2008 DFW Commercial Real Estate Forecast
Whether you rent, develop, or broker commercial real estate in North
Texas, 2008 is likely to be a more challenging year. As a result,
tenants are being urged to move fast on good deals.
It’s not that Robert Deptula and his colleagues at Transwestern are leery about Dallas-Fort Worth’s commercial real estate market in 2008. They just want to be prepared. While Deptula, a principal with Dallas-based Transwestern, is actually optimistic about the market next year, he and others are girding for a surprise.
|READY, SET: Robert Deptula says Transwestern has backup plans to help make the quarterly numbers work. photography by Jeremy Sharp
“We’re already planning contingencies for the next couple of quarters, where if we don’t meet certain goals by the end of each quarter, we immediately cut ... expense, cut advertising—wherever it makes sense to make the numbers work,” Deptula says, reflecting over drinks one recent evening at the Northwood Country Club in North Dallas.
“But that doesn’t mean we think we won’t meet those goals. Right now, everyone just seems to be in a holding pattern,” he says. “The credit crunch is everyone’s excuse to stall things. But if things don’t go well, we don’t want to waste time later figuring these things out. If we don’t meet goals, we have a plan ready.”
Deptula’s not alone. All across North Texas, office tenants, developers, and brokers are preparing for a new year marked by slightly higher rental rates and a little less available space. After gangbuster years in 2006 and ’07, 2008 should bring a decent but slightly tougher commercial-property environment, complicated in large part by the ongoing credit crunch.
While developers will have a harder time finding financing—and office users should face more challenging conditions—the experts say this remains a good time for companies to make long-term real estate decisions. Up to 20 percent of all local firms face the end of their office leases in any given year and, just now, far more are looking to expand than to shrink.
“I am concerned that we are entering a short-term bear market,” says Mike Wyatt, an executive director at Cushman & Wakefield of Texas Inc. “However, long-term fundamentals are still in place in the DFW area—and Texas in general—for sustained economic growth, not only in the real estate industry but across all sectors of the economy. [My advice to] any company looking ahead and making real estate decisions in the next 12 to 18 months: Move ahead cautiously and with sound due diligence.”
Randy Garrett, another principal at Transwestern, concurs. “Don’t be skittish” about expansion or relocation space, Garrett says. “It’s less expensive to have too much space than to have too little.”
The numbers tell why.CONSTRUCTION IN CHECK
Dallas-Fort Worth’s office market boasts 263 million square feet of space—the eighth-largest inventory among U.S. cities, according to a report by Delta Associates, a Virginia-based firm that tracks real estate in all the major metros.
Net absorption here for 2007 (through September) was 2.8 million square feet annualized, seventh-best among big U.S. cities. There were 6.9 million square feet of office space under construction or renovation in the DFW area in the third quarter of 2007, the same as at mid-year 2007, but up from 4.1 million square feet a year ago.
That’s not that much new construction, and about half of it—or 3.5 million square feet—is already spoken for. The rest, or 3.4 million square feet, is speculative space. “That is 1.8 years of supply at long-term rates of absorption,” says Gregory H. Leisch, Delta’s CEO, who revealed Delta’s findings at a recent real estate forecasting event.
According to Delta research, the DFW office market saw continued expansion during the third quarter of 2007, albeit at a moderate pace. Vacancy rates crept up slightly, while absorption remained positive due to deliveries of pre-leased space.
Based on projected demand and job growth, and with the likelihood that some new projects on the drawing boards will remain on the boards through much of 2008, office vacancy rates next year should stay about the same. Leisch projects 17.7 percent vacancy in 2008, the same amount we’ve experienced this year. In 2005, considered a great year, vacancy was north of 18 percent.
As always, some submarkets will fare better than others. Uptown, Las Colinas, the North Dallas Tollway, and Preston Center will probably see the best gains in terms of new space leased. Developer Craig Hall of Frisco’s Hall Financial Group sees favorable prospects for the North Dallas and Far North Dallas submarkets, as well as for Richardson’s Telecom Corridor. “The Uptown market and Victory are doing well,” Hall says. “There are even a lot of positive signs in the Arts District, which will hopefully have a positive spillover effect on other areas inside of Woodall Rodgers.”
With 2.9 million square feet of sublease space on the local market—that’s 1.2 percent of the standing inventory—companies needing extra space on a budget will have plenty of options.
So, what do all these numbers mean to the average office tenant? That really has to be examined through the lens of job growth.STRONG JOB GROWTH
Jobs are the fuel of commercial real estate because, obviously, employees take up space (the good ones do more than that, of course). Happily, the DFW area continues to add jobs at a robust rate. During the 12 months ending August 2007, the Dallas metro area gained 78,800 jobs, behind only Los Angeles and New York.
“And those are metros which are four times larger than Dallas,” Leisch points out. “That’s 30 percent above the long-time job-growth-rate average.”
|OPPORTUNITY KNOCKS: Developer Craig Hall says now is a good time to lock in long-term office leases. photography by Dan Sellers
Nearly half of DFW’s job growth—or some 36,700 jobs—involved professional positions. As Leisch puts it, they are the “high-income, white-collar, desirable workers that occupy office space, spend dollars in high-end retail facilities, and occupy the more expensive apartments or buy high-end homes. These are the kind of jobs we want in the Dallas area.
“And, what we forecast is similar job growth through 2009,” Leisch continues. “The Metroplex economy will likely remain strong … with a broad range of economic sectors contributing to the growth. We estimate Dallas-Fort Worth will achieve employment growth that averages 70,000 jobs per year over the next three years—plenty of jobs to support a robust commercial real estate market into 2009. Provided we don’t overdevelop.”
That’s where the 2007 credit crunch comes in.
Until recently, the main holdup getting new commercial projects under way was the rising cost of construction. Spikes in the prices of copper, steel, and cement have been almost commonplace in the last two years, says David Snyder, executive vice president of corporate business development for Dallas-based Constructors & Associates. Construction booms in other domestic metros, post-hurricane construction along the Gulf Coast, and the rapid pace of building in China have been eating up materials faster than they could be replaced. However, a slowdown in new-home construction has actually eased that problem recently.
“Construction costs have begun to stabilize,” Snyder says. “While we’re not seeing the continuing rise (almost 1 percent per month) that we’ve seen over the last 24 months, prices are not declining, but are remaining fairly constant for the near future.”
Now the drag on development is a different kind of cost: the cost of financing. Real estate investment bankers have become much more conservative in doing deals. Lenders have tightened conditions, re-priced terms, and implemented much stricter underwriting standards in response to investor concerns.
“Financing is getting harder. That and high construction costs are what’s slowing everyone,” says Dallas developer Neal Sleeper of Cityplace Co., the man who turned a dead pocket of Uptown into West Village and Cityplace. “We’ve been working on finishing two large, mixed-use projects at Cityplace for two years now, and they’re still in a holding pattern.”
Developer Hall says that, on the financing side, Dallas (as well as the rest of the country) is currently in a period of adjustment, where lenders are viewing commercial real estate much more cautiously than they did just a few months ago.
| SOURCE: DELTA ASSOCIATES
“In particular, the collateralized-debt-obligation form of financing, which financed the riskiest parts of commercial loans, has experienced traumatic write-downs” totaling more than $20 billion over the last few months, Hall says. “This has basically brought a halt to this portion of the financing of commercial real estate. Commercial real estate will go back to the days where more equity is needed, and returns in the short run will be diminished. In the longer run, this will cause rents to go up and returns will be restored by higher rents.”
Hall nonetheless predicts lower interest rates in 2008, helping to mitigate some of the negatives for office tenants.
If lenders are skittish, it doesn’t appear that investors and owners are. Investment sales volume in the Dallas area totaled $2.7 billion through the third quarter of 2007, compared to $2.1 billion during the same period in 2006, which many considered a pacesetting year. Sales prices were down a bit, averaging $118 per square foot in DFW through the third quarter of 2007, compared to $129 per square foot in all of 2006 and $114 per square foot in 2005.
|(LEFT) $300 million: The price Stream Realty listed downtown Dallas’ Chase Tower for earlier this year. In 2006, Stream partnered with Highland Capital Real Estate Funds and purchased the skyscraper for $260 million. (RIGHT) $600 million: The price Fortis Property Group has put on a real estate portfolio including Galleria Towers. Fortis purchased the building for $290 million in 2006. photography by Scott Womack
(The culprit that brought down the average price was the third-quarter sale of Cityplace Center East in the Central Expressway submarket for just $89 per square foot. 7-Eleven Inc. left 500,000 square feet of Cityplace vacant when it took up residency in Lucy Billingsley’s One Arts Plaza downtown.)
The demand for office property among investors, Leisch says, remains much higher than the supply. And that demand is translating into healthy sales prices. Stream Realty, for example, partnered with Highland Capital Real Estate Funds in 2006 to purchase Chase Tower in downtown Dallas for about $260 million. Earlier this year, Stream listed the property for sale at close to $300 million. Fortis Property Group purchased Galleria Towers at LBJ Freeway and the North Dallas Tollway in November 2006 for $290 million; today it’s being listed as part of a $600 million portfolio. INDUSTRIAL STRENGTH
Meantime, experts say, it’s telling that DFW’s industrial market will likely experience steady expansion in 2008. Trade between Asia and North Texas will continue strong in the coming years, creating a steady demand for warehouse and distribution properties in Dallas-Fort Worth, Leisch says.
One strong driver will be the increasing importance of the new inland port in South Dallas, an intermodal facility servicing incoming rail cargo from ports on the West Coast. In addition, Dallas recently signed a cooperative agreement with the inland port of Guanajuato, in central Mexico, to facilitate trade between the two locations.
The North Texas industrial market—and especially the distribution sector—should be among the top U.S. performers over the next few years, Leisch believes. “The large amount of speculative space currently under construction will likely keep vacancy rates relatively stable, despite consistent demand,” he says.
Robert Fulford, a vice president of brokerage services at CB Richard Ellis who specializes in the industrial market, agrees with Leisch’s assessment.
“There are great deals being made, especially in South Dallas, and especially for bulk users,” Fulford says. “There is more new product in South Dallas than there has ever been, and the developers are building state-of-the-art facilities down here. The Interstate 45 corridor reminds me of what Coppell was like back in the day. Anyone needing industrial space needs to act sooner rather than later.”
|SOURCE: DELTA ASSOCIATES
Ross Perot Jr., chairman of the Dallas-based Hillwood Development Co., says that whatever challenges the DFW property market faces are short-term ones. Chatting during a cocktail mixer at Delta’s industry forecast event, Perot was characteristically upbeat.
“This is the most dynamic real estate market in the country and the most affordable,” Perot says. “This is where deals get made. The future of this market is very good. We’re looking at having 9 million people by 2030 in Dallas-Fort Worth. In a market where we’re adding two or three million people, if you’re in this business you should do well.”
Developer Hall, like Perot, is optimistic about the long-term. And he thinks the “challenges” of 2008 will present office tenants with some hidden opportunities.
“Now would be a good time to lock in a lease for office space on a longer-term basis,” Hall says. “Overall, this may be the last really good opportunity for some time to come in terms of the consumer side of renting commercial space at a favorable rate and tying it up on longer terms.”
In sum, Hall believes, 2008 should be a relatively steady year. While demand for property may soften somewhat, he predicts, the local market should be reasonably in balance. “Over the next three or four years,” Hall says, “I would say vacancies should be going down and rents going up as demand picks up and supply is more constrained by a combination of higher costs to build and higher financing costs.”
Which is another way of making Transwestern’s point about DFW’s commercial real estate prospects in 2008. “If you get too cautious and pass on a good opportunity [for new space] because you’re overly cautious, it’s going to be your loss,” says the company’s Deptula. “You’ll be stuck expanding your operation on a different floor or in different building, which will double your operating costs. Don’t be timid.”THE TAKEAWAY
>> If the 2008 local real estate market were a road, it would be marked with a “caution” sign.
>> But “caution” doesn’t mean “stop.”
>> While lenders have appeared skittish, investors are still bullish.