Killed Deals On The Rise As Retailers Grapple With Soaring Costs

By nearly all measures, Dallas-Fort Worth’s retail market is on the upswing. But toiling behind the scenes is a scrappy gang of tenants, landlords and brokers scrambling to make the numbers work as rising costs threaten to snuff out deals.

Vast progress has been made in Dallas and around the nation since market occupancy nosedived during the pandemic. Net absorption in DFW reached 4M SF over the last 12 months, and vacancy declined to 4.6% as demand outpaced supply, according to Transwestern.

But those wins have not come easily. Solutions for getting cash-strapped tenants through the door have become essential as inflation intensifies and interest rates go up, said Phillip Hooks Jr., a partner at retail brokerage and development firm Advisors Commercial Real Estate.

“We are having to stretch ourselves a little bit more than we have had to in previous years,” he said. “But that’s kind of where you make your money in real estate. We solve problems, we get creative.”

One of the biggest pain points is the skyrocketing price of build-out. CBRE forecasts a 14.1% annual increase in construction costs by the end of 2022, driven by lead times that are, in the most extreme cases, 800% longer than before the pandemic.

Stewart Korte, a vice president in the retail division at NAI Robert Lynn, said he has seen bids come in 65% higher than average, which requires more tenant improvement dollars to keep projects afloat.

“On shell space, when I first started five years ago, we were typically seeing an allowance of $25-$30 per square foot,” he said. “Then we hit a spike, and now we’re happy if we can do a deal for under $40-$50 per square foot.” 

Landlords will sometimes offer tenants an interest-carrying loan for the additional TI dollars, amortized over the life of the lease. As borrowing rates go up, Korte said, this is often a cheaper option than going through the bank.

In some cases, though, the overage is so significant there is no realistic path forward for the tenant or the landlord.

“I’ve lost more deals [this year] than I ever have for these reasons,” Korte said.

The cost of construction has also impacted the type of space tenants are asking for, Hooks said. Units that are more or less turnkey, or that housed a similar business in the past, are in much higher demand today than they were previously, he said.

“Second-generation [space], if it’s available on the marketplace, has been the go-to option,” Hooks said. “With there being less inventory on the market, there’s a slightly higher premium, but they’re OK with it, because they don’t necessarily have to go in there and do a bunch of build-out.”

In addition to higher-than-average construction costs, DFW’s retail tenants are also grappling with rising rents.

The Metroplex is poised to register the fastest annual rent growth among major Texas markets in 2022, a Q2 report from Institutional Property Advisors said. By year’s end, IPA forecasts the average retail asking rate will reach $18.05 per SF, up 4.2% year-over-year.

Part of the increase can be attributed to brands with aggressive growth plans accepting rents 20%-50% higher than average, which raised the bar for tenants across the board, RSC Real Estate Advisors Managing Director Ed Coury said. 

Now, as consumers tighten their belts, those rates are increasingly unsustainable.

“Inflation is cannibalizing disposable incomes,” Coury said. “If you’ve just opened a new store, and you overpaid, or you paid based on very elevated sales expectations, you could be sitting there going, the consumers are not shopping like they were. They’re spending their money elsewhere.” 

On the flip side, landlords grew accustomed to record-breaking rental income and favorable lease terms, and many are hesitant to adjust their expectations as the market slows down, Coury said. 

“When silly deals get done by somebody else, it does have an impact,” he said. “[Landlords] are going to benchmark against the last great deal.” 

As reality sets in and landlords make peace with choppy waters ahead, some have begun to make concessions that help tenants weather the storm. Hooks said his team is willing to bend on rental rates so long as an escalator is put in place to safeguard returns.

“By keeping open communication, being collaborative with our tenants, understanding the struggles they go through and keeping in mind the struggles that we go through at the same time, we can always work something out,” he said. “These things are never simple, they’re never comfortable.” 

DFW’s retail pipeline continues to shrink, with construction now 1.6M SF below the pre-pandemic average, according to Transwestern. As demand wanes and the delivery of new product slows, Hooks expect rents to come down, which will provide much-needed cost relief for all parties involved.

“I think it levels out,” he said. “There’s still a lot of deals being done in the marketplace right now. But once those deals are finally executed, you’ll start to really see a slowdown.”