Once regarded as one of America's most overbuilt cities, Dallas is coming on strong with positive absorption and development activity, according to industry experts at a recent roundtable discussion sponsored by National Real Estate Investor magazine.
A surge in employment growth and property values has given the Dallas area one of the nation's fastest growing commercial property markets.
Tenant demand for commercial space and rental rates are at 10-year highs. And a jump in development activity has put Dallas/Fort Worth once again near the top of the list of the country's most active commercial and residential building markets.
After a year of strong leasing, sales and development in 1994, Dallas' leading brokers, developers and building owners at a recent roundtable discussion predicted that in 1995 the local
The Dallas office market has already recovered much of the ground lost during the 1980s overbuilding and a regional recession. Last year tenants absorbed more than 4 million sq. ft. in Dallas office space - the highest demand in eight years. Suburban building vacancy rates are now about 18%, with some prime buildings quoting more than $20 per sq. ft. annually for the first time since the mid-1980s.
Q. (from moderator Steve Brown) The statistics we've seen show how strong the office sector here has been in the last 18 months. What types of tenants are accounting for the expansion we're seeing in the office sector?
Jerry Fults: We're seeing a tremendous growth and expansion in the service sector. As you know, we had, depending on what numbers you read, in excess of 80,000 new jobs last year, and the bulk of those were service sector jobs which relate directly to office absorption. In the last two years we've had outstanding absorption and we're seeing it with the increased rental rates and decreasing vacancy. We're seeing both move-ins from out of town and expansion by tenants already in the market.
Q. We've been hearing a lot about rising rental rates. How are the tenants accepting the fact that this is no longer the distressed market it was five years ago?
Reagan Dixon: They all recognize now that probably in every market, with the possible exception of the central business district, the longer they wait to renew (leases) the higher rental rate they're going to have to pay. That's driven by the job growth, which is the engine to this whole train of absorption and, therefore, the upper pressure on the rental rates.
We're starting to see tenants coming to us now with three, four, even five years left. We're working on a deal right now, a significant deal, with five years remaining on an underlying lease. The tenant is saying let's go ahead, renew, lengthen it out and see if we can lock in at least as much as possible the rates that we have today because tomorrow and the next day rental rates are going to be more.
Q. Dallas' office market is still at an overall average rate of about $14, statistics show. How fast are office rents rising?
Dixon: It changes almost daily in the suburbs. You see rates going up a half a dollar to a dollar even during negotiations. But we're still south of $20 downtown and even in the AA buildings they're not in the $20 range.
Q. Developers are making plans for the first suburban office construction Dallas has seen in more than seven years. What kind of rents will the market need to make these buildings economical?
Dixon: We're going to have to be probably in the $24, $25 range in many areas before you'll see much construction. Right now there's a lot of industrial construction going on because the rates do make sense for industrial. But I would say we're still two or three years away before we see any significant construction.
Q. Is new office construction closer than that in the build-to-suit market or in some of the hot suburban markets, like along the Dallas North Tollway or in Oak Lawn where there is very little vacancy space left and the number of options is rapidly declining?
David Gruber: I think right now tenants still see that there are enough other options available that construction doesn't make sense for them. But I could see in a couple of years build-to-suit opportunities going on. There still is a heck of a lot of vacant space in Dallas. So I think it'll be a long time before you see purely speculative development going on again, but it wouldn't surprise me at all within the next three years to see a build to suit with some spec space.
Charles Anderson: From a build-to-suit perspective, we're seeing tenants are now learning to accept they don't have to have the granite and the marble anymore. We have two deals which we did with Cushman & Wakefield that are under construction in Las Colinas where, in essence, they are tilt-wall office buildings, two-story, between 50,000 and 90,000 sq. ft. and the rental rates to justify those are probably in the $16 to $17 a foot range. So for the right kind of tenant, I think you'll be seeing more of that.
Q. While vacancy rates in suburban Dallas office buildings have fallen significantly during the last two years, the inventory of empty office buildings downtown remains historically high - about 33% at the start of this year. At the same time the amount of empty office space in the suburbs has dwindled, rents downtown have remained below suburban rates in many cases. Hasn't this helped the downtown market?
Anderson: I think we've seen over the last 18 months that this is a bigger market now, it's not as segmented. But if you're a tenant with 50,000 sq. ft. and above and you're looking at the entire Dallas market, you are being forced to look back downtown. And with the lower rental rates I think that makes a big difference. A lot of perception problems that downtown has suffered over the last three or four years have been fixed. The parking problems are not really the problem that people perceive them to be. The crime has declined every year. We are starting to see tenants from (nearby) Oak Lawn and further north, move back downtown, which is just a reverse of what we saw in the late '80s.
Q. How good of a deal can a 20,000 to 30,000 sq. ft. tenant nub in downtown Dallas?
Anderson: You're looking at a deal on a Class-A building somewhere in the neighborhood of $12 to $13 a sq. ft. Compared to the suburbs, it can be a $4 to $5 per foot spread.
Dixon: You've got to remember the factor for parking downtown can make a $2 to $3 a sq. ft. difference. But I agree, the differential with the suburbs is increasing rapidly in rate and the downtown area is at least stable now. People are going to have to start looking back downtown.
Q. Prudential recently made a sizable new investment in downtown Dallas, buying out its partner in the 72-story NationsBank Plaza Office tower. What kinds of tenants are you seeing looking at the central business district market now?
Mike Lafitte: You still have the major banks and the law firms. We are starting to see tenants now on Stemmons Freeway, Central Expressway and in Las Colinas that are facing real rates of $17, $18 a foot and are starting to look downtown.
Q. One of the advantages Dallas has had in recent years has been that with all the vacant Office space, we could immediately accommodate corporate relocations and expansions from outside the market. Are higher occupancy rates going to put us at a disadvantage in the short term in attracting some of these moves?
Dary Stone: I don't think so. That was a nice opportunity for big tenants that were relocating to have a place where they could be warehoused for a period of time. It's kind of unusual to have a tenant like Exxon move (in 1990) and then temporarily be in a space for rive or six years before building a permanent office. There's lots of relocation activity and companies mostly all want to build buildings. I think we're going to see more relocation activity because of the fundamentals. We're well located. We don't have corporate or personal income tax. We've got user-friendly governments and we have good quality.
I know Las Colinas is generally full. The entirety of Las Colinas, which is 17.5 million sq. ft., is 90% occupied. The urban center is 95%.
Q. During the last few years, Dallas has presented investors with one of the best commercial property purchase opportunities in the country. Billions of dollars in real estate have changed hands, mostly from lenders. How many opportunities are left out there for investors to acquire income properties, and how much harder is it to find deals
John Goff: There are still transactions out in the marketplace because there are a lot of restructurings left to occur. I'm concerned about some of the pricing that I've seen in certain transactions, but, generally speaking, we're continuing to find opportunities.
There's still a big disparity not only in the pricing of our rental rates vs. the rest of the United States but also just in the quality of product, as we virtually doubled our office inventory in the 1980s. So this is all very new product that was built and capitalized in the '80s at amounts that were far in excess of real economic value. Not all of that product has been resurrected or recapitalized, so there still are transactions out there.
Q. Recent surveys suggest that commercial property sales prices in the Dallas/Fort Worth area were up anywhere from 20% to 50% last year. How is the investor market reacting to that news? Are they seeing the income stream there to support that?
Goff: With the exception of only two transactions that I have seen, for the most part every deal has been based on true economic cash flow today, and the buyers weren't paying for future growth. I've really only seen two transactions, in my opinion, of any size that were truly overpriced.
I think what you are seeing investors do, though, in the last six months is back off of deals. I've seen more properties not trade that may have been under contract or under letter of intent because either the capital couldn't be obtained at that price because the price was too high based on the cash flow today, or it's just a matter of sending a signal to the market that you're not going to pay for futures.
Q. There has also been a big decline in the availability of large tracts of land. The federal government is almost out of the real estate business in Dallas. Have all the good, large land deals been done here, and how likely are some owners to retrade into the market?
Ross Perot Jr.: Certainly the Resolution Trust Corp. is virtually out of the market, which is positive. From our standpoint, we don't have any large acquisitions on the horizon in Dallas/Fort Worth, and maybe that's because we've already purchased a lot (several thousand acres) over the past three or four years. The real values that we saw two or three years ago are now out of the system and some of the land owners might try to trade them again. I think most of the land owners are probably going to develop their properties - that's what we plan to do. I think Texas is back to a normal market and I think we should have a good four or five years in front of us.
Q. What about institutional investors? Now that the market is back and the prices have started looking better, are they going to be sellers or buyers?
M. Thomas Lardner: I think that the idea of a good real estate deal is appealing for an institutional investor more in the market that we're seeing in Dallas today vs. two or three years ago. The market today is more of an investment market as opposed to a speculative market, and that's good for institutions, and I think they'll be back and are back. I think that you'll see more interest in downtown Dallas where there are structurally interesting deals from the institutional point of view in that they're highly capitalized and have a long-term trend of income potential.
I think what the institutional investor is more cognizant of today than he has been historically is that real estate as an asset class needs to be in in his portfolio, not necessarily from a speculative point of view but from an income point of view as that income is to match beneficiary obligations 10, 15 and 20 years down the road.
I think the market for Dallas, as a place for institutions, is coming into an institutional framework which will be positive for both our business and for the marketplace.
Q. How much competition is there for new investments?
Lardner: I think in some assets there have been bidding wars. One was in Oak Lawn recently, an office building that a pension fund purchased. I know there were at least five or six interested parties and the pricing increased from its original offering.
Q. Does that mean gambling on future rents and values?
Lardner: I think we're right on the edge of that. But I think it's no different than what we heard earlier with regard to the tenant who is seeing five years out is when his lease is expiring. That's really the same position that an investor is taking when he's looking at the marketplace. Then that's not a speculative play anymore because if this market is moving and the economy is moving and then you move from speculation to a rational investment that simply takes two to three years that I think most of us are willing to predict.
Q. How has the investor market accommodated the increase in interest rates? What has this done to minimum yield requirements and just the viability of some investments?
Goff: We certainly attempt to pass that on to the seller. So to the extent our true cost of capital is going up we've got to pass it along. And I think that's essentially true for most buyers. I think that's the other reason that you're seeing a fair number of transactions that have been tied up recently not close.
Q. Are lenders keeping a close watch on the Dallas real estate market? Will they cut off funds again at the least sign of a fall-off?
Stone: There is a spiritual difference on the part of lenders now and they don't want to be embarrassed, and they are going to be conservative. Secondly, it's a matter of legislation and regulation. Rules are different, they're harder.
You're not going to find ever again a situation where somebody can go buy a small S&L and grow it 100 times and then use their lending capacity for commercial real estate loans or investments in any way, shape or fashion. I think you'll see capital come in from die traditional lending sources. It'll come in different ways. You'll see pension funds do more equity deals as opposed to straight loans.
Q. As the Dallas real estate development market comes back, are we going to see more firms getting back into the building business? And will they be doing this work for their own account for third-party investors like pension funds and investment groups?
Anderson: I think the reality is that with the lenders and the equity partners and pension funds and institutions that's where the next real estate boom, if you will, is going to come from. It's not going to be driven by the banks who are giving loans to the developers. I think there will be a lot of fee development. I don't think any of us would want to get back in the '80s where you had all the developers lined up signing notes at the bank and building as fast as they can. I think there's going to be much greater equity requirements going on and equity is going to have to come from an institutional type.
Q. Dallas has already seen the beginning of a new wave of industrial development. More than 2 million sq. ft. of speculative construction was under way at the start of 1995. Vacancy rates in the warehouse market have fallen below I 0%. What's causing all of this new activity?
Henry Knapek: The No. I thing that's driving it is a lack of supply. There's no inventory. If you are a sizable user of industrial space you don't have a lot of opportunities in the marketplace where you can go and make deals today. I think you will see more spec space announced. We have seen a dramatic change in the last 12 months, and I will tell you 12 months from today you will see more dramatic change. I think there are some excellent opportunities in the marketplace to do deals with pension funds and I think you'll see more business of that type done. I think that's where the future of the business is going. I don't think you'll see the developers lining up to sign notes, as you said. I can guarantee you we're not going to. We've just come through all of those battles with scars on our back and we're not interested in doing that today.
Q. There is a lot of institutional investor interest in Dallas industrial properties. How hard are these deals to get built, then how interested are potential buyers?
Gruber: The industrial market indeed is very good right now and we had a real good run in 1994. 1 think we built seven or eight buildings and added about a million-and-a-half square feet. And we've got planned at least that much for 1995. A good bit of it and almost all of it has got a very, very substantial prelease. As far as the lenders go, I know that the requirements have been stiffened up through regulation. But the lenders and the pension funds are anxious to make investments these days. When we finish a building it's not unusual to get half a dozen calls from institutions saying, "Would you like to sell it?" So we know they're here.
Perot: Our real focus in Texas now is warehousing. We started 1.1 million sq. ft. of warehousing (near Alliance airport in north Fort Worth) last year and we are programmed to start over 2 million sq. ft. this year.
Q. Have we seen any impact yet from the Texas trucking deregulation?
Perot: We've got a lot of customers that talk about it, but I can't say there's actually one deal - that we've done besides Fed Ex.
Q. What do the latest Dallas-area industrial market surveys show?
Jack Fraker: The industrial market is extremely strong right now. The overall vacancy rate is 6.5% in a market with about 260 million sq. ft., and there's only about 12.5 million sq. ft. vacant. In 1987 1 think there was 40 million sq. ft. vacant, so the absorption has really taken a toll on the supply. Speculative projects that have been announced or built are virtually leased upon completion in every instance.
It's gotten so strong that the institutional interest in warehouse properties is Lit an unprecedented level. Virtually every building that was built in the '80s in the Dallas/Fort Worth area has been sold to institutional investors. Where there might have been 45 buildings over 100,000 sq. ft. vacant 2 1/2 years ago there's probably 13 to 14 today. And leases are working on at least a third of those.
Lease rates have increased 50% in about two years. The rates in new buildings are well into the mid-$3s and up on a net basis.
Q. It seems that some institutions are selling portfolios to other institutions. What's driving these deals?
Fraker: Some of those funds are closed-end funds that have a life of 10 years, and maybe they're not at the tenth year today but they know there's so much institutional demand that if they're going to sell anytime in the next two or three years now would be the time.
Q. The Dallas shopping center market had its best year in a decade in 1994, with almost 3 million sq. ft. of space started. And tenants absorbed almost 3.3 million sq. ft. What's caused this turnaround?
Herb Weitzman: A lot of it is because of the great job growth and all that disposable income has gone into the retail market. And the market has continued to have near record housing growth. So the retailers have come into Texas with a vengeance. They've had increased sales. And the land was so cheap that they decided to reposition. You put new space on the market and you're back where you were in the pre-'85 days leading up to the boom. We're seeing costs at that point or higher. We're seeing rents at that point or higher. I'd have to say that the voids are taken care of.
Q. Is new retail construction once again getting ahead of developing residential areas or choosing secondary locations?
Weitzman: You have to have a good location. You can't start going into the marginal location just to get a deal done. Retailers today aren't projecting on future sales. They don't go until they have sales today to warrant a return on investment.
Gruber: The dominant regional malls will continue to have a good ride in the future provided they offer the special fashion goods that people go to them for, and they provide the entertainment, the excitement.
Q. Does it bother you that Dallas is ranked second in the country in per capita retail space - about 24 sq. ft. for every resident?
Weitzman: Absolutely, because when you have anything like a tightening of money or the consumer gets concerned and gets more conservative they stop spending. There's not much slack. And all we want to do really is have a good, stable, solid growth. We don't want things off the charts. We'd like good, steady growth rather than having these big peaks and valleys in terms of building.
Roundtable
Participants
Charles Anderson, executive vice president, Trammell Crow Co. Reagan Dixon, managing director, Cushman & Wakefield Jack Fraker, senior director, Cushman & Wakefield Jerry Fults, president, Fults & Associates*Oncor International John Goff, CEO, Crescent Real Estate Equities David Gruber, president, MEPC American Properties Henry Knapek, president, The Bradford Cos. Mike Lafitte, vice president, Premisys Real Estate Services M. Thomas Lardner, president, The L&B Group Ross Perot Jr., chairman, Hillwood Development Co. Dary Stone, president, Faison-Stone Herb Weitzman, president, The Weitzman Group