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Dallas faces glut of office space

DALLAS — When Seattle-based Boeing Corp. came to Dallas this past spring looking for a new headquarters location, real estate developers rolled out the red carpet and showed off their buildings. Boeing’s decision to move its home office to Chicago instead of Dallas was a disappointment for North Texas. Still, the futile exercise to win the big office tenant turned out to be an eye opener for building owners and brokers.

”It wasn’t until the Boeing headquarters search that we realized just how many large blocks of office space were available,” said Dallas developer Steve Means with Means Knaus Co. “I think a lot of people were surprised at just how much office space is out there that we weren’t tracking.”

Surging tide

Don’t blame Dallas real estate execs for underestimating the amount of empty office space. A downturn in the local economy — led by high-tech companies — has caused a flood of office space to enter the market. Companies that either leased excess space or are consolidating or closing Dallas area offices are finding themselves with a surplus of real estate.

By current estimates, between 5 million sq. ft. and 7 million sq. ft. of Class-A, sublease office space is now available in the Dallas area. Much of it has come on the market since the beginning of the year.

“2001 is proving to be a shakeout year for companies, and more office space will be turned back,” said Staubach Co. executive vice president Paul Whitman. “We think there will be even more sublease space coming on the market.”

That’s bad news for Dallas developers and building owners who were already facing a slow year. Demand for office space in the Dallas area has slowed to a trickle in 2001.

After absorbing more than 6 million sq. ft. of space last year, first quarter net leasing turned negative for the first time in almost a decade. By some brokerage company estimates, as much as 500,000 sq. ft. of negative absorption was recorded in the Dallas area. Building owners and leasing agents say it’s been tough finding new deals.

“It’s just like a spigot was turned off,” said Dallas developer Marc Myers. “It’s surprising how the leasing activity has slowed. What makes it worse is no one really has a good handle on just how much sublease space there really is. It makes it hard to figure out just what is going on.”

Some new reports are detailing just how much sublease space is available in the Dallas area.

The Dallas office of New York-based Julien J. Studley Inc. just completed a sublease survey that shows a whopping 6.4 million sq. ft. of sublease space in the area. The survey counted all Class-A and Class-B office spaces over 20,000 sq. ft.

“There is no question that sublease space continues to come back onto the market, and, while a large percentage of it is from high-tech companies, the shift can be tied to no single industry — it is coming from everywhere,” said Greg Biggs, branch manager at Studley’s Dallas office. “This impacts the Dallas market in such a way that the sublease space can now be used as leverage against the landlords.

“It's truly a tenant's market,” Biggs said. “The large amount of sublease space puts the Dallas market in a position it has not seen in some years.”

No, really it’s Class-A

Unlike in previous cycles when sublease space in Dallas has been shopworn secondary offices, this time the vacant space put up for rent by companies is just as likely to be top of the market.

Veteran Dallas office broker Wayne Swearingen is leasing one large sublease office block in the northwest suburbs. The 25,000 sq. ft. top floor of the One Hickory Centre building was leased to Austin-based Internet company Aperian. But a change in plans caused Aperian to consolidate instead of expand, and the Dallas office space was never fully occupied.

Now the entire space — complete with new workstations and furnishings — is being marketed for rent at a couple bucks per square foot below going market rates.

“It’s state-of-the-art office space with vaulted ceilings and high-tech workstations,” said Swearingen, who’s already working with a few prospects. “You could be in business there in a week. This is some of the best office space in Dallas and will certainly meet someone’s needs.”

Los Angeles-based Kennedy-Wilson International’s recent study of the sublease office market in Dallas has turned up about 5.5 million sq. ft. of empty space. Two of the most popular suburban office districts — Las Colinas and the Far North Dallas area along the Dallas North Tollway — each had more than 1 million sq. ft. of available sublease space.

“Depending on the submarket, it can play havoc with landlords,” said Bob Young, who heads Kennedy-Wilson’s Dallas regional office. “And with marketing on the Internet and traditional flyers, we get information about more sublease space every single day. It’s becoming an increasingly important part of our office market.”

Kennedy-Wilson estimates about 1.1 million sq. ft. of sublease office space is in the Dallas central business district. It’s a burden on a market that has more than 25% direct vacancy.

During the last two years, high-tech and telecom companies have filled up many of the older downtown Dallas office spaces, but that has now come to a stop.

Brokers Jim Strubble and Myra Maher-Martin with Dallas’ Joe Foster Co. are marketing a full floor of office space in downtown’s Univision Tower. Much of the building has been leased to telecom and Internet companies that use the office space to house equipment. But Strubble and Maher-Martin say 20,000 sq. ft. formerly occupied by an accounting firm may wind up as standard office space.

“It’s first-class, headquarters-style office space, and there is five years and nine months left on the lease,” Maher-Martin said. “You get the entire floor.”

The former tenant is asking $16 per sq. ft. annually for the space, which is more than $4 per sq. ft. below downtown’s average office rent. Such cut-rate office deals are a bane for developers still leasing up new buildings.

“A lot of the demand is moving toward sublease space,” said Michael Dardick, president of Granite Properties. “That’s taking away demand from the other space.”

And that’s not good for companies like Granite, which is finishing work on its new Granite Park Two tower on the Dallas North Tollway in West Plano. The 10-story office tower opens in September with about 256,000 sq. ft. of Class-A office space. The building joins the first tower Granite completed and leased in the office park in 1999.

“I would be lying if I said the sublease market wasn’t impacting rates, but it’s not a disaster,” Dardick said. “Building owners aren’t even trying to compete with sublease space. Why would you?”

Skidding to a halt

Some developers are opting out of the market altogether.

Developer Means Knaus Co. halted work on a mid-rise office building in the northwest suburbs rather than compete in today’s market. Knaus of Means already had built and leased two six-story buildings to i2 Technologies in its successful Colinas Crossing office park.

“The Boeing headquarters search showed us just how many blocks of office space are available in that area,” Means continued. “We decided that we didn’t need to deliver this building to the market next January. We can finish the building in seven months if we need to.”

At the end of the first quarter, about 6 million sq. ft. of office space was under construction in the Dallas area, either in new projects or major renovations. Developers have put several deals on holds to wait and see how the rest of the year turns out.

“Everyone in the business is hoping that the economic downturn is short-lived, and that things bounce back later in the year,” said developer Jeff Swope with Champion Partners. “Right now, everybody is on hold but there’s no panic. I don’t think it’s anything to get carried away about.”

Swope said he doesn’t think that office market demand in Dallas is any weaker than currently in most major U.S. cities. But he agrees the sudden growth of the sublease market has rattled some major building owners.

“Brokers are telling property owners that it’s so bad that they have to lower rents,” he said. “But it’s nothing like we saw in the late 1980s.”

Overall direct office vacancy in the Dallas area was at about 15% at the end of March. Average building rents are just under $24 per sq. ft. annually.

“We always have significant sublease space in a market of this size, but it is larger than normal now,” said Jack Eimer, president of the Dallas office of Phoenix-based Transwestern Commercial Services. “It is so directly tied to tech and the dot-com demise over the past several months that it is creating an even greater consternation than normal. In some ways it’s not so different than back in ‘80s with the energy companies cutting back.”

Whatever the cause, he agrees that the chances for spec office construction in the Dallas area this year are nonexistent.

“It is going to make it extremely difficult for anyone to do a spec building at this time,” he said. “That’s good for the market. This market does not need additional spec office space.”

For tenants that need immediate space, some of it furnished, Eimer said the sublease market in Dallas will prove to be an attractive option.

“Sublease space definitely can provide a good opportunity for tenants depending on their space needs,” he said. “But it certainly won’t work for everyone.”

But there’s still hope

Developer Cawley Wilcox Cos. hopes there is demand for the huge Chase International Plaza under construction on the Dallas North Tollway. The two-tower development is the largest multi-tenant office project currently under construction in North Texas.

Together, the 13- and 15-story buildings contain about 715,000 sq. ft. New York banking giant J.P. Morgan Chase & Co. has leased one of the buildings going up. Chase already occupies the first tower in the project. Cawley Wilcox Cos. is leasing speculative space in the third tower.

“I think we will be able to lease that up,” said Reagan Dixon, Cawley Wilcox’s new president. “It would have been better a year ago and will be better a year from now, but the timing will prove okay.”

Dixon predicts that the job cuts and growth of sublease space in the Dallas market will slow in the months ahead.

“There have been lots of knee-jerk reactions by companies to lay off some people,” he said. “You have a lot of space coming back on the market at the same time the layoffs are occurring. But I think conditions will improve over the next year.”

The silver lining

The latest employment growth estimates for the Dallas area confirm that the local economy has slowed. For the 12-month period ending in May, about 87,000 new jobs were added in the area. That’s down from about 110,000 new jobs in the same time period last year.

“Sure, 87,000 jobs is down, but it’s still one of the highest job growth rates in the country,” said Dardick of Granite Properties. “The quicker the sublease space rents, the quicker we get out of the woods.”

Some building owners that had been preparing for a wave of sublease space have dodged the bullet.

Billingsley Co. had specifically sought high-tech and dot-com companies for its International Business Park west of the Dallas North Tollway, so the developer was preparing for a shakeout.

“I have three or four companies that leased extra space to accommodate growth,” developer Lucy Billingsley said. “Instead of growth, they now have excess space. It’s really a quick turn around from the days when these companies were taking the office space before we could finish it.”

But so far, Billingsley says she hasn’t seen a flood of sublease in her project. “We have one company that wants to lease some sublease space but hasn’t yet,” she said.

Meanwhile, Billingsley said she has kept signing new leases. “I hope to have one big deal signed soon,” she said. “Year-to-date, we’ve signed 170,000 sq. ft. of deals. We think that’s great considering the market.”

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