2015 Texas Midyear Review, Part I

Of the 3218 counties in the US, only 65 have fully recovered from the recession. By “recovered”, we mean that employment is back to prerecession numbers, GDP is same or better, and real estate values are at or better than prerecession. It’s important to understand this context when talking about the market in Texas, where all of our major metros have recovered and surpassed prerecession benchmarks.

Over the next few blog posts, I thought it would be appropriate to review the fundamental numbers of each major Texas metro. This piece will focus on Austin.

Jobs

The economic success of Texas and it’s major metros stems from robust job creation. The state’s economy gained 276,400 nonagricultural jobs from June 2014 to June 2015, an annual growth rate of 2.4 percent compared with 2.1 percent for the United States.

Austin added 32,200 net new jobs, or 3.5%, in the 12 months ending in May 2015, making it the eighth fastest growing major metro in the US. Travis county has the third best growth rate for counties over a million in the country.

May’s 2015 year-over-year job growth is higher than any month since last October 2014. In the same time frame, the number of unemployed has declined by 10,039 or 23.3%. At 3.2%, seasonally adjusted unemployment is at its lowest level since before the early 2000s “dot-com” recession for the city.

Single family residential

June 2015 MLS statistics

  • 3,051 – Single-family homes sold, five percent more than the previous year in June 2014 and an increase from May 2015 of almost 300 units, a 9% increase.
  • $272,250 – Median price for single-family homes, eight percent more than June 2014. Not varying much from previous month, only $2500 more.
  • $333,866 – Average price for single-family homes, two percent more than June 2014. Due to more inventory in lower price points we saw average values decrease this month ($15,000) from the previous month.
  • 42 – Average days on market, a continued sign of a healthy market. 24 days better than the nations average.
  • 3,812 – New single-family home listings on the market, three percent more than June 2014. Down from the previous month. For a population of close to two million in the metro, these is not enough to keep up with demand.
  • 8 – Months of inventory of single-family homes, unchanged compared to June 2014. It continues to be a sellers’ market, with little room for negotiation on asking values.
  • $1,018,625,166 – Total dollar volume of single-family properties sold, eight percent more than June 2014. This is the first time ever of over a billion in home sales in the Austin area.

Multifamily residential

For a number of years now, occupancies in central Texas have stayed at a very healthy 93 – 96%. At the end of June 2015, occupancy stands at 93.6% Equity and investors have aggressively pursued product in this market, which is one of the reasons multifamily sales and construction have been so strong.

Rent values continue to increase, even with over 16,300 new apartments brought to the market in the last two years. Average rents have grown more than 32 percent in the same timeframe. With the number of units brought to the market, you would think occupancy and rent values would drop. Yet the market has absorbed all new units, and is clamoring for more. The strength of this market has helped investors in all classes of residential investments. Sales have been brisk, with most well valued properties receiving multiple offers.

Strong demand combined with the slower entitlement process for real estate development has heightened demand for housing. The undersupply of housing is elevating both single-family home prices and apartment rents. Since 2007 the median single-family home price rose 37+/-% and is one of the reasons a large share of the metro’s sizable young-adult population are pushed to the suburbs, unable to purchase homes in desirable areas. This, in turn, is driving demand for area apartments in CBD and inner ring neighborhoods.

Retail

Deliveries of new retail in Austin will be below the past three years’ retail boom, as builders bring just 500,000 square feet of retail space online during 2015. Last year, retail developers completed 726,000 square feet of retail space in the five county Austin area. During the last four quarters retail developers completed approximately 370,000 square feet of retail space, including 35,000 square feet of space brought online in the first quarter of 2015

The largest concentrations of new retail were 90,000+ square feet of space concentrated in the Cedar Park area. South Austin followed, with nearly 70,000 square feet of space. The largest project under construction in the Austin metro is the 82,000-square-foot retail portion of South Lamar Plaza in South Central Austin. The retail portion is scheduled for delivery midyear and consists of retail, restaurants and theater space already open. The mixed-use project also contains apartments.

Strong preleasing and rising demand from retailers to expand in the market kept occupancy above 95%, continuing the trend of the last three years. These numbers are dramatically better than the rest of the nation and reflects the strength of the market locally. Tightening conditions in the metro and a lack of new supply coming online will contribute to asking rents rising 3.5 percent to $18.89 per square foot this year. Average asking rents grew 2.8 percent in 2014.

Competition for single-tenant assets remains fierce, forcing some buyers to shift their focus to two- to four-tenant strip centers, leased by na­tional and regional credit tenants, on outparcels of anchored developments.

Office

Approximately 2.9 million square feet of office space will come online in 2015, up from 1.1 million square feet last year. The three largest office buildings that opened during the first quarter averaged 78 percent full. This aggressive preleasing shows the huge appetite for office space in the Austin metro. Strong net absorption is projected to continue this year, tightening vacancy and lifting market rental rates.

Despite the surge in deliveries throughout the metro this year, which will reach 3.2 million square net absorption feet in 2015, occupancy is still around 88%. Asking rents will advance 4.8 percent in 2015 to $29.43 per square foot citywide. Last year, rents increased 4.3 percent.

Forward

The Texas metros have been blessed in their recovery from the recession with some of the shortest turnaround times in the nation. Locally and regionally we sometimes forget that and think the rest of the nation must be doing just as well.

We are over three and a half years into this positive market. Six years is the longest positive run I’ve seen in my 35+ years in the region. With job creation and demand continuing, Texas still has a ways to go for supply to catch up to demand. It’s not bragging, just facts.

Hopefully, these numbers will convince you of the robustness of the Austin market. We will visit Dallas and San Antonio in the next few installments.

 

 

A look at the Austin economy

The Austin economy has outperformed the US economy for several years. We wanted to examine the strengths and weaknesses of the Austin economy, and determine where we are headed in the future.

Let’s start with apartments, which have been very attractive to investors over the past three years.

Austin was one of the first markets to see apartment construction return after the recession. Job creation and population growth have strengthened apartment and new home demand dramatically. Over the longer term a surge in apartment deliveries should lead to an uptick in vacancy, however vacancy rates have remained very low as the new supply is absorbed by the market.

At the end of 3rd quarter 2013, there were 145,099 rental units, with 95% occupied, leaving 7,105 units available, and an additional 10,000 units under construction to be completed in next 12 months, giving us 17,105 rental units available.

Once built, these newly delivered units will increase the supply of Austin apartments by 7%. In addition, there are over 36,000 apartment units in the development pipeline. We may be at a tipping point in apartment development. The substantial apartment revenue growth, which is what had attracted apartment developers and equity to Austin after the recession, has begun to slow. In 3rd quarter 2013, Austin saw annual revenue growth of 4.1%, compared to 8.9% just two years ago. Driving that decline was a slowdown in rent growth. In 3rd quarter 2013, year-over-year rent growth measured 4.2%. Though healthy, that was down 3.0 points from a cycle peak in 4th quarter 2011.

Occupancy has remained healthy at over 95% for the last couple of years and should maintain that with continued great job creation (particularly in the higher paying jobs). One thing that has driven the rental market was the lack of inventory in for sale homes. We have added 75,000+ new jobs since the beginning of 2008; Austin’s employment base has expanded by a nation-leading 9.7%. Due to the recession and the lack of lending, there was not enough shelter (rental or for sale) for the new arrivals. The lack of resale and new home inventory drove those people to new apartments. As new home and resale inventory ramp up to meet this need, it should affect rental growth and sales.

Apartment sales have remained healthy over the last few years due to the strength of the rental market. During the last year, competition among the large REITS and institutional investors drove cap rats for large well located assets in the low 5 percent range, the nirvana cap rate for most apartment investors. The upturn in lending rates has not yet affected the desired cap rates as many of the properties bought were Class ‘A and B” built in the 1990’s offering upside potential. Most apartment brokers and investors will tell you that they anticipate continued strong activity for a couple of more years. As rates increase it will put added pressure on Class ‘C’ apartment complexes as cap rates should move above 6%.

The multi unit rental will need to bear watching as the inventories and employment growth change over the next couple of years.

Housing inventory continues to be challenged in keeping up with demand. There will be 9,200 to 9,400 starts this year. There should have been 15,000+ last year, and another 11,000 this year based on current employment numbers, yet we are 8,000 home starts short with the inability to address new developed lots to decrease pressure off of new home demand. There are 5,536 active listings in Austin MLS.

Starts and listings are where we are challenged. Almost every one of your desirable inner core (Tarrytown, Barton Hills, Northwest Hills, etc.) and suburban neighborhoods (Circle C, Avery Ranch) are extremely tight for inventory, causing record appreciation. I would say that new and resale market is around 5227+/- units short for just this year.

Because of the increase in demand, Austin homes have become some of the most expensive in the state. This should be somewhat of a concern, as we continue to compete with other metros on cost of living. Steady appreciation should continue in most neighborhoods through 2014.

Where do we stand overall for shelter needs in Austin?

17,105 rental units available
9,400 starts
+ 5,536 listings =
32,041 units available with current numbers and no more people moving here.

There have been around 60,000 people moving per year for the last three years. It has slowed a little, but we still don’t have enough shelter. Remember we have over four years of catching up on total units needed, plus what we need currently.

Rentals are caught up, with over 35,000 in the development pipeline, and the amount coming on line the next two years ( 18,000+)

Apartment occupancy per submarket in Austin:

Bastrop (97.3%)
Williamson (95.05%)
North (88.87%)
Southwest (94.87%)
Cedar Park/Leander (89.35%)
Northwest (91.32%)
CBD (90.27%)
Far NW (96.5%)
NWH (96.22%)
Southeast (84.44%)

What is current lot availability in the Austin area? Even with over 6,800 new developed lots brought to the market this year, new lot inventory continues to be challenged to keep pace with demand. Austin has a 1,000 fewer lots than we had a year ago, now 14,417 according to Metrostudy. This is the tightest we have seen the lot market in over ten years. With nearly 9,000 starts last year and 9,400 this year and only 7,500 lots in the delivery process, the number of lots will not keep even with demand. The result of this, is higher land, lot and labor prices. As higher lot pricing results in new home pricing in many areas we expect some push back from the consumer who will be forced to the resale market or more affordable locations.

Where are most of the available entitled lots located? What areas of Hays, Williamson and Travis County are primed for growth and further development? Available and marketable would be a better question. Those areas that have the most available presently are the least desirable.

Entitled, undeveloped lots
Over 7,000 in Bastrop County
Over 7,000 in Buda
16,000 in NE Austin / Manor
2,000 in NW Austin
7,000+ in SE Austin
8,000 in Georgetown
4,000 in Hutto
5,000 in Kyle
8,000+ in Leander
6,000 in Pflugerville
9,000 in Round Rock
5800 in San Marcos
30,000+ in unincorporated Travis County
11,000 in unincorporated Williamson County

There are over 150,000 entitled undeveloped lots in the five county area

The forecast for 3.0 to 3.2 percent in annualized GDP growth reflects a level strong enough to expand employment by approximately 23,000 new jobs, down from previous years. Unemployment, however, is expected to remain in the low-5% percent range. Total employment for the metro now sits 5% over prerecession peaks. Austin maintains a healthy growth remaining in the top ten job growth areas in the country.

On a state basis, the continued federal budget impasse will cloud government employment growth for a while. Sequester and budget cuts have affected 90,000 jobs in defense in Texas. Ask the Realtors in El Paso, Killeen and San Antonio if they have felt the difference.

What about other real estate channels?

Office continues to improve. Austin’s high tech heritage has been rooted in manufacturing, (IBM, Dell, Samsung, AMD, etc.) This side of the industry is having major shifts as evidenced by AMD and Freescale downsizing this year. However, the ‘soft-tech’ side has more than picked up the slack with strong growth (“soft tech” is IT management, software design, computer engineering). Speculative development has begun to reemerge in the traditional areas (CBD, NW corridor), but it will be at least twelve months before many of these begin to show an effect on inventory. During this period, employers will be challenged to find large available contiguous spaces, which may hamper moves from other states.

The office channel is now different in its attraction of major investors brought by the continued booming economy and lengthy development cycle. Most major investors and REITS continue to focus on Austin on the Class A and B space in the CBD and other traditional business core areas. Rents continue to improve and should maintain with the limited amount of new construction and the new medical school and center coming on line.

Retail has had a great year in Austin. The market’s favorable demographics and high paying jobs growth continue to attract major retailers here. Home sales have had a positive effect with more sells of appliance and home goods. Austin has been a bright spot for most national and regional retailers due to the strong job growth. Rents continue to improve, and improved occupancy is apparent when driving around with many more store fronts open. Developers have moved over 700,000 square feet into the development pipeline which will slow down interest as the market sees if it can be absorbed. Outer rim neighborhood community centers are still in the double digit vacancy rate area, slowing interest from most investors in those areas. The lack of retail development over the last few years has allowed single tenant and multi tenant sales to improve. With little development apparent in the pipeline, inventory will be tight for buyers.

Austin’s demographic trends will continue driving economic growth, which will support near- and long-term residential, office, retail and industrial space demand, presumably for the next 3 to 4 years with current demand and pipeline. Population over the next 20 years will double in the Austin area. In addition the strong rise in population will stimulate consumer spending, trade, and manufacturing. Rising capacity utilization rates and inventory rebuilding will stimulate industrial demand. With focus on the proper industries, demand should continue to improve in our region.

Where is new development going? In-fill continues to be a major change in last 4-5 years. Mueller, Crestview, and the whole north Airport Boulevard area are a great testament to that. PSW, Milestone Communities, and other custom builders have continued to change the building environment with over 400 for sale / sold units over the last year.

As always the next undeveloped outer ring for many. With the recession we saw production slow above 620 in the NW Austin corridor. All that has changed with the increased number of jobs being created in that area (12,000+). Most of the undeveloped land along 183, Parmer, etc. has been put under contract, forcing most developers to look along Hwy 29. Many community announcements will be happening soon.

With more tenured builders like Jimmy Jacobs changing management and improving equity positions this last year, we may see different products and thought processes to address to meet the needs of Austin newcomers. 2014 and beyond will be interesting to watch.

With continued strong real estate appreciation, is there a concern over a housing bubble in Texas? We continue to get this question about our local and regional market.
The quick answer is no.

First four things have to be available for a housing bubble: tight supply, demand, regulation, and easy financial terms. Two of these are present, only in Austin does regulation come into play. Financing is still a challenge in today’s environment.
With current demand, job growth, more demanding lending standards the potential is there but not near as much as the run up in 2004 through 2006. Supply and demand will continue to be the governing factors and presently they seem to show favorable strength of the Texas regional market for a while.
There is a lengthier article about this on the Independence Title blog dated 3/29/13.

What about shadow inventory in Austin and Texas? There will always be foreclosures and short sales even in a good market. However this is not a concern presently, because of the small amount of foreclosures in Texas and the continued decline of such. There is a lengthier article about this on the Independence Title blog dated 3/22/13.

When will lending get easier? Because of the numerous restrictions placed on mortgages as well as banks, it may be another 5 to 7 years of challenging financial origination. I wish there was more optimism about this. But current government actions hamper any optimism. The good news is that because of the strength of the local and regional market, most banks and equity are very interested in Texas loans. Don’t expect the lending values and opportunities of the last 20 years. Equity and banks cannot afford to be as liberal. That said, there is plenty of loan interest in the Central Texas area. Loan originations for most channels of real estate will benefit from pricing near cyclical lows, rising occupancy, rent and income growth. Further, stronger bank balance sheets and continued low interest rates will increase small business loans, aiding recovery in our regional demand.

In the coming weeks we will visit the other Texas metros and review their opportunities and needs.

Texas real estate: no sign of slowing down

Texas continues to lead the national economic recovery. Home prices are on the rise, businesses are relocating here, and jobs are being created. I wanted to revisit the major Texas metros and examine all channels of real estate to really show how well we are doing.

First, understand that the median price for homes in the state of Texas hit another all-time high in the second quarter of 2013 as demand for homes in the Lone Star state continues to rise as supply struggles to keep up. On a statewide basis, 79,760 single-family homes were sold in the second quarter of 2013, up 17.78% from the same quarter of last year. This also represents the most homes sold in a single-quarter since the Texas Association of Realtors began this report in 2009. Austin had their best month ever since records were started in the early 1960’s, with 3,135 single-family homes sold in the Austin area, which is 35% more than July 2012.

To put that in perspective, realize that there were only 6,100 listings, so a little over 50% of all listings sold in central Texas. San Antonio had a record month with 2430 listings sold, over a 24% increase in sale over a year ago. Dallas had a record month with close to 9,400 home sales in July. Houston also had a record month. In Texas, demand in the state was strong as ever, with 43 out of the 47 markets included in the report showing an increase in sales year-over-year.

More homes are selling, and for higher prices. The median price in Q2 2013 was up 9.98% from the prior year, reaching $177,300. The average price rose 10.44% from the prior year to $235,075. According to the Texas Association of Realtors, those are the highest figures for median and average price ever seen in Texas real estate. All of us living in one of the Texas metros sees or hears about the strength of the residential market, with home values increasing at around 10% this year.

The economy is booming with job and population growth. And, for the first time perhaps ever, home values are appreciating at double digit rates. We don’t believe this will last forever. But for a limited time, we have the opportunity to experience what the rest of the country has had in appreciation in the last boom and now.

Houston
Houston’s economy continues to remain well positioned with over 99,000+ jobs created this year. This continued increase in employment will feed housing, office, and retail absorption. The rapidly expanding energy and medical sector are the major economic catalysts for Houston. New and resale residential properties are doing well, with the lowest supply of homes on the market since December 1999. Houston is leading the nation in home starts, adding pressure to an all ready tight market. 2013 should bring in excess of 27,000 starts. This is still far below the boom days of 2006, when home starts neared 50,000, but a strong recovery compared to other cities. Rental rates are also way up — in office towers, in apartments, warehouses and even for people who are leasing single-family homes.

Metro wide, over 9,200 apartment units are under construction with another 20,000+/- planned. While new apartment supply continues to increase, demand is outstripping development, putting pressure on rents, particularly in class A complexes. With the potential of overbuilding, and with average Class A vacancies below 7% and rents spiking, developers have been hustling to be first in line to bring new multifamily product out of the ground and to the Houston inner loop market. Apartment absorption has caught up with new construction, shown by the 92% occupancy citywide, even though there was a 77% increase in construction the last twelve months rental rates have increased 5%. With the continued strength of the market, we see sales continuing to improve particularly in the B and C class with apartment communities that have less than 100 units.

Over five million square feet of new office space will be delivered this year. That said, vacancy rates stayed stable with not a dramatic increase in the 85% occupancy even though over twice the amount of space as last year was brought to market and rents continue to increase. With the strength of the energy sector and all its support industries, CBD and the energy corridor have put pressure on raising rents. That has been offset by slower interest in non-core areas such as Greenspoint where office leasing continues to be a challenge. Because of the strength of employment, many institutional investors continue to show high interest in core office space. Sales velocity increased more than 50% over the previous 12 months.

With over two times the national employment growth, retail continues to buck the national trend. Retail rents and sales continue to improve with a conservative (220,000 sq ft in 2012 and 240,000 in 2013) amount of space coming on the market. There has been a flight to quality on the loops and areas of high housing growth which should continue into 2013.

San Antonio

San Antonio employment grew this year by 32,000 jobs, or a 3.6% increase. San Antonio’s future continues to look bright, thanks in part to the strength of oil and gas production in the Eagle Ford Shale, which continues to strengthen renter demand in south SA and counties south of the city. In the northwest and west, Nationwide’s new campus along with expansion in the growing bioscience sector will continue to drive the market.

Apartment leasing is still strong at just under 95% occupancy and rents and sales are still rising, even with over 4,000 units coming on line this year, another sign of a good market. Rising construction costs, particularly framing and lumber may slow down development with lower paying industries adding jobs primarily. There is some chance of higher vacancies with the amount of units coming on this year.

Office continues to be a bit challenged compared to other Texas metros, with 85% occupancy and the hardest hit classes being b and c class properties. This is due primarily to corporate relocations and owner-occupied and/or build-to-suit properties. That said, rents are stable with a little rise, due to the Eagle Ford Shale play south of SA. Corporate relocations to owner occupied and build-to-suit have caused office vacancies to increase over last year. However, the strength of the Eagle Ford Shale play and stronger housing market conditions are working to revive previously stalled developments.

Eagle Ford drilling has had a dramatic effect on boosting retail in San Antonio. San Antonio experienced a spike in buyer demand as in Class A properties, which in turn has encouraged more sellers to enter the market. Rents continue to rise despite the fact that occupancy dropped just over 1% due to over 400,000 sqft coming to market. Retail should continue to improve with modest increases this year, as continued job growth in most sectors has allowed San Antonio families an increase in spending in San Antonio. Most tenants are concentrating in areas with high home sales and job growth, causing retail space demand to exceed supply this year, gearing the market toward healthy vacancy improvements and modest rent growth.

Dallas / Fort Worth

The DFW economy has turned the corner with over 96,000 jobs created last year, a 3.2% increase. Of all four major metros, D/FW has lagged behind the others in returning to prerecession employment. However it is doing better than most of the country at 99% recovery. The economic slowdown and hesitancy to build is apparent in the tightness of the market.

With apartment occupancy at 94%, and a limited number of new apartment communities coming on line (13,500+/-), rents should continue to rise and lease negotiation should remain firmly on the sides of the landlords. While this is sizeable increase from 2012, when just fewer than 7,500 units were delivered, the market remains 25+% under the metros cyclical peak in 2009. Construction was slower than other Texas metros till 2012 because of the competition from the large amount of foreclosures. Now that these have largely disappeared, the market is prime for growth.

The DFW office market continues to post improvements in occupancy as new supply continues to stay current with demand. Over 2.6 million sq. ft. will come online this year, more than doubling last year’s output of 1.2 million square feet. DFW vacancy is still challenged at 80 to 85% occupancy. However, with 80% absorption of new product this year, rents are still improving for lessors. Dallas offices include the homes of 24 Fortune 500 companies. Demand for retail continues to tighten the market. Over 2.1 million square feet of new retail space is planned to be finished by the end of 2012, a 100% increase over last year. Occupancy is good at 90% and should continue to improve with the uptick in housing demand in the outlying suburbs. Commercial real estate in rural Texas towns has also improved from demand in the energy sector as evidenced by the strength of rents south of San Antonio and in the energy counties around Midland/Odessa. Barring a catastrophic event in the Texas economy, we should continue to see strength in most portions of the commercial market in our state. With an improving market, office sales have improved 40+% with over 50% of the transactions being under 50K sq. feet.

With improved employment, over 800,000 sq ft of retail space will be delivered to the market, and another 4 million planned. Rents are slowly improving even though vacancy has grown to 12.8%. Buyers are pursuing high quality, triple net in prime locations. The trend should continue till saturated, and the attention will turn to the lower rated tenants and locations.

Austin

Austin continues to be an economic success story in the face of nationwide uncertainty, with employment at an estimated 4% annual growth rate and the addition of 33,700+/- jobs annually. Austin is coming off of their best home resale market since the records started in the 1960’s. Austin has an extremely limited supply of resale homes – 2.6 months of inventory, which is a 40% decline from a year ago. Residential and commercial rents continue to rise due to lack of supply.

Austin apartment owners are in an enviable position with 94+% occupancy, even with 9,000 new units coming on line. Almost all channels of Austin’s economy are comfortable at or above prerecession values and income. Apartment sales continue to improve with almost a 40% increase in sales from 2012. Median prices have improved to $86,500. Compared to a cyclical low in 2010, the median price per unit has increased approximately 80%. With the good fortune of job creation, drawing over 60,000 people per year to the Austin area, the market should continue to hold its values and strength. Asking rents will continue to rise 5% or more, which means the housing affordability gap has closed for class ‘A’ renters with upward pressure on ‘B’ and ‘C’ renters.

With employment improving 4+% annually, office space continues to see rents and sales improve even as occupancy drops to 88%. Of the 520,000 sq. ft. being delivered this year, over 45% is medical. Medium sized transactions of 50,000 sq feet or less accounted for the majority of the activity this year and the potential of continued strong values in sales and rents over the next few years seems probable.

Retail continues to be challenged nationally as evidenced by the downsizing of most retailers, except grocery and medical. That said, local retail is doing ok with approximately 120,000 sq feet brought on line this year. Rents and sales should continue to rise with some concessions.

The bottom line is that our metros offer the amenities and economic stability that so many investors are looking for. Texas real estate will continue to grow as individuals and businesses move here. The bottom line is the same across all channels: the property you look at today is going to be more expensive or gone tomorrow.

The Era of Big Box Retail Dominance Is Coming to an End

I have talked about national retail being challenged in the past few issues of the Independence Voice. Since not everyone reading has access to the information that we have, I want to inform the reader of the facts and trends that are happening nationally in different channels of real estate.

One trend to watch is the evolution, and perhaps demise, of the ‘Big Box’ retailer and other retailers as consumer shopping habits continue to change.

We know that future trends in the retail industry can be tricky to predict. Generally, the state of the retail industry closely follows the state of the economy, as much of retail is discretionary spending – the first thing to get cut as consumers are squeezed. Retailers have had to respond to new realities with strategies such as discount stores, factory outlets, slick websites and store closings.

While most retailers have already closed their worst performing stores and made their operations as lean as possible over the past few years, the uncertain economic climate might lead to a substantial number of store closures in the first quarter of 2012, according to an article on Retailtrafficmag.com.

In total, analysts estimate more than 5,000 stores will close in 2012, and that’s not counting closings related to bankruptcies and liquidations.

A short list of some of those that have been announced are below:
600 Fashion Bug stores (through early 2013)
500 Blockbusters (already closed through bankruptcy)

180 Abercrombie & Fitch stores (over the next few years)

137 Ritz Camera & Image / Wolf Camera stores
123 Collective Brands stores (Payless, Stride Rite) by 2013
120 Pacific Sunwear stores
113 Food Lion stores (including Sprouts stores and reorganization under bankruptcy)
103 Christopher & Banks (starting in Q4 2011)
100 Family Dollar stores
100 The Gap stores
100 Sears
96 Avenue stores
93 Esprit stores
60 Staples stores
50 Best Buy stores

Other department store chains like Macy’s and J.C. Penney are treading water, while apparel retailers like Gap and Talbots have fallen victim to changing fashion preferences. According to many national retail analysts as many as 150 retail chains are struggling to keep their stores open.

Make no mistake about it —retailers are having to change and the big box store are going through a thinning of the herd, as you can see plainly see above. Were it just one or two struggling to stay above water, we could probably just chalk it up to poor decision-making or off-target marketing. When a bunch of them are in dire straits, though, it’s not weak management; it’s an epidemic without a clear cure.

After fifty years of putting mom and pops out of business, big box retail is having somewhat of a mid-life crisis. A slow economy has hurt some store sales, narrowing margins. Meanwhile, consumers, armed with price-comparison technology, are visiting more stores seeking deals or exclusive merchandise rather than making one-stop, fill-the-cart excursions.

When we look at the big box retailers, they basically come in two flavors; so-called category killers such as Best Buy that focus on one type of merchandise, and discounters like Wal-Mart and Target, which sell a broader range of goods.

Since the recession, big box retailers have struggled as evidenced by their earnings. Until its third fiscal quarter in 2011, Wal-Mart had posted eight consecutive quarters of declining sales at stores open more than twelve months. Best Buy posted five straight quarters of profit decline before reporting a $2.6 billion loss on March 29 of this year, while analysts forecast declining same-store sales and profit for Target this year. All of these chains are prioritizing a return to profitability, which means looking at downsizing among other solutios.

Big box retail was born in 1962. That’s the year that Wal-Mart, K-Mart, and Target all opened their first large discount stores. As they grew, the new big boxes began offering broad selection and low prices to a growing population of suburbanites who had left the cities in their new cars, searching for their piece of the American Dream.

The big box chains boomed in the early 1990s, and began expanding from suburbs into small towns, fueled by a strong stock market and easy credit. The housing boom propelled the big box retailers into the new millennium with increase demand and further expansion. Then came the recession and consumers pulled back.

During the recession you began to see a seismic shift in retail. Consumers began cutting back and people began buying more products online. That shift of 18% to 25% of online purchases began to affect brick and mortar stores. There became a real case for downsizing stores.

Amazon.com began as an online book retailer in 1993. By the late 90’s it had gotten into other consumer goods and overnight delivery, forever changing the retail landscape. Most retail chains and mom and pop stores were not ready for this dramatic change in profit margins and access to quick delivery. Not many were ready for the level of online shopping to come.

Other forces began working against the big box model. Aging baby boomers no longer had kids at home and didn’t need to stock up on food and packaged goods or buy new appliances. Their kids are marrying later and delaying having their own children, meaning fewer are buying houses that need to be updated and furnished.

Retail developers began to see both big and small retailers push back on renewal of leases and in many cases scaling down in size rather than renewing or expanding, so there was a rush to open smaller stores. By 2016, Richfield, Minnesota-based Best Buy plans to have as many as 800 Mobile Stores, up from 305 now. It’s part of a plan to generate revenue from warranties, accessories and connections between phones, tablets and other electronics.

The hope is to have these stores support a larger network of retail channels. Between the big box, the kiosk, and online and mobile shopping, consumers will have access to retailers anytime, anywhere, anyhow they choose. This multi-channel discipline approach that they are taking will require less square footage. Stores such as Staples and Office Depot are looking at the same model in hopes of downsizing and staying profitable.
However, not all are leaving big box retail behind. Wal-Mart is sticking with big stores. While the company aims to add at least three times as many Neighborhood Markets as in 2011, it plans to add up to 150 Supercenters, compared with 122 last year.

The growth of online shopping is also hurting big box chains and all retail. A new consumer behavior has emerged – so-called ‘show rooming’. They see something while out shopping and immediately go online to see if they can purchase it cheaper. Consumers don’t even have to delay their satisfaction very long, as Amazon and other retailers offer next-day delivery. As stated earlier the biggest beneficiary of that shift is Amazon.com which continues to grab market share from Wal-Mart, Best Buy and Target and other retailers.

The retailer’s biggest challenge is increasing the consumer’s confidence in making online purchases and having a good return policy to stay competitive. When you look at this, Best Buy, Staples, Office Depot are arguably more exposed than the Wal-Marts of the world that are heavy in the food, apparel and consumables category. In the case of consumer electronics, it comes down to price over all.

If these retailers are to survive, they’ll have to evolve and do a better job of integrating their brick-and-mortar locations with their web stores. For me, a great personal example is the clothing chain Joseph A Banks. When you see something online they are ready to match the price or help you in the store with ordering it online. So while the big box retailers are struggling, they aren’t going away, but are shifting to smaller formats and investing in online retailing.

As you look at the evolution of retail over the last forty years, you can see that there are some pretty fundamental reasons why the big box retail chain and the suburban shopping center have grown up together. One of the main advantages to running retail chains was that you had the ability to identify best practices that you could spread them to scale quickly, learning faster and operating more productively than smaller outlets. There will continue to be growth opportunities in urban America (they’ve begun building an urban format mixed use Wal-Marts), but they’re not the low-hanging fruit of the past.

So when big box retail chains like Circuit City, Dillard’s and Office Depot and others began to close doors in 2008 and 2009, it made sense. The recession crimped consumer spending, and these oversized, over-staffed, and over-inventoried stores had to shed some dead weight in order to survive. A funny thing happened on the road to recovery in 2010 and 2011, though: retailers didn’t pull out of their nosedive. More casualties are on the way, and unfortunately these retailers are powerless to prevent their own demise.

What separates the survivors from the also-rans? It’s not an easy answer, but there is an answer. Investors, take note, because the men are about to be separated from the boys in a contest that really should have happened a long time ago.

So, what does this matter to you? As we have discussed before, retail is doing OK here in Texas in almost all metros and towns. Austin leads with its growth and is having great success with less than 7% vacancy and most of the other Texas metros are in the low 90% of occupancy which typically would cause retailers to look to expansion. However, with the challenges of the national retail market and harsher lending standards, don’t expect to see new malls and neighborhood retail expanding. You may see some remodels, and some moving of stores into older space. But presently the challenge is to survive the slow turn around, changing tastes of consumers and learning how to give the consumer that low-price and near immediate gratification that Amazon.com and others have trained the market to expect.

Those who think ‘outside the box’ (pun intended) will have a greater chance of succeeding.

The Best Economic News in a Long Time

Last week’s national housing starts and permits report is the best economic news in a long time. Why? Because housing always leads the economy, and the direction of that lead lasts a year or two into the future. And at this point, the positive trend in housing construction is strongly established.

The most important measure of housing construction isn’t how much of a recovery there has been relative to the last peak, but how many additional houses are being built now compared with the last measurement period. For example, going from 0 to 200,000 new houses in a year adds just as much new employment as going from 2,000,000 to 2,200,000 new houses. The same amount of new construction workers are needed to build those 200,000 additional houses, the same amount of appliances and furniture will be bought to fill them, etc.

This isn’t just theory; it’s backed up by the data. Here are some graphs to drive the point home. First, here is a graph of the year over year change in the number of houses built (blue) vs. the year over year percentage change in GDP since 1983 (red).

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For every 200,000 additional houses built, GDP consistently increases over trend by 1%, with a variable lead time of several quarters to several years. Of course, GDP growth is an imperfect measure of workers’ economic well-being. What the next graph shows is that GDP growth (red) consistently leads job growth (black).

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Because increased housing construction consistently leads to GDP growth, and GDP growth leads to job growth, it should be no surprise that housing construction (blue) increases lead to job growth (black).

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This week’s data shows us the best housing construction growth in eight years, and equal to the best growth in over 25 years! This rate of growth in construction is associated with a subsequent 4-5% year over year GDP growth, and with 2% or 3% jobs growth within the next year or two.

In other words, the best national economic news in a long time.

While I’m at it, there is more good economic news in car and light truck sales. This shows that small business (85+% share of US GDP) have improved confidence in their future business. The average age of trucks and cars on the road is over ten years old, which is a strong indicator that consumers have been putting off new vehicle purchases.

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Another piece of positive data is that consumer credit has been growing fairly consistently since reaching a low point in 2010. The chart below shows that the average consumer has increased their spending in the last couple of months. When you look at this realize that consumer credit has been virtually non-existent since the recession. The unemployed or those facing foreclosure spend very little on retail purchases

Most in the real estate business are aware that retail nationally has been challenged over the last few years. Real retail sales are the “holy grail” leading indicator for jobs over the next six months or so. Measure consumer credit levels year over year and then divide by two, and you usually get a pretty good idea of national job growth in the near future. The trend in growth had been declining but has now rebounded.

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We have begun to see the re-accelerating of retail sales growth. Americans may have slowed their spending in September 2012 after splurging in the month before during the busy back-to-school shopping season. But more importantly, they are still spending. Still, given the economic and political uncertainty that weighs on many Americans right now before the election, analysts say the results are an encouraging sign for stores as they head into what’s traditionally the busiest shopping period of the year in November and December.

Right now consumer confidence is at a seven-month high as people are feeling better about rising home prices and a rebounding stock market. Still job growth remains weak and prices for everything from food to gas are higher. On top of that, there’s a worry that the U.S. economy will fall into another recession next year no matter who is elected. That’s when tax increases and deep government spending cuts will take effect unless Congress reaches a budget deal.

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Because of economic and political uncertainty, The National Retail Federation, the nation’s largest retail trade group, tempered its expectations for the winter holidays. The group said early this month that it expects sales for the November and December period to rise 4.1 percent.

That’s more than a percentage point lower than the growth in each of the past years and the smallest increase since 2009 when sales were up just 0.3 percent. But the retail forecast still is higher than the 3.5 percent average over the past 10 years.

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Another indicator I became aware of many years ago was how restaurants are doing. When I first got into looking at market indicators for housing, I was told by one of my mentors (Nash Phillips and Clyde Copus) to talk to the dry cleaners to see if the use of nice tablecloths and napkins was on the rise. Now, having just received a degree at the University of Texas, it didn’t seem right to use what I saw as a silly indicator ……Guess what? We still look at what local restaurants as well as national restaurant chains are doing as an indicator of national and local economic strength.

Below you can see that restaurant owners are saw a recent spike up in their outlook. (They’re a great measure of consumer discretionary spending).

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Looking locally in our Texas metros, we have seen aggressive expansion of local and national restaurant groups. In Austin, Larry Maguire has opened three new restaurants (Fresa’s Chicken Al Carbon, Clarks, Elizabeth Street Café) in the last eight months to strong acclaim. San Antonio and Houston are seeing the same level of expansion of the local national chains. These expansions are taken lightly in light of the last five years of closing many stores.

Another indicator that always has been a bellwether to better home sales is home improvement stores performance. With the surge in construction, you can see below Home Depot continues to improve People tend to either fix up their old house to live there longer or sale to move up. Home Depot performance shows continued strength for an extended period.

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The unemployment rate is improving. Both the headline rate (U3 BLS) and the “true unemployment rate” (U6 BLS) of unemployed and underemployed are declining. With the continued confidence, businesses should continue hiring and employment rates should continue to improve. Is the worst behind us? There will always be some concern after such a long recession and loss of personal wealth in real estate and investments. But again most indicators seem to have turned upward away from the bottom.

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The takeaway from this analysis is that both the long leading indicator of housing and the short leading indicator of consumer spending are pointing to an improving jobs picture in the near future.
Take these indicators with a healthy dose of caution. Most of the nation’s metros and states are five to ten years from full recovery, and some areas are 20+ years (think of Texas in the 90’s). Further, the financial constraints of Dodd-Franks and Basel III will put a damper on this growth nationally.
Then again, if you’re reading this you probably live in Texas, where one out of four jobs since the recession is created. What Texas has to worry about is where we are going to put all the people moving here – a good problem to have.

So what does this mean for us in Texas? Hopefully continued employment growth. According to data from Texas A&M Real Estate Center, Texas real estate has increase 240% over the last 5 years for a total value of $1.6 Trillion. All channels, residential, commercial, industrial, and ranch have increased in value and should continue to appreciate.

If you are thinking you should wait to buy or till rates get better, I think based on the data you better hurry…we have long passed bottom in this state.