a better quality of life are factors drawing new residents to the Southwest, says Larry Feldman, president of Phoenix-based Feldman Equities Inc. “The commute for the worker is much shorter,” he says. “And employers have 365-days-a-year business — no hurricanes, no snowstorms, no fires, no tornadoes. We've been in this market for almost 20 years, and it continues to break housing records year after year; the population surges keep coming.”

And big-box retailers are lining up to take money from Southwestern consumers. Kohl's unleashed a blitzkrieg, opening 13 stores in Houston on a single day, then moving on to conquer Phoenix. Barnes & Noble followed suit.

Such massive rollouts have fueled the Southwestern mall machines for the past year, but the wave of development opportunities may have already passed, says David Deason, a vice president with Barnes & Noble. “Look at Phoenix right now; we have about six or seven stores that will have opened up in 18-24 months, but there may not be another opportunity for three years.”

Another result of the growth spurt is higher prices. It's becoming extremely difficult to find affordable property in most of these markets, says Drew Alexander, president of Weingarten Realty Investors, a Houston-based REIT with a 27 million-sq.-ft. portfolio. But Alexander says that rents are rising accordingly, adding that the Southwest “has some of the strongest rent performance in our portfolio.”

With a continued weakness in the rest of the Southwestern commercial markets, retail has become a leading investment vehicle. “There is generally a voracious appetite for retail,” says Adam Howells, a director with Holliday Fenoglio Fowler in Dallas. “The grocery-anchored center has traditionally been a preferred asset type, but over the last 6 to 9 months power and lifestyle centers have become increasingly desirable — especially well-located centers with long-term leases.” Dallas and Houston are the preferred markets for investors, he notes.

What property types are selling? “People are very into going back to basics,” says Alexander. “Supermar-ket-anchored centers are very well thought of, selling at record-low cap rates or record-high prices. Right on their heels are centers with good discount stores and more value-oriented retailers, like Marshall's or Ross.”

Arizona

More than 6 million sq. ft. of Arizona desert was turned into retail GLA in 2001. Several large developments sprang up in Phoenix to capitalize on Maricopa County's exploding population (a 44% increase since 1990), including Desert Ridge Marketplace and Chandler Fashion Center. These two behemoths made up 35% of the Phoenix market's total 5.6 million sq. ft. in retail completions for the year. Though both projects opened doors at the nadir of post-9/11 consumer confidence, management at both properties says sales figures are satisfactory. Phoenix's 2002 completions also include 25 new grocery-anchored centers, according to Integra Realty Resources.

This glut of new space isn't doing much to hurt the city's vacancy rates — which Marcus & Millichap predicts will rise to 9.2% from 9.0% in 2001. The firm predicts a substantial slowing of Phoenix retail completions in 2002 (to an estimated 1.5 million sq. ft.) will enable the market to maintain its average rental rate of $15.94 for another year.

Owners, however, say rents are moving up — a bit. “We own a neighborhood center in Phoenix and a mall in Tucson, and we've seen modest upticks in rent — unlike offices, which have declining rents,” Feldman says. Those upticks are “a couple of percent a year,” he says. “But if you buy at a 9% cap rate you make a lot of money with 2% rent growth at today's interest rates.”

Phoenix is feeling some pain nonetheless. Developers and brokers busy filling 250,000 sq. ft. recently vacated by three Big Kmart stores are finding big-boxers prefer setting up shop at new centers to avoid retrofitting complications. And Feldman says additional retail growth may slow because construction lending is getting tighter. “You can't get any money on a pure spec project; you need at least a grocer (for a strip center) or one or two big boxes to start a power center; and of course, a mall needs anchors,” he reports.

Tucson, which acts as the hub for the state's southern region, is home to a population that is growing at an estimated annual rate of 2.04%, according to Integra Realty Resources. Currently numbering 8.53 million, the market's consumer base continues to attract expanding retailers such as Target, Home Depot and Office Max. Kohl's, in particular, is circling space in Tucson after its recent successful entry into the Phoenix market.

Due to a falling number of new home permits and a 4% decrease in retail sales growth, several projects planned to open in 2001 have still not started construction. More than 1.2 million sq. ft. of retail space, including the proposed Steam Pump Village and River Crossing, is currently stalled due to a dearth of pre-leasing to tenants. According to Integra Realty Resources, Tucson completions for 2002 will total 180,000 sq. ft., significantly lower than 2001's 630,000 sq. ft. Even with this construction slowdown, store closures and some vacant multi-tenant space pushed vacancy rates up 1.3 percentage points, causing rents to grow by only 2.1% to $15.01, according to Marcus & Millichap.

Nevada

Nevada is one of the Southwest's biggest growth spots, with Las Vegas continuing to attract visitors and new residents. The Las Vegas Chamber of Commerce claims the city was the fastest growing metro area in the United States in the 1990s. The city has ranked first nationally in employment growth since 1995, according to the Arizona State University Economic Outlook Center.

“The retail market is on fire, with the big REITs like Weingarten and Pan Pacific continuing to move in,” says Chris C. Waizmann, vice president with the Reno office of Dallas-based Trammell Crow Co. “I'd say right now it's No. 2 in the nation after Phoenix.”

Weingarten's Alexander agrees that “Las Vegas is quite strong.” Tourism is returning to normal, with local passenger enplanements/deplanements up to 90% of pre-9/11 levels, according to Marcus & Millichap.

Of course, with 10.5 million sq. ft. of new space delivered between 1999 and 2001, the Vegas market has gotten more competitive. A crowded playing field will keep a lid on asking rents, according to Marcus & Millichap, which says average rents will inch up to $18.56 per sq. ft. over 2001's $18.41 per sq. ft.

Developers are eyeing the outer loop of the Las Vegas Beltway for sites, while fast-food and drug chains are seeking single-tenant net lease deals to expand, Waizmann says. Retail sales on The Strip continue at a frenetic pace. Simon Property Group is moving ahead with plans for a two-phase expansion that will increase The Forum Shops at Caesar's by 200,000 sq. ft. by 2004. Across the street, Trizec Properties recently inked several new leases at its troubled Desert Passage property. Hilo Hattie, ABC Stores, Georgiou and Anna-Bella are among the retailers opening doors at the 475,000-sq.-ft. center, whose Alakazam Food Court will be reborn as Sevilla, a 34,000-sq.-ft. Spanish steakhouse and nightclub. The Rouse Co. is expanding its Fashion Show Mall to 1.8 million sq. ft., bringing in new anchors Bloomingdale's Home, Nordstrom and Lord & Taylor.

All this action by major developers is squeezing smaller players. “The smaller developers are not doing as well,” Waizmann says. “Land has gotten so expensive it's hard to make deals pencil.” Still, he notes, Vegas has a lot more land than Reno does, with an existing beltway that can “open up a whole new bunch of doors in the market.”

Reno, though not as much of a boomtown as Vegas, has seen steady growth, says Waizmann. “We've got about 1.5% to 2% annual growth,” he says. “It's been very healthy, due mostly to an influx of Californians from the Bay area and southern California. Housing costs here have been going up quite a bit, but Californians see them as a bargain.”

Retailers in Reno have been taking advantage of a previous lack of product. “We're starting to see a lot national tenants come into the market,” says Waizmann. “There's a huge influx of food retailers, including Starbucks, with seven locations — all built in less than four years; Jamba Juice, which just opened its first outlet; Panda Express; Baja Fresh; PF Chang; Mimi's Café; and Claim Jumper. There's a whole slew of casual dining here now; pretty much everyone is in this market.”

As for the big-box retailers, Reno now has three Wal-Marts, including a Wal-Mart Supercenter with a grocery; two Lowe's; and the first Greatlands, which opened in October. As for soft goods, Ross, Borders, Barnes & Noble and “all the office supply and pet store guys” have opened in the Reno market within the past five years, Waizmann reports.

New retail sites are becoming scarce, however. “If there was more land, the retailers could lease the space,” Waizmann asserts. “There are still quite a few tenants looking to move into the market.”

New Mexico

New Mexico has also experienced a strong retail market. In fact, gross retail sales for the state have increased nearly 40% in the past five years, from $14.7 billion to $20.5 billion, according to the New Mexico Taxation & Revenue Department. Some of the largest sales categories in 2001 were retail food stores — $2.2 billion; furniture and appliances — $1.6 billion; and general merchandise — $1 billion. Department stores generated $774 million.

Per capita personal income has also grown substantially, nearly doubling in the 1990s, from $14,960 in 1990 to $27,511 in 2000, which bodes well for retail sales. “Things are quite strong in New Mexico,” Alexander says. “We have five properties in Albuquerque; it's a good market for us. We have very good occupancy there, and we continue to see positive rent growth.”

“We recently repositioned a store in Albuquerque, but nothing else is on the drawing board at all,” says Barnes & Noble's Deason. “However, that doesn't mean it's a bad market. If there was a submarket trade area we identified that met our needs I'd say ‘Put another store in.’”

Texas

In 2001, the Dallas/Ft. Worth metroplex led the nation in retail space completions, with 8.8 million sq. ft. of new space. Houston saw a similar glut of new developments, with more than 4 million sq. ft. opened for business the same year. Much of this space consisted of pre-leased big boxes and new regional malls such as Taubman's The Shops at Willow Bend in Plano.

According to research from Marcus & Millichap, both cities are seeing a significant drop in construction for 2002, with only 3 million sq. ft. planned in Dallas and 2.5 million sq. ft. in Houston.

“The most significant aspect of all the new retail space to be completed and opened in Houston in 2002 is that 90% of it will either be developed, constructed, leased or owned by or for major chain stores,” says E.D. Wulfe, president of Houston-based brokerage house Wulfe & Co. “There will only be 10% worth of speculative space constructed in 2002, which is minimal and very conservative and fiscally responsible.”

The slowdown in construction comes just in time, as both markets absorb empty space abandoned by bankrupt retailers Kmart, Service Merchandise and Factory 2-U. Houston's 2002 excess space includes more than 1.5 million sq. ft. left behind by these big-box casualties. And those big-boxers that are expanding prefer new space to recycling dead sites. According to Wulfe, Wal-Mart opened seven 200,000-sq.-ft. Supercenters and three Sam's Clubs, Target opened five super concepts, Kohl's opened 12 86,000-sq.-ft. stores, Sears Great Indoors opened two stores, Lowe's added three home improvement centers and Home Depot opened one store in Houston this year — all in new space. Marcus & Millichap predicts such activity will push vacancy rates for 2002 to the high levels of 11.2% in Dallas and 12.9% in Houston.

Supermarket chains account for 16% of Houston's new retail construction, Wulfe says. “Fifteen new supermarkets will be constructed and opened, with H.E.B. to open five, Randall's to open three and Kroger to add two new ones. In addition, Wal-Mart will open five of their new neighborhood supermarkets.”

But none of these expanding grocers will compare to Houston market dominator Kroger, Sears says. “Kroger just bought 16 Albertson's stores when they left the market, and they were already No.1 before that.” His firm has two Kroger-anchored projects under construction in the market, and three more planned for 2003.

As the cities battle vacancies and weak leasing activity in 2002, Dallas and Houston will only achieve inflation-like increases in rental rates, according to Marcus & Millichap. The firm predicts that Dallas rents will rise to $13.73 per sq. ft. over $13.46 in 2001 and that Houston rents will rise to $17.97 per sq. ft over $17.79 in 2001.

Steve Lewis is an Atlanta-based writer.

Southwest markets by the numbers

Dallas-Ft. Worth
1999 2000 2001 2002*
10.7 10.7 11.2 11.7 Vacancy rate (%)
12.82 13.20 13.46 13.73 Annual asking rent ($)
11,610 7,630 8,820 3,198 Total retail completions (sq. ft.-000s)
3.7 3.8 0.7 -0.3 Employment growth (%)
3.1 3.1 4.4 6.0 Unemployment rate (%)
Houston
11.0 10.8 12.9 13.9 Vacancy rate (%)
17.11 17.79 17.79 17.97 Annual asking rent ($)
3,923 4,534 4,188 2,539 Total retail completions (sq. ft.-000s)
1.8 2.5 1.8 0.0 Employment growth(%)
4.5 4.1 4.2 5.2 Unemployment rate (%)
Las Vegas
7.2 7.5 8.5 8.5 Vacancy rate (%)
17.49 18.12 18.41 18.56 Annual asking rent ($)
4,016 3,576 2,909 2,016 Total retail completions (sq. ft.-000s)
7.6 5.5 3.6 0.3 Employment growth(%)
4.4 4.2 5.2 7.4 Unemployment rate (%)
Phoenix
10.0 8.1 9.0 9.2 Vacancy rate (%)
15.33 15.94 15.94 15.94 Annual asking rent ($)
3,311 2,670 5,678 1,500 Total retail completions (sq. ft.-000s)
4.6 3.5 1.1 0.0 Employment growth(%)
3.1 2.7 3.8 5.4 Unemployment rate (%)
Tucson
6.1 5.5 6.8 6.2 Vacancy rate (%)
14.09 14.43 14.73 15.01 Annual asking rent ($)
450 600 648 180 Total retail completions (sq. ft.-000s)
3.8 4.0 0.1 0.1 Employment growth(%)
3.1 2.8 3.3 4.4 Unemployment rate (%)
Source: Marcus & Millichap. * forecast