Super Sun Belt Markets Phoenix &San Antonio Lead in Retail Demand

Article originally posted on CoStar on September 13, 2023

The retail sector remains a bright spot in the broader commercial real estate landscape, as healthy consumption patterns keep tenants in expansion mode. Nearly every major U.S. market had more retail space occupied than vacated in the 12 months ending in the second quarter, though the pace of expansion is notably easing.

A familiar pattern emerges when ranking the top markets in the country for annual net absorption — defined as the change in the number of square feet occupied — as a share of inventory.

The strongest performance comes from the South and West regions, driven by robust demographic trends and steady job growth. “Super Sun Belt” markets, a designation from the Urban Land Institute’s latest annual report, dominate the list, with all seven areas making the top 20. These core cities, which include Atlanta; the Dallas-Fort Worth area; Houston; Miami; Phoenix; San Antonio; and Tampa, Florida, were recognized by the trade group for being top migration destinations for residents and businesses and having the brightest real estate outlook.

Phoenix recorded 4.4 million square feet of positive net absorption over the past year as its nation-leading population growth encouraged retailer expansion. That figure represents 1.8% of the market’s retail inventory, earning Phoenix the top ranking. Other positive demand drivers that support strong retail performance include its growing labor market and commercial space affordability, as well as its expanding and diversifying local economy.

New development has not kept pace with robust demand, causing space availability to fall to the lowest level on record. When construction does occur, it typically takes place in Phoenix’s high-growth suburban areas, where land is more available and retail options are fewer. This frees up capacity for retail expansion as tenants find little availability near the primary population centers. As a result, the strongest demand figures come from areas like the Loop 303 corridor, Mesa, Queen Creek and Pinal County.

Phoenix may be approaching a structural growth bound as space availability tightens. Leasing activity has already shown signs of easing, and the construction pipeline remains thin. The Valley of the Sun’s long-term tailwinds will continue to support underlying retail demand, though the absolute absorption figures could be headed for normalization in the near term.

The drivers behind San Antonio’s retail market parallel those of Phoenix, and South Central Texas has long been a target for store expansions and domestic migration. San Antonio has had the nation’s fastest-growing major city proper since 2020, according to the U.S. Census Bureau, released earlier this year.

Population growth has brought significant tailwinds for retail demand, as tenants have sought to lease space in fast-growing portions of the city and its suburbs. Between the beginning of last year’s third quarter and the end of this year’s second quarter, retailers absorbed 2.1 million square feet of inventory in the San Antonio market. That was roughly 400,000 square feet more than what was completed.

Key expansions from the likes of Crunch Fitness, Office Depot and Five Below have buoyed demand in the local retail market. H-E-B’s ubiquitous and expanding presence around South Central Texas has stabilized grocery-anchored retail developments, encouraging other tenants to lease space alongside it.

As Kroger and Albertsons plan to sell more than 400 stores nationwide and contend with antitrust concerns from regulators, the San Antonio retail market features neither chain, relying instead on the locally headquartered H-E-B: the nation’s sixth-largest privately owned company. H-E-B’s consistent and growing business provides stability to many local neighborhood and retail centers, such as Lincoln Heights, where the retailer is developing its physical footprint to accommodate increased consumer demand.

Substantial absorption levels in grocery-anchored retail centers have narrowed the market-wide retail vacancy rate to 3.5% as of mid-September. This was 70 basis points lower than the national average, despite San Antonio seeing more retail development than any other major market in the country between the third quarter of 2022 and the second quarter of 2023 when controlling for the size of its existing inventory.

While the future remains uncertain due in part to a cloudy macroeconomic backdrop nationwide, optimistic trends are encouraging for Phoenix and San Antonio over the next few years. Demographic growth, in terms of population and median income, continues apace in these two markets, fueling retail in Arizona and Texas.

Because Phoenix and San Antonio are affected by the broader national economy, they have been affected by macroeconomic and environmental challenges of late. The ongoing drought in the Southwestern United States poses some risk to the longer-term outlook for these two markets, possibly affecting real estate development and demographic momentum. Still, Americans do appear to be continuing to move south and west, and “Super Sun Belt” retail markets such as Phoenix and San Antonio are likely to continue to grow alongside their expanding suburbs through the balance of the year.