Big D's real estate movers say good economic times have brought back the cranes for a while.
Editor's Note: You don't have to be a genius to drive around Dallas and see that the commercial real estate market is alive and well. Actually it's red-hot. Steve Brown's article in the front of this special Dallas focus provides ample evidence of that fact.
But in addition to Steve's story, we wanted to convene our third annual roundtable of Dallas real estate experts, so we gathered a group of local luminaries once again at the fashionable Mansion on Turtle Creek for a breakfast pow-wow. Here is what we heard.
NREI: A year ago, our headline for the Dallas Review said, 'Big D is back!' Is Big D still back and why?
Jerry Fults: Dallas is back because of the sound fundamentals that exist in the marketplace. We've had substantial job growth every year since 1990, and we're projected for over 100,000 new jobs this year. Up until recently we've had no new development, so the new jobs have thrown off more demand for office, industrial and other types of space, and thus continue to lap up the oversupply that we had for many years to the point where we have greater demand than supply, which of course drives rental rates up and creates a lot of activity.
Jerry Grubstein: Clearly as far as the retail industry goes, population growth is driving the retail market. And Dallas is now a much larger city than it ever was and continues to grow further and further north with the growth of its population and job growth concentration out there, so development in the retail sector has become very active and continues to be active.
Mickey Ashmore: To add to that, the growth's not only in the suburbs and the edge cities but in the infill markets as well. The densities in the Uptown/Oaklawn market just continue to grow annually. Everyone says that Dallas is over-retailed and you continually hear that we have the most retail per capita in the country. The point is that a lot of the retail here is obsolete.
NREI: Why are so many people attracted to Dallas?
Jack Eimer: As Jerry (Fults) said, it's got such tremendous transportation and infrastructure. The cost of living and the cost of doing business are well below average. We've got a very young population and we've got a very large educated workforce. It's a great combination.
NREI: Let's focus on the office market for a little while.
Jeff Swope: It is interesting that in this cycle, all the different ways projects are being financed. I think that's the biggest change that we're seeing. That's probably characteristic of most product types, but the dollars are so much larger for office. If you look around the table, everyone's involved in office. If you asked that question three years ago, there were a couple of us trying to lease, but that would have been it. None of us was doing development. The fun part about job growth is that the absorption in office typically lags that. So with 90,000 to 100,000 new jobs this past year, and the previous year's 60,000 or 70,000, we should see some pretty good absorption. Today is a pretty good time to be in it.
NREI: What's been the magic kick-off for the activity?
Swope: It's just a cycle. It takes good things happening. This time last year there were three or four buildings under construction. Now there are 31 today. Some of those I can't count because they aren't really under construction.
Reagan Dixon: Well, you've got 56 planned for 14 million sq. ft.
Swope: I would say this time next year, there will be a lot of cranes in the air. But rents are still rising. Other interesting things in the office market, there is a stratification of the tenant demand. So many of us build so-called taller or vertical center core buildings, and clearly there is a stratification occurring in different types of buildings coming through this cycle. And I think that's characteristic around the country.
They're smaller from the standpoint of height, but the square footage in some cases is more, and the large absorption we're seeing is still occurring in that product type. One of the issues we'll have is, will the big tenants, the typical four-, five-, six-floor users in the center core, 25,000-ft. type of building, if they have an alternative are they going to continue to go in those buildings? And before very long, that's all that's going to be built because of land prices.
We're all risking a lot. We're back in the risk business.
Eimer: What's going to be interesting, Jeff, it's not just the big users, when you get up in the mid-$20s, you've got a user base or a portion of them that can't pay that level of rent, or a portion can pay it but just refuse to. As a result, your lower one- and two-story product may be a lot more attractive.
Mark Robertson: I don't see any price differential on those buildings right now on the purchase side. My concern from an investment point of view is that those buildings are carrying the same valuations today. The weakness is in that side of the market. There are larger floor plan buildings being built that are probably not of the highest quality. Those rents will go down and what happens to the market if we continue to see a saturation of that kind of building?
NREI: David, you've just kicked off a large building in North Dallas, phase III of Colonnade. Why?
David Gruber: It was something I didn't think I'd see in my lifetime. (laughter) It was a natural progression for us. We had the two buildings up from the mid-'80s. They have been full for a number of years. Rents have finally risen to a level where we could justify new development. In reality, we had to build a third building to accommodate the demand to a large extent from the existing tenant base that we have. We would start losing tenants if we didn't build one because we had expanding tenants.
NREI: From where is the capital coming to develop these new projects?
Chuck Anderson: You're seeing a lot of the opportunity investors deciding to develop properties as opposed to buy. We're seeing a lot of those types of funds in the market today providing equity capital and conventional banks are doing construction loans.
But even the construction lenders today are certainly not as aggressive as they were in the '80s. We're seeing people doing one or two deals, then pulling their horns back and saying, 'We're going to do one or two spec buildings, see how those work, and if we get taken out on those, we'll do more.' Which I think is good for the marketplace. I think it's good for all of us if we don't have a plethora of capital out there chasing a whole bunch of deals, some of which are real, some of which are not. The capital is there, but the fundamentals of the project have to be in place.
NREI: Jeff, you had some earlier comments about the sources of capital in the local market.
Swope: We're seeing capital coming from three different sources. One is the REITs. They're doing some development and they will do more. We'll see some REITs, and it's happening already, in partnership or some sort of fee arrangement with developers.
Two, we're back to the old way we used to do it where we had construction debt and put equity together to cover the gap between debt and equity.
The other thing that is sort of surprising to us is the direct investment in new construction by pension funds. It surprises me. It's the riskiest of all because the development groups that are having to build some of that product don't have near that much invested in it. So those deals are being promoted in the marketplace everywhere. There is going to be quite a bit of product built right now. When you see a major domestic pension fund into a major $50 million or $60 million project with a fee developer -- and there is a lot of that starting to happen, and it clearly happened in Atlanta in the past year -- you've got to be a little concerned. That is a yellow light.
NREI: Dean, you're building offices. What's your take on all of this?
Dean Macfarlan: We're pretty active. Las Colinas is generating a lot of internal growth. Certainly the job creation has had a lot to do with it, but just the corporate growth that we're seeing out in that particular submarket is going to fill a lot of the space that's already on the market and a bunch to come. That's pretty exciting, that we don't require corporate relocations to fill up some of this space that's being built.
The folks that are getting deals done are the ones who are willing to put their own assets at risk. What gets scary is when that's not a requirement to doing a deal anymore. That's my take on the market. How quickly do we evolve from a market where it takes the sponsor's resources at risk to a market where there are no requirements for a sponsor to get a deal done. Right now, it's a pretty exciting time given the demand in the market.
Swope: I agree with Dean, the demand for that product is unbelievable now. I think the biggest concern that the marketplace has is there is going to be too much of the vertical product built at prices that are not going to lease. I ask anybody who's building today, would you rather have a two- or three-story building under construction, risk wise, or would you rather have a 14-story building under construction? I think the majority of us would say the two- or three-story from a risk standpoint.
NREI: Dary, Las Colinas has come back from all of the bad stories of the early-1990s to be a hot market today.
Dary Stone: That wasn't a market change, that was a management change. (laughter) Land prices have moved dramatically in the Las Colinas area thanks to Dean and Jeff. Last year we sold more land than we sold in five years. This year, we'll sell twice as much as we sold last year. We've got the internal growth that Dean was talking about, but we also have external growth. This is one way that Dallas distinguishes itself from Atlanta. We've got a good internal engine cranking out a bunch of jobs, and we're going to continue to get a disproportionate share of relocations.
NREI: How attractive is downtown versus the suburbs?
Raul Toledo: I believe a lot of the money is starting to look down there, looking for values and cheap buys that they haven't seen in the suburbs for a couple of years. Downtown is picking up the spillover from the guys who can't or won't pay the higher office rents. I think it's going to lag and take a little time, but it's definitely on the upward path. And the residential market in Uptown is starting to spill over into downtown and that's going to evolve over some time.
We started looking at the concept of converting residential downtown, Uptown was just starting with the stuff Columbus (Realty Trust) did. They were pushing rents to that magical $1.00 a foot number and they've blown through that number up to the $1.25 range and you've got the project behind the Mansion here with rents at $1.70. There are whole new stratas of residential rents that nobody would have conceived, and all of a sudden a lot of numbers start working a whole lot better as you start moving those rent levels up.
NREI: Reagan, do you see a point down the road where downtown could become more attractive than the Planos of the world?
Dixon: That happened a year or two ago when there was an inversion in rates between the CBD and suburban areas and people were coming downtown because they could actually get cheaper rates in some quality buildings. But now that's changing, and other than in a few buildings like Lincoln Plaza or any good space at all, you're up to $20 a sq. ft. Even the new buildings coming out are going to be in the $21 to $26 sq. ft. range as far as rents, so now if we sell any more buildings to Crescent (Real Estate Equities) downtown it will be close to $30.
But I think downtown now has recovered much sooner than what I thought it would. If you had asked me five years ago if we would be where we are now, I would have said no way. So I'm really, really encouraged about what's happened in the CBD.
NREI: Let me jump into retail for a minute. My original question was does Dallas have enough retail? Is there a good balance of retail to population in this market?
Ashmore: I think so. Dallas is a little different than a lot of cities. Shopping is one of the things people really do here. They dine and they shop. We don't have the natural amenities to send us out to the mountains. We're five hours from the mountains.
Fults: By plane (laughter).
Ashmore: I'm not sure what it says about Dallas, but shopping is really a big part of life here. We have more restaurants per capita than New York. What's happening, there is a need for retail for two reasons to continue. I think whether it's downtown or Uptown, there's really a void of retail there. And then there's Northeast Tarrant County, South Lake, Colleyville, Grapevine. There's still a need there. The explosion of the population growth there is phenomenal.
The mall tenants, the high-end lifestyle specialty tenants as opposed to the big box users, are looking for retail venues. So what's happening, this urbanism is happening in the suburbs as well. I think they want a different form of retail.
You're going to see grocery store-anchored centers continue. By our last count, there were 90 announced (for development). The need is for specialty lifestyle, there are still big voids there, but these entertainment zones are happening, and that hasn't landed yet in Dallas. There will be that type of project like the Irvine Spectrum in Los Angeles. It's rumored to be at Galleria, it's rumored to be in Uptown. But these types of projects will continue to happen.
NREI: Jerry, what's your take on the Dallas retail market?
Grubstein: I don't think you can talk about retailing as a segment per se. I think you have to break it down. I view the grocery-anchored center as one. It's like the blue-and-red-striped tie that will always be in fashion. I think today you're seeing an anchored center with probably a grocer of 70,000 sq. ft. and 30,000 to 50,000 sq. ft. of peripheral space whereas five years ago you would have seen 70,000 to 100,000 sq. ft. of shop space. So I think you've narrowed it, but it will always be in fashion and the investment market loves it and is very comfortable with it.
As far as the box users and the other retailers coming out of the malls, I agree with Mickey, but I think there's another reason for it. The cost of operating within a mall, occupancy costs, have gotten so high withina mall and competition has gotten so tough with margins, that they've had to reduce their occupancy costs dramatically to survive and be profitable. You can't pay the rents in the mall today unless you've got tremendous volume and therefore a lot of the retailers are looking towards a strip center or community center environment so that they can be more profitable and ring the malls and ring their sites with secondary sites, so it's less volume but higher potential profitability.
Ashmore: One of the things that is making the grocery-anchored center so successful is the fact that it is 15,000 to 30,000 sq. ft. of spec space as opposed to 70,000 to 100,000 sq. ft. There's a group of national credit small users that come into Dallas that are doing lots of deals. These are bankable tenants, with AAA credit.
NREI: Don, you run the biggest multifamily REIT today in Dallas.
Don Daseke: Today we own about 9,000 apartment units in Dallas/Ft. Worth, and with the merger with Drever Partners which will close in October we'll be up to 12,000 apartments in Dallas/Ft. Worth out of our 41,000 total.
NREI: How does the Dallas multifamily market look to you?
Daseke: There's a tremendously rapid consolidation of the ownership as we move to the securitization of real estate in this part of the world. A year ago there were four apartment REITs headquartered in Dallas. At the end of this year there will only be one, which is our company. We had Southwest, Paragon and now Columbus will merge out of existence as separate entities. The consolidation is really rapidly occurring. As you get larger the cost of money becomes less. Wall Street loves large companies and it is nowhere more evident than in the apartment area.
The other trend is the new construction really is all on the high end, Uptown area, Las Colinas, West Plano, the $1.00 and $1.25 rents that were discussed here earlier. So there's no new construction competing for the middle-income apartment resident demand. And a lot of those workers involved in the new office construction will have to live in apartments and they will typically live in middle-income apartments that rent for $0.70 a sq. ft.
NREI: It seems that the apartment industry in Dallas is indicative of the public nature of real estate these days.
Daseke: I think that's really true. Today of all the apartments built in the '90s, about 18% of them are owned by REITs. So about 45,000 apartment units in the Dallas/Ft. Worth area are owned by REITs today versus none 10 years ago. That trend continues.
NREI: Udo, you probably work for some of these people.
Udo Walther: Not nearly enough! (laughter)
NREI: What do all of the cranes on the Dallas skyline mean to you from the contractor's standpoint?
Walther: Other than the fact that I want to go out grocery shopping and have some fun ... I've been listening to this and obviously it's a great time to be in Dallas, but it's scary to me being on the construction side. Having been with a developer here in Dallas and going through this, the 10-year moratorium where there was frankly nothing built I think has left a tremendous void in the quality of the people who do the actual construction.
Without a question, if what I'm hearing here occurs, not only do I think that there is a lot of scrambling that we need to do in the industry to get quality people here. There is a 10-year gap of people who got out of the business and who aren't there.
Ten years ago it would have been a lay down to run out here and throw up a five-story building in Las Colinas. Today we have to work harder at it.
Chuck Anderson, Area President, Trammell Crow Co.; Jerry Grubstein, President, Cencor Realty Services; Mickey Ashmore, President & CEO, United Commercial Realty; Dean Macfarlan, President, Macfarlan Real Estate Services; Don Daseke, Chairman, Walden Residential; Mark Robertson, Managing Director, Landauer; Reagan Dixon, Managing Director, Cushman & Wakefield; Dary Stone, President, Faison-Stone; Jack Eimer, President, Transwestern Property Co.; Jeff Swope, Managing Partner, Champion Partners; Jerry Fults, President, Fults*Oncor; Raul Toledo, Partner, Southwest Properties Group; David Gruber, President, MEPC American Properties; Udo Walther, President & CEO, Precept Builders.