After years of abuse and neglect, downtown Dallas is showing signs of life once again, thanks largely to the surprising success of a residential housing component.
Editor's Note: When I lived in Dallas back in the early- and mid-1980s -- the go-go years -- the mere concept of living in the downtown core was unthinkable. It was simply not done. Downtown was a 1 2-hour city with sidewalks that rolled up at 6 p.m. Nowadays, downtown Dallas has changed dramatically. There is nightlife. There are actually a number of new residents living downtown, and that can only mean one thing - a bright future.
NATIONAL REAL ESTATE INVESTOR recently brought several of Dallas' leading real estate professionals together for breakfast at The Mansion on Turtle Creek for an open discussion about the state of the downtown Dallas market and where the values lie for investors in the future.
Q: What are some of the dynamics in terms of job growth and the overall economy? Has the trend up continued?
Ron Witten: Actually it has. It's surprised us. The final '95 numbers came in at about 89,000 jobs were added for Dallas/Fort Worth over 1 994. Right now the growth has slowed down, but only marginally. I think we're still running at about 82,000 to 83,000 jobs gained on a 12month year' over-year basis. We expect to see a slowdown along with the national economy, and we're sticking to that story. We still think that's going to happen. If and when the national economy slows that will certainly be reflected here, but that has not occurred yet by any stretch.
Q: How does that job gROwth translate to the real estate market?
Witten: Dallas is the epitome of the example that people wouldn't live here if there weren't jobs. The jobs are available for lots of folks moving in and we're seeing significant migration and that's creating housing. And as employers are filling up their payrolls that's filling up the office buildings and industrial buildings. And consumers are spending money so retail is doing well also. We're really seeing solid growth across the full spectrum for real estate markets. The challenge has become managing the supply side, which is a challenge we haven't had for quite some time here. That's definitely true with apartments, and with retail. And within the next six to 12 months it will become evident on industrial since we're building a lot of spec warehouse space. We're still OK on office, so far.
Robert Edge: My perspective is really as a street broker. I spend a lot of time downtown. It's really pretty simple as far as I'm concerned. There's still activity downtown. The activity has been moving from the older buildings to the newer buildings, still taking advantage of attractive market conditions in comparison with suburban markets. It's still the best buy in the city, the best value in the city. The jury is still out on how much movement there's going to be from the suburbs to downtown. That's a big question in my mind. There are limits to how much the decision of economics will play, but if you've got a $4, $5 or $6 gap per sq. ft. per year and it's 100,000 sq. ft. of space and you've got a 10-year lease, that's an awful lot of money to hit the bottom line. It's causing people to stop and think.
The other question of course is what about the tenants that are already in downtown. It seems like I'm seeing a little more optimism among the tenants downtown in terms of the future and not so much doom and gloom. And those are good signs. But offsetting that you'll see some adjustment downtown. For example, there are companies that if and when they move they're going to take a look at restacking and maybe getting into the trend that seems to be spreading through Corporate America and that's downsizing into higher density per floor, less space per workstation. So you may have some growth, but it may be offset by that trend.
The better buildings are doing better. The value is there. The rents are creeping up. If I had a client and he's got three to four years to go on his lease, and he asked my opinion, I'd say, "If you wait a year from now I don't think the rates will have gone up that much." But if he needs 100,000 sq. ft. in a Class-A or Class-AA, where I really think he would lose out is in his options, because I think that the availability of large blocks of Class-A space in the better buildings downtown is going to continue to shrink. If I was a tenant, that would concern me.
Q: Are there a lot of big blocks left?
Edge: There aren't now. There is a lot of space sitting there in a couple of buildings but it seems to be mothballed and I'm not sure what the owners will be doing with it. There's still a lot of space left downtown, but if you start looking for a big block of Class-A space and you need some room to grow and expand, the number of buildings that could accommodate you might be two or three.
Q: Any movement by tenants to do their own build-to-suits in the suburbs?
Edge: My own limited experience tells me that over the next 12 to 24 months a number of large users who are downtown now are going to be `in the market,' and I think that some of them will probably say to their representatives, in addition to their other alternatives, `Let's take a look at build-to-suit.' Whether that build-to-suit will be downtown or whether it will be in the Uptown area, Las Colinas or Far North, I don't know. I think if they take a look at that, unless they're willing to take a secondary or tertiary location, a lower-quality building, they're going to pay too high a premium to do a build-to-suit. So they may go through the exercise to say they looked at all of their options, but they're still going to come back and say the best value is in an existing building downtown.
Jack Eimer: I think in both directions, you've got downtown tenants that will use build-to-suits in the suburbs as an alternative. How viable of an alternative I think is a big question mark. But it's a great negotiating position without question. And you've got the reversal of that. You've got the suburban users that will use downtown as a bargaining chip alternative.
I think you're going to see more migration from the suburbs downtown though. I don't think it's going to be the savior of downtown by any stretch, but I think it's going to be a surprising amount, because that differential is getting to a point where it's great enough that many firms have to look at downtown as an alternative, or maybe if it's a regional operation the head of the region doesn't want to but the home office does.
Dary Stone: If you're a big tenant, the gap between what you can get downtown and what you can get in a build-to-suit is half. I'm going to say it's $10 or $12 a foot.
Edge: We just went through a process with a tenant like that for 100,000 sq. ft. They wanted a Class-A building and they looked downtown and the premium versus where they were was $8 million over a 10-year lease, in the $26 to $27 range. The developers said if they sat down in a room with architects they could value-engineer it down to give them a comparable building, but that would only take $3 million or $4 million out of it.
Stone: Look, downtown looks good today. It's been torn up for five years with DART (Dallas Area Rapid Transit) construction, and street and sewer construction. All of a sudden, it looks great. It's easy to get around and there's not a fundamental, substantive reason not to be downtown. Traffic is easier to deal with downtown than it is being on Central (Expressway). One of the problems was that the CBD had these too-early positive prognostications of turning the corner. But when it really does, you'll be shocked by how quick the rates will move. In North Dallas, we're doing $20-plus deals. A year and a half ago they were $15 to $16.
Edge: Now you've got two or three prospects for every space out there.
Eimer: How long will it take for downtown to do that, to cause the spiking that we've experienced in the build-to-suit market?
Stone: It could take a while, but the second a tenant has choices eliminated, and you know there might be three banks of space of 200,000 sq. ft., that's not lot of choices. And one of the buildings isn't giving any TI (tenant improvements). You've got a de facto 90% market even though it may still be only 70% leased in the overall CBD. The market is a lot more micro for a tenant.
Edge: Class-A is over 80% occupied down-town n so it's not that far away from being 90% occupied.
Stone: What I'm worried about though is, we talked about this higher density usage. How do you park those people? Every big tenant in the suburbs needs at least one space per 200 cars and in a lot of cases one per 100. The disparity between the parking problem downtown and in the suburbs I would rate as a major factor.
Clifford Booth: One partial remedy for that is we passed a TIF (Tax Increment Financing) here in downtown several weeks ago, sort of a parking TIF, for two reasons. One is to accommodate the of the conversion of the vacant historic buildings to residential, but it's also to construct parking garages to accommodate the office buildings as well. This is important because without it, this city is going to be handicapped to attract large tenants to these buildings.
Q: What area does the TIF cover?
Booth: It's mainly the center of the historic financial center, but there is about $1 billion in current tax revenues included in this bill. It's not the large Class-A buildings on Ross Avenue, but a number of the older ones.
Q: All downtowns are struggling with their stocks of Class-B and -C buildings. What will Dallas do? How can owners make improvements that pencil out?
Witten: What Cliff just touched on is a partial solution. But the strengthening of the residential market around downtown, the new development, the loft conversions, has been surprising given the number of units that have been delivered. The leaseups have been strong, the rents are moving up, but still it's probably the only location in Dallas and in Texas and maybe in the Southwest where new and finished apartment projects are still able to raise their rents. The Uptown projects have been extremely successful, and we're now seeing that transition into the downtown. That's a step in the right direction.
In some ways what we're seeing is downtown Dallas growing up to be a mature center city. In Dallas we think of downtown as being old. But it's not as far as functionality. We're seeing downtown growing and redefined. We're doing some of the right things I think with mass transit and housing and the parking TIF, and it's like being a 12-year-old's father -- it's not a pretty site watching that progression mature. We're going through some growing pains and maturing pains and restructuring and re-elbowing. With the success of the housing particularly, I'm more encouraged about downtown than not too long ago.
Tom Lardner: No only in the rental market, but what we see is a lot of interest in single-family zero-lot-line product. The implication is that there will be more of them as people realize that there is an affordable alternative to have some yard or some ground in or near the central business district in the $200,000 to 5225!000 price range. The number of 225,000 people are in office buildings on the north side of downtown Dallas to the Uptown area, and as that population increases and moves toward the single-family component I think you will see a continuation of upward rents in the rental property market. To build an apartment building in or near downtown is going to come out of the ground at $1.00 to $1.10 a sq. ft. When you translate that into an adjustable rate mortgage you can still afford a home of 1,500 sq. ft. at approximately the rental value of a 1,400 sq. ft. apartment. And as those things continue to merge with one another, I think you're going to see an increased rental value for apartments.
Q: Is the downtown area merging with the Uptown area?
Edge: In the last 40 years since I've been associated with downtown Dallas, the main street has moved successively north. It's never backed up. When I first came to town it was Commerce Street. Now arguably it's Ross (Avenue). I think it will he redefined. l think in the next few years the development will be to the east and to the north. So I think we'll have a redefinition.
Lardner: Clearly the land available for residential development is north of the Arts District between Highland Park and the CBD. The positive aspect for downtown to me is there are few cities in the last three years that are able to say there has been in excess of $100 million in single-family residential developed within five minutes of the core area.
Q: In most cities, there is the chicken-and-egg theory of needing both retail and residential to create a 24-hour downtown. What is the state of downtown Dallas' retail market?
Booth: First I want to add something when you're talking about the rental housing in the State Thomas area and McKinney. It's quite a different kettle of fish than the projects that are being started right in the downtown core. When you're talking about downtown housing it's night and day. The cost of land is significantly higher in the core. That's why the city of Dallas put together its intown housing program several years ago and these new projects all are recipients of that money. About 25% of our total capital improvements are coming from this soft speculative money at 5% interest and without it we couldn't do it. That's important to note.
Stone: One of the biggest challenges our CBD has overcome is, we lost all of our banks. All of our banks went through receivership. That was a huge blow to downtown Dallas.
Edge: We're still recovering from that.
Stone: For us to have, over the last 18 months, positive absorption in the CBD, is incredible when you realize the history behind our banks.
Q: Ron, we need some hard and fast numbers on the CBD market.
Witten: The downtown office market, in the short term at least, will recover if for nothing else by having space available when it's not available elsewhere. Out of the 20 million sq. ft. of space that's vacant in metropolitan Dallas, about 11 million of it is downtown. That figure does not count many of the older buildings that have been physically taken off the market, mothballed and aren't actively leasing. So there's a substantial amount of availability downtown and given the limited new construction that's happening, downtown is going to be the game for the next 24 months at a minimum in terms of the value of space for significant size users.
Q: Will there be any major new repositionings downtown?
Edge: There is some discussion about Equitable and Crow repositioning 2001 Bryan. That's been going on for some time and we haven't seen it happen yet. They were trying to decide to redo the whole building including the skin and go after the A market, or redoing the interior and going after the B market. I'd like to see that happen. It would help that area. That's the one that might have the best chance of happening.
Eimer: With major users the commitment would be made to renovate and bring it up to a good solid B-class product downtown, but it's going to take a major tenant to drive that, 400,000 or 500,000 sq. ft. at least. Nobody's going to do it on a spec basis.
Lardner: I think you'll see some ownership changes in the next 12 or 18 months. All of us at the table recognize that either there are purchase and sale agreements that are in place or process changes of ownership that will take place. When you combine that with what we've talked about this morning, the $10 differential between suburban and downtown, in reality that means that $25 in gross rents are out there and they're hanging limpid at this time but not far into the future. As new ownership assumes an equity position in buildings and there is an anticipation from the investment point of view ... we see today versus three years ago people looking more to what the rents will be three years from now as opposed to what the cashflow was the last two years. As those two factors merge, l think you'll see both tenancy interest and investor capital cause a significant infusion of capital into downtown Dallas that will bring the Class-A buildings to north of $20 in short order. Sponsorship has been dealing with other things, and once you are able to focus on a market and the margins going with it, you're going to see significant things take place. And you could see a major office building in the CBD that will bring along a renovation of other space as alternative tenancy for the marketplace.
Eimer: Corporate America and that's not necessarily downtown, is looking for a lower-cost, more efficient, less glamorous building, that's well-conceived inside, but not as much marble. Unless they feel the pressure from within their industry to pay a higher premium for a new building, that may not come back for a while. l think they're going to look for the best compromise they can get of location, image and rent.
Lardner: Downtown Dallas is the most inexpensive alternative for the Metroplex today, and for Corporate America in the United States as it relates to major markets that have access to the transportation that Dallas does. It's the best buy. Even if you were to develop a new Class-A building today in downtown Dallas, and the rent that we just talked about approaches $30, relative to other Class-A space it's competitive. When you're two-and-a-half hours from either coast and with a rental rate that's at least 40% less than other available alternatives in the country, you're talking a terrific package for Corporate America.
Eimer: The one thing we haven't talked about is for a major back-office type user, that the downtown market presents a more affordable employee base.
Q: What is it you're telling your clients about downtown Dallas?
Lardner: It's clearly a buy opportunity. We have acquired in the central business district in the last 12 months and we will be acquiring more. We are currently looking at the possibility of a joint venture for a development project in the central business district. The clear story is that the market today is anticipatory of what rents will be and in that regard downtown has the best story to tell.
Clifford Booth President Southwest Properties
Robert Edge Executive Director Cushman & Wakefield
Jack Eimer Executive Vice President Transwestern Property Co.
Thomas Lardner President The L&B Group
Dary Stone President Faison-Stone
Ron Witten President M/PF Research