How was leasing activity in 2017?
Karla Smith: It depends on the retail category. Some retailers are doing very well, while fashion, department stores, and others are struggling. But overall leasing activity in Dallas-Fort Worth is strong. We came out of a pretty exceptional 2016, so people probably wondered what 2017 was going to bring. But through the third quarter, we’ve seen occupancy remain the same. It’s remained steady—still above 94 percent coming out of 2016. I don’t really know of a dip in activity maybe with the exception of the big box absorption rate from this time last year, comparatively.
Frank Bullock: From the landlord side, from the [Henry S.] Miller perspective, our rents are higher than were budgeted last year. They budgeted before I got there, so it looks good for me. From the tenant side, we’ve seen fewer concessions given by the landlord just because of lack of space.
Are some different types of retail centers looking better or worse than others?
Herb Weitzman: The best part of the market is the grocery-anchored center. That property is most acceptable to lenders and banks. There’s a negative narrative about malls, and there are also some concerns about apparel and the junior boxes. If you’re doing a power center today and you have a low cap rate and high land cost, you’re probably going to have a problem. I had one of the biggest financers tell me this morning that he might not take on a power center if it had a lot of apparel in it. The market’s tight with existing space, and so I see renewals being very healthy. Tenants are renewing at a high rate, rather than moving out. They’re staying in the location, and there are good increases in the NOIs.
Eric Deuillet: In our centers, our retention rate is almost 95 or 100 percent. But I do feel like in the last six months on new deals, we’re starting to get a little bit of pushback from the tenants who are saying it’s a landlord market. I don’t know if the rates have just gotten so high that some tenants can’t sustain an increase.
Weitzman: What I think Eric’s saying there is that we need to keep rents where they are and not try to take advantage of where they might be. When you get $35-$40 [per square foot], that’s going to be a point where some people are going to be able to stay and make it and work, and others are going to have to close up. I’d rather have them making a living than giving the keys back.
Smith: That’s the big question. Where’s the tipping point? Is it trade with Mexico? Is it labor costs? What is it? And then what are we going to do about it?
Weitzman: When you get into the non-mall centers—and Terry can talk about specialty and lifestyle and so forth—the volumes are OK, but they’re not great. People don’t have a lot of $450, $500 and up [sales] per square feet tenants. Other than food. Subway and Jersey Mike’s are doing $400 to $500 a foot, but they don’t make a shopping center. And so when you look at a lot of these people, they’re between $150 and maybe $250.
Smith: I think you’re right on the grocery-anchored centers. I think the market perceives them as recession-resistant, so they’re strong.
Terry Montesi: The activity in 2017 should be bifurcated. It’s not overall great or overall bad. The toughest part of the business is conventional full-price fashion. Lifestyle centers and conventional malls are not landlords that have a lot of leverage. The tenant has leverage in that business. The active part of the business is [food and beverage], fast-casual, services, boutique fitness, and some entertainment.
Gar Herring: Agreed. You can’t broad-brush the market or even segments of it. Certainly in the mall sector, there are fewer tenants doing fewer deals at tougher terms. That’s just the nature of where fashion is. In power centers, we are excited about possibly getting a box or two back because we know we could back-fill it in with a better tenant at a better rent, and have a better overall cap rate and value for the project. I agree with Herb.
We’ve switched even more this year to accepting a lower rent for an as-is space, versus giving somebody a larger allowance to try to push up the rent. Because we are concerned, we want to keep our tenants at very healthy occupancy costs, so that if something happens in the marketplace, our tenants can still afford that rent versus coming back to us and asking for some concession when it’s really been more of our money in the deal.
What sort of activity are you expecting in 2018?
“We need to keep rents where they are and not take advantage of where they might be. I’d Rather have them making a living than giving the keys back.”Herb Weitzman, Weitzman
Herring: It’s going to be very hard to predict until you get to March, April. The Christmas cycle will show who’s going to be bankrupt, what spaces are going to be on the market to backfill, what’s going to happen with Sears. It’s very difficult in this segment to understand the supply and demand even six months out.
Smith: If the space is there, we’ll probably see a lot of discount retailer activity—TJ Maxx, Ulta, Burlington. I think it’s very cool how food is becoming the new anchor in some cases. And I would venture to say that developers are looking to get three or four unique, cultural-type concepts that could be their anchor.
Herring: In one of our projects, we have a vacant pad and I can either do a good deal with a national brand that has very strong credit, but it won’t really add a lot of excitement to our shopping center—or I can do a deal that probably has a better mix, better economics and, in terms of rent, would probably cost more.
I’m unsure if I really want to roll the dice on a new tenant to the market that may have much higher risk. All of us at this table have probably invested in a restaurant that has gone belly up—that is painful. You put out the big allowance dollars and they go bad, and everything in that restaurant has negative value.
Bullock: Here’s a specific war story. The ownership at Pepper Square is fairly conservative. We have this great spot on Preston Road, 6,500 feet, and we have four or five restaurants all fighting for it. Great brands, great operators, restaurants you want to put in your center. They all wanted $50-$60 a foot in TI. We put Pet Supplies Plus in there. We changed the $60 to $150 feet of restaurant for a very good quality tenant that just has great sales and great profitability. Why throw out all this dough just to be cool?
Weitzman: Gar, are you getting the restaurant to put in cash to put in all their equipment? So if they leave, at least have a second generation?
Herring: We found that the second-gen is worthless. In a large boutique restaurant, they want their own layout, system, [furniture, fixtures and equipment], presentation, signature. Literally everything in [the first gen-space] has a negative value. They want to gut it and tear it out. Then they want new money on top of that.
Montesi: There will be continued pressure on full-price fashion and department stores, upward bullet on F&B, upward bullet on services, fitness, entertainment. We’re looking at some food hall configurations and they are a little more costly than a restaurant, but you can have more upside if they work. For restaurants, if you’re doing it right, we consider it a buzzkill to do a full-service restaurant that’s a national chain.
Whereas 10 years ago we would’ve loved to have had a PF Chang’s deal. Today if we have to do a PF Chang’s, we think our real estate’s not good enough. There’s going to be continued fear in institutional markets around anything that has retail around it. Now, my other forecast is, that would create opportunity because we haven’t had enough fear in the market the last seven, eight years to have created any opportunity.
I kind of like it when there’s fear because that causes people to paint retail with a broad brush. Whereas maybe two-thirds of the properties should be painted with that brush. A third of them maybe not. And if you can invest in that third at a discount, I think ’18 could be an interesting opportunity.
Herring: I concur with Terry. Grocery-anchor retail has the most risk exposure over the next few years in that it has the most similarities to disruption in the mall segment over the last five years. Years ago, we said people want to be at the store. They want that customer engagement.
They want to feel the merchandise and try it on. And the reality is, there’s been very little e-commerce activity in that sector. And it’s caused major disruption. When you look at how we’re going to be shopping for our groceries in the next two to three years–the vast majority of people are no longer going to be spending two hours a week at the grocery store. What’s that going to do to their format and their layout and their traffic? There’s a lot of risk in that sector.
We’ve seen a lot of grocers come to North Texas or say they are. How is that impacting the market?
Smith: There’s been a lot of talk about grocers coming—in my mind that’s H-E-B and Lidl. Neither one of them are here yet. So what’s that mean that they’re talking about coming? I don’t know. If H-E-B comes, it certainly changes the total grocery landscape dramatically. But everybody else we know is pretty much slowing down. Kroger’s slowing down, Walmart’s slowing down. There are no new Trader Joe’s planned. I don’t know that we’re ever going to have a lot of grocery activity. We were tracking about 70 grocery-anchored centers in DFW in ’15 or ’16. Now we’ve got 40, and half are H-E-B.
Deuillet: We’ve got some land under contract with Lidl, and it’s getting close to closing. After getting to know them better and talking to them about other properties, I know the stores that have already opened are supposedly undercutting competitors by almost 30 percent in organic food sales.
Montesi: I think the grocery business is a proxy for the rest of our business. The stuff in the middle is really troubled. Both low- and high-price tend to be healthy and active. The stuff in the middle is really troubling. That’s usually things like Safeway, Tom Thumb, Kroger, the conventional grocers. Central Market in Fort Worth just continues to rage.
I was very excited as a Whole Foods developer to see Amazon acquire them, because overnight they became perceived as high-quality and low-price and they used to be perceived as high-quality, high-price. What an amazing overnight transition of brand voice. And they did lower a number of prices in the store, so it’s at least partially true.
Smith: I think that has spooked the grocers too.
Montesi: Look at what Safeway and Kroger stock did the day Amazon announced it was buying Whole Foods.
Herring: We’re in a world where Amazon says, “We’re maybe thinking about prescription drugs.” And those stocks tank the next day.
Weitzman: Retail has moved into experiential. However, we’re now moving to a new word: adventure. That’s where it’s fun and the merchandise is new and it turns quickly. Trader Joe’s fits into that category. They have new things on the shelf all the time. TJ Maxx—that’s why they’re doing so well. To send somebody through a store to look through all the aisles and see the same old merchandise over and over again, they’re not going to get the repeat customer.
Montesi: TJ, Burlington, Ross, and Marshall’s are all a treasure hunt. What’s so interesting about those—many of them do 0 or 1 percent of their overall sales online.
Which projects have impressed you in 2017?
Weitzman: Legacy West is without a doubt the biggest and most fascinating project that has opened in ’17. There are a lot of urban redevelopment projects, but nothing holds a candle to Legacy.
Herring: They put thought into getting food and retailers that may be more internet-proof—a new Barnes & Noble concept that feels more like a restaurant. The food hall will be the most fascinating experiment to follow, with a landlord-tenant relationship that’s more of a partnership than a lease.
Bullock: You walk down that street at Legacy, which I did last week—at 98 degrees outside—showing a 4,500-foot fitness guy from California around. He freaked out at what they saw. That was really pretty neat. We as brokers, landlord reps, or even as tenant reps have to become more marketers and better salespeople, rather than commodity fillers.
Montesi: Storyteller. Storytelling for a grocery-anchored neighborhood center is less important than it is for a large, new mixed-use neighborhood. Because Legacy West is not a retail project. It’s a mixed-use district of significance.
Montesi: Another is The Star. And then Victory Park, Design District, Trinity Groves, West End, that zone is sort of an extension of Uptown. Victory’s been really interesting because we signed five local F&B folks. We’re doing a bunch of fitness and service uses also. People are really responding to that. When you combine that with the rebirth of the West End and continued development west of the [Margaret Hunt Hill] Bridge, and the Design District, that zone has a lot going on.
Bullock: That’s why I’m so fascinated by the districts we have now. Finally, we’ve become a city. Even the Cedars—they’re a little farther out, but gee whiz.
Smith: I was surprised by the North Fort Worth corridor. You had Trademark and Hillwood centers there for a long time with the Alliance Town Center.
Then all of a sudden you get a Costco and a Target, and the whole thing blows up. Now you’ve got 70 acres already developed on the west side and it’s moving up north to Artemio [De La Vega’s The Citadel] deal and it’s moved up to Tanger Outlet Mall. It’s just on fire.
Bullock: There’s nothing but rooftops out there.
Deuillet: Corporations that have been moving here talk about how they’re moving from California or New York, and Dallas is kind of stale. We didn’t have an identity and we’ve kind of started building one with Klyde Warren Park. Dallas has an identity and it’s making people actually want to stay here instead of move here [just] for their job.
Montesi: We’re so desperate for places of character, and Dallas is really short on that.
What does the so-called retail apocalypse look like in Dallas?
“We can deal with really good news and we can deal with really bad news, but uncertainty is toxic to any transaction.”Gar Herring, Mgherring Group
Bullock: I think 2018 is going to be very strong. We are a very rare cone of security because of the Texas economy and the fact that we’re pro-business, pro-growth. The lenders aren’t going to let the developers go crazy. I don’t see an apocalypse.
Deuillet: I see construction costs keeping development down: the [Class] A’s leveling off their rates, which will cause people to go to the [Class] B’s. The B’s are already thriving, but they may be able to bump their rates a little bit. These neighborhood centers were putting churches and bounce houses in their big boxes 10 years ago. Now we’re moving them out for these tenants that can’t afford the A’s. They’re moving to the neighborhood centers. So I don’t see a crash at all. If anything, it’s just going to be leveling off.
Weitzman: Most of the real estate recessions have come about because of excessive over-building. And we don’t have that. I don’t see the near-term prospects of that because the banks, on their own this time, are really cutting back.
Bullock: The lenders are out there, but so is the equity.
Herring: Nationally, I think the narrative will only get stronger in 2018, especially as retailers go bankrupt over the Christmas season like they have for decades. I believe one of the best days in our industry from a mall perspective will be the day that Sears finally goes bankrupt. We all can deal with really good news and we can deal with really bad news, but uncertainty is toxic to any transaction.
The unknown of where they are makes it almost impossible to deal with any property that they’re a part of. It’ll be good news when you start to finally get resolution of what they’re going to be next, whatever that is. We’ll continue to have disruption with a lot of major tenants due to internet-related activities. But that what angers me most—they think that we’re all just dodos in our industry who just sit around. People in our industry are creative and innovative, on both the landlord and retail side. We’re adaptive, and we will figure out how to continue to improve our properties.
The idea that suddenly every shopping mall is just going to cave in on itself and just be this vacant blight on our city—this apocalyptic world of the future—that’s frustrating. We will see the continued failure of malls, simply because the debt that they put on them five, 10 years ago is coming due and can’t be refinanced. But we’ll find ways to work through that. Look at what’s happening with Collin Creek, Vista Ridge, Valley View, and Red Bird.
Montesi: I think there is going to be a selective retail apocalypse. And you’re seeing this rapid transformation—it is by far more rapid than it’s ever been, and I don’t personally think that it’s going to slow down. But it depends on your perspective and how you’re prepared for it. We have too many square feet of retail.
Y’all listed some examples of malls that are going away or should go away. But I think you’re going to see lots of strip centers that got built for the wrong reasons during an era where we had a rapid consumption mindset. I expect to see a lot of those retail projects become other things or revert back to land. I do think e-commerce, as Herb mentioned—supply has stayed restrained. I don’t think it’s all rosy.
I think it’s rosy for some products and some locations, and I think it’s terrible for some. It’s an interesting, crazy, tough time to be in our business, but we’re leaning in, because we think that the institutional market is going to be more fearful, and when they’re more fearful they’re going to want help. They’re going to be less likely to do it themselves or do it with generic providers. They’re going to want interesting, vested partners that are trying to stay ahead of this rapid change.
Bullock: Terry, are you saying a selective apocalypse for DFW or, Texas, or the nation?
Montesi: All of the above. To paint DFW as always hunky-dory because we have job growth—no. I can show you a bunch of retail projects whose ability to lease in the future is going to get harder and harder. And I can show you many that aren’t.
Which submarkets are you bullish on for 2018?
Bullock: The districts surrounding downtown.
Herring: Frisco will be very fascinating with Legacy West, The Star, and Wade Park.
Montesi: I heard that there are 35,000 restaurant seats planned, under construction, or just opened in the $5 billion mile.
Deuillet: There’s always a wave, and pull backs. It used to be a run back to the [I-635] loop if things die. Maybe the new loop is George Bush. Richardson’s already seen it, but maybe Carrollton/Farmers Branch/Grapevine is a new ring. In my business lifetime, I’ve been in on a lot of the deals where it’s the stuff everyone’s passed over. We buy it cheap, and then when the market comes back, everybody floods back, and we’re sitting there holding. It’s worked out every time. When the market’s hot, everybody’s hitting home runs. When the market cools those people that are getting $40 or $50 rents and putting in way too many restaurants, they can’t sustain it. Where we’re the ones sitting there saying, “Come back. We’ve got $18 rents. We’ll take you.”
Weitzman: The best investment in the whole industry is 15,000- to 20,000-foot strip centers.
What deals or developments stick out in 2017?
Smith: I was surprised by the 70-acre IKEA purchase in Grand Prairie.
Herring: When does Cinépolis open in Victory?
Herring: That’s a big transaction that’s going to be really interesting, where [Victory Park] used to be a mess and now it’s coming back.
Montesi: We haven’t ever had anything like Texas Live! [in Arlington]. That’s a big deal with the Loews Hotel.
Smith: One more for ’17 is Collin Creek.
Bullock: Grandscape out at the Nebraska Furniture Mart has probably four or five brand new retailers that have never been in Texas.