The North Texas office market has seen profound changes in the span of just a few years. Companies are moving in and workers are flocking here, too. Unprecedented projects are breaking ground, redevelopment activity is booming, and investors of all stripes are targeting Dallas-Fort Worth.
Is the region prepared to handle this growth, and what does it mean for the future?
To find out, we gathered seven industry experts for a roundtable discussion. Participants included Greg Biggs, managing director, JLL; Robert Deptula, principal, Transwestern; Celeste Fowden, senior vice president, CBRE; David Pinsel, former managing director, Colliers International; Drew Steffen, managing director, Hines; Sabine Stener, CEO, Gaedeke Group; and John Zogg, managing director, Crescent Real Estate.
Q: How has leasing activity in North Texas for 2015 matched your expectations?
CELESTE FOWDEN: We’ve outpaced 2014 based on the stats that have come in year to date, which is incredible. And based on what we felt last year, it’s no surprise. This year seemed to get off to a bit of a slow start, but is ending up strong, and I think 2016 numbers will be strong as well.
DREW STEFFEN: So are you saying the market met expectations in 2015?
FOWDEN: I’d say it exceeded them, based on what we saw in 2014 and seeing those tenants take occupancy. It definitely outperformed.
GREG BIGGS: We’re seeing rental rates that we’ve never seen in Dallas before. That’s what has exceeded my expectations. It’s an amazing thing to talk about $50 rents in Dallas. Just think about where we were just 10 years ago or 15 years ago, looking at $20 rents and thinking, “Boy, could we ever get to $30?” And now here we are at $50.
ROBERT DEPTULA: And we went from $20 to $50 in a period of, what, about 18 months?
STIFFEN: The amazing thing is looking at the older 1980s assets, which have seen rent growth of 30 percent to 40 percent over the last 18 months, if you just follow that—the numbers. They’re now pushing high $20s, low $30s. That’s kind of crazy, right?
BIGGS: It’s obviously supply and demand driven, but tenants are willing to pay those higher rents for different reasons today. They’re all after employees. And some of the interior finish outs they’re putting in these buildings are just phenomenal. It’s really cool to see what they think attracts new employees.
JOHN ZOGG: I never understood why Dallas was so cheap. Even compared to Austin and Houston, we’ve always been a cheap market. … I know we have a lot of good developers here, and a lot of competition. But at this point, I really think Dallas has just caught up to the rest of the country. We’re still not where Austin is, and Houston was outpacing us until the recent oil crisis.
DEPTULA: Dallas is still cheap, nationally and internationally—very cheap.
SABINE STENER: To the point about older buildings—Dallas used to be a market about the bigger and better mousetrap. So if you had a new building, everybody was moving there. Now it has become dense in the urban core, and people are more looking at location. If you have a building in a great location that is an 18-hour market where there’s an amenity-rich base, people are paying for it where, in the past, they wouldn’t.
BIGGS: They’re paying for walkability, because they know what it means to the employees.
FOWDEN: And on top of that, it’s a destination versus just product out there. … It’s hospitality-driven, and it’s what you have to offer for new recruits, as well as retention for the existing employee base.
STENER: When we’re looking at building new buildings these days, or even refurbishing the old buildings, we’re putting in tenant lounges, gyms, coffee bars. It’s amenity-based, and it comes down to trying to serve the tenants, and the tenants are trying to serve their employees. They’re competing for workers—getting the best employees. So you offer them flex work time, you offer them a tenant lounge, you offer them all kinds of amenities, free car washes, what have you. A lot of those things are not money-based; a lot of them are lifestyle-based. And that’s how the pricing comes about. It’s not just about the newest building and the new-paint smell. It’s about the whole package.
FOWDEN: And not just checking the box on a package. Actually doing it correctly and thoughtfully.
STENER: What we have found is that office space decisions aren’t being made by the corporate real estate departments anymore; they’re made by HR executives. They’re the people charged with hiring new recruits. It’s very different. The $50 rents may sound high, but really, occupancy cost is probably one of the more manageable costs you have in your whole expense stack.
DAVID PINSEL: That’s true. Employee retention is much more expensive than real estate.
FOWDEN: Typically, if we lose a deal, it’s not based on the pricing. It’s based on something that somebody else has to offer that we can’t—the intangibles we can’t put our finger on.
DEPTULA: We’re also seeing big movement in the sublease market. Some of the best sublease space I’ve ever seen had been languishing for a year or year-and-a-half. Then, in the last two months, all of these deals are hitting. … It’s speed to market, not having to go through design and permitting, whatever. That’s something I’ve been shocked to see—how many subleases are coming off the market.
Q. What are tenants demands in terms of office space today, and how are developers responding?
STENER: We’re responding by amenitizing as much as we can. You can’t just get away with the gyms people used to put into buildings, with two treadmills or whatever. Now, great care is being taken to put together these gyms, because they’re actually getting used. We have a tenant lounge at one of our developments up on the tollway at Millennium Tower. People use it every day, and it’s part of their daily lives. So we are very heavily thinking and getting input from tenants, actually, to figure out exactly what should this lounge look like, what should it have in it. And it’s not just geared around business. So many people have 10- or 12-hour workdays, and they need to be able to just unwind for a little bit. Employers recognize that if workers have to leave and go off site—which is why walkability has gotten so big—if people have to start getting into their cars, they’re gone for an hour or more and you’re losing that productivity.
BIGGS: That’s right.
STENER: If I can walk to the little café around the corner, if I can go into the tenant lounge in the building, if I can go work out in between in my building and I have a decent gym and maybe have towel service, and I have a trainer there and so on, that really adds to overall happiness and productivity, and so that’s how developers respond. We’re not just in the business of renting space anymore. We’re in the business of supporting our tenants in whatever way they need.
ZOGG: The decision-makers know what they can do within the four walls of their premises, and they can build out a great space. But they’re looking hard at what landlords offer outside of those four walls: What does that travel experience look like from the time we enter the garage until we get to our space? How much light and vibrancy exists outside of those four walls, etc.? … As Sabine said, you see HR directors in real estate meetings now; you didn’t see that before. They’ve come to your building because they like the location. Now they’re concerned about that employee experience outside their own four walls.
STEFFEN: That’s true; it’s all about the experience. If you look back at the mid-1990s, a lot of the college campuses started to transition from traditional cafeterias to experiential. Everything was put into little stations, you go to the pasta station or the pizza bar or the whatever. Then you started seeing student housing become more experiential, and then it became an expectation in multifamily. I don’t think it’s any big secret that what we see in multifamily, in terms of trends, concierge service, hospitality—all those things are now transitioning into the workplace. The live-work-play is being blended, and that’s how we’re having to analyze things.
BIGGS: Efficiency has become very important. That’s one of the reasons tenants feel like they can afford more expensive space. If they become more efficient, put more people in less space, that’s one way to look at the math. But it’s still got to be a great experience for the tenant, and that’s one of the reasons that the tenant finishes that you’re seeing are really something special, because they do want to make it an employee experience. But what that also does is put pressure on parking ratios and on systems in buildings. And those things, over time, take a toll.
STENER: Parking is a rather interesting issue. I think we’re lagging behind in Dallas-Fort Worth. In other markets, we’re seeing the whole mass transit have more of an impact, or people getting to work on a bike. The movement is coming here. We’re building a new building in Legacy West, which will have bike trails, and people are expecting workers to get to the office via bike. It’s the next consequence of the live-work-play—the walkability score, the mass transit score, the biking score—how can I get to work without going by car.
FOWDEN: And as we’re doing new development, our parking software is having to get more sophisticated to keep up with those employers that have, you know, 1,000 employees but at any given time, only 500 are in their seats at one time. To be able to give access to 1,000 cars, but only allowing 500 in the garage at a time. It’s one of the things we’re looking at.
STEFFEN: As an owner, I look forward to the day we don’t have to provide three [spaces] per 1,000 [square feet] parking. We’re building things in other cities with lower ratios, including a 200,000-square-foot office building in Minneapolis with 0.5 per 1,000, and it’s a downtown location. I don’t know what your parking ratio is at McKinney & Olive, John, but tenants still want it. They want to walk everywhere once they’re at work, but they want to drive to the office, so it hasn’t totally crossed over.
ZOGG: We’re doing 2.75 spaces per 1,000 at McKinney & Olive, and I’m worried about selling all my spaces. If I look at who’s coming in so far and I max out butts in seats for their plans, I think I’m going to have trouble selling 2.75. That was very surprising. But to Sabine’s point about having bike storage—not racks. … That’s one of the other big check-the-boxes for users today: Where are my employees going to be able to park their bikes? And it’s not just a park them outside and lock them up; it’s inside storage. Sometimes these bikes cost $5,000.
STENER: Yeah, we have that in our building in Plano, because people are asking for it.
FOWDEN: There’s a huge focus on wellness, with the bikes, with natural light and and internal stairwells, so people can walk up and down between floors instead of taking elevators. That’s so important.
Q. There’s a flurry of redevelopment activity in the core. What impact is this having on downtown Dallas?
ZOGG: I’ve never seen such reinvestment in product as we’re seeing today. That’s super important for the market. And it’s institutional ownership like we’ve never seen—quality institutional ownership. That means it’s not people looking to trade and flip buildings, but really long-term owners willing to invest money and make these buildings great. I look at the skyline and I can’t tell you a building that’s not going through a major renovation, I mean, minimum $10 million, every one of them. It has a good chance to transform the market, but I get even more excited about the long-term ownership, the stability of that.
DEPTULA: You said downtown versus urban core. The urban core certainly includes Uptown now. I think downtown still has some real struggles. If you look at where the occupancy has come from, in two big cases, it was driven by something besides a desire to be downtown. It was because they’re owned by the company that also owns the building.
FOWDEN: Klyde Warren Park continues to be the biggest catalyst in the success of Uptown jumping over the freeway. We continue to see lease rates move up, and it’s directly correlated to the develoment of the park.
BIGGS: Some of the new development that you’re seeing is based around parking. Specifically with regard to two projects downtown, they’re throwing tons of money into increasing their parking ratios, and not only increase their parking ratios but add a multifamily component to it and retail on the street. I think that’s a big deal. And I think what JPMorgan is going to do next to Trammell Crow Center is going to change Ross Avenue. It’s going to be something special.
ZOGG: That and the redevelopment of Fountain Place. And what’s going on in the West End is very exciting, too.
PINSEL: When I got here, there was no Klyde Warren Park, there was no Perot Museum. And it’s not just in Uptown. I live in East Dallas, and what’s happened on Greenville Avenue has been amazing. I came here with pretty low expectations. It was a work move for me. I had never been to Dallas before my first day of work here. But the city has surprised me in so many ways. The entrepreneurial spirit that came into play with the park, to get that off the ground. In most places across the country, it would have been impossible. And the fact that it happened in the time-frame it did is pretty spectacular. Dallas is becoming more on the radar for people in other markets who want a more affordable cost of living, good schools, business opportunities, no state income tax, a right-to-work state. There’s a lot of things going for Dallas right now. Long-term, you’ll see people from California continuing to come, and people from New York continuing to come, which bodes well for office, for multifamily, for retail—for all product types.
Q. How is demand in Uptown pairing up with supply, and what is the outlook?
FOWDEN: We’re doing $40 net deals at 2100 McKinney. There’s no supply on the ground. Currently there is only one block of 100,000 square feet and six blocks of 50,000 square feet. McKinney & Olive is obviously doing very well, and Trammell Crow’s Park District is going to do incredibly well. The tenants have no issue paying higher rates if we’re providing what they need to attract and retain employees.
STENER: Uptown really has become Dallas’ 24-hour market. It’s the most amenitized market; it’s the most walkable one. You have everyone from larger corporations to small corporations to even single professionals leasing office space there because you can walk to your meetings and walk to lunch and dinner. Preston Center used to be that market; but Uptown has really overtaken Preston Center as that market. I think Klyde Warren Park just cemented that, along with successes on the fringe of downtown.
DEPTULA: I just wonder how much demand there is at $45 or $50 per square foot. Not everybody, by any means, can pay that rent. When do we reach saturation? Is it the first, the second, or the third building that goes up? On the ground, you can get it. But will the third guy that goes vertical get it?
FOWDEN: We’ve talked about Dallas being such a great value for companies that have various locations throughout the country and the globe. So I think we’re going to continue to see the influx of deals moving into Dallas, now that we can offer an amazing cultural package and different things that weren’t here 10 years ago.
PINSEL: From a macro standpoint, the migration trends still strongly favor Dallas. If you look at the West Coast, the Northwest, the East Coast, $50 rents don’t scare a lot of those people away.
STEFFEN: I think the risk we run, to Robert’s point, is people look at Dallas-Fort Worth as a market as a whole and they see it as affordable. And they come here and start to realize that the Legacys of the world are self-sustaining and are very independent. They’re becoming cities within a city. That’s the risk that Uptown runs. We want it to be as fantastic as we all know it is, but the supply-and-demand factor is real.
STENER: The two markets you just singled out are actually the two hottest markets. The rents in Legacy are the same as the rents in Uptown.
ZOGG: I was going to say, is Legacy really cheaper? I don’t think so.
STENER: It’s not cheaper. And actually, the other thing going on is you have people coming in from out of town and they look at two submarkets, Uptown and Legacy West, which for us who are here, it’s really weird, because those two markets are not alike.
STEFFEN: That’s true. The only other thing to tack on to what I was saying is the ability for the workforce to get there. And right now, I think the centrality of some of these other locations as you head up the Tollway or what not, it’s just easier to suggest that the different incomes in some of these workforces makes it more affordable to live up north.
FOWDEN: If employers are targeting millennials, it’s probably more of an Uptown requirement. If it’s Gen Xers, it’s probably Frisco and Legacy.
PINSEL: For schools—that’s the other big question we get: “Where can we put our kids in public school and have it be decent?” And that’s not Uptown, right?
ZOGG: I don’t think I’ve ever been as bullish on Uptown as I am today. Ten years ago I gave two speeches, one in Uptown and one in Buckhead [an affluent area of Atlanta]. Both markets were building an incredible amount of supply. I was doing the math and I said, in both speeches, “I don’t get it. Building a 10-year historical absorption supply in one year—tell me how that works?” People told me I just didn’t get it. Well, Buckhead became way overbuilt, and we were one building heavy in the last cycle. But this time, if everybody goes that says they’re going to go, we’re talking about a 15-year historical absorption number on the ground in a year-and-a-half. Now, I don’t think everybody is going to go. People are going to be prudent. But some will. And I think every building that has been announced makes sense in the long term. Everyone will potentially get their lead tenant. It’s what’s going to happen on that last 50 percent of the building, slugging it out for that. At the Crescent, we were worried about that—making sure we don’t have expirations in the 2017 to 2019 timeframe, because of our fear with that.
Q. How are supply and demand matching up at big suburban projects like CityLine in Richardson, Legacy West in Plano, and The Star in Frisco?
DEPTULA: If everything breaks ground along the Frisco miracle mile, I think it’s 50 years of absorption. So where is that demand going to come from? We’ll see how much goes vertical and who gets the next five tenants that do go and who doesn’t.
STENER: We are seeing really strong demand. We are a little different in that we are decidedly mul-titenant; we want to be the landlord for the companies that want to come into the area and do business with the corporate headquarters that are up there. We’re really trying to cater to the people that are coming in from the outside, saying, “I now have to be in Plano, Texas.”
Q. What other trends are impacting the office market?
BIGGS: One of the things that could hit us is the cost of construction, which has gone up dramatically. Somebody was telling me the other day, John, that you guys repriced your building just to see what it would cost to develop today.
ZOGG: Yeah, we locked in our numbers two years ago. Today, they’re 7 percent higher. Labor and some materials made up most of that. And if we looked at what our land cost would be versus today, it’s almost, in some cases, double. We were very fortunate to start when we started. We couldn’t build a quality building, a Cesar Pelli-designed building. I don’t think Dallas is ready for $56 rents, and that’s what you would need. Sabine, you’re probably feeling this a little bit out there, but the guys that are about to start are feeling it even more.
STEFFEN: We’re very afraid.
BIGGS: It’s not just the core of buildings; it’s the interiors, too. And tenants are feeling it. Landlords want to give the same amount of money in tenant improvements that they have in the past, and that’s one of the things we always argue about. Well, if costs go up, it’s squarely on the tenants’ shoulders. So they’ve got to make those decisions about what their space is going to look like and how much they’re going to spend. At some point in time, you may see construction costs on interiors projects kill a deal.
FOWDEN: We’ve already seen that.
DEPTULA: Second-generation space functionality counts now. One thing I’m surprised about is how some of the markets haven’t recovered. How can Stemmons not be getting overflow from Uptown and Preston Center? But it isn’t.
BIGGS: North Central Expressway is, though.
DEPTULA: It’s starting to. But they’re getting $22 per square foot instead of $18.
FOWDEN: No, they’re getting higher. There are definitely a handful of buildings—NorthPark Center is about to be full, Park Lane is filling up. That really was kind of the catalyst to pop deals down Central.
DEPTULA: But look at Stemmons—it has not taken off. There’s a $10 delta, a $15 delta within a chip shot.
STENER: Part of that, again, is that you’re very isolated there. So you may have great egress and ingress from Stemmons, but other than that, you’ve got to get into your car to go anywhere.
FOWDEN: It’s the lack of retail.
STENER: And you could argue a lack of housing, too. There’s housing in the Design District now, but those types of tenants for that housing, they work in downtown or Uptown [or the Medical District].
BIGGS: You know, you just mentioned one of the things that’s really important to Dallas that we don’t necessarily feel on a day-to-day basis, and that’s the Medical District. The growth of that particular submarket, if you will, is unbelievable, and it’s also something that companies consider when they look at coming to town, too. That area just continues to spring up with new possibilities, new buildings, and then I think it’s its own little industry that kind of gets ignored a little bit, but I do think it’s very important. Some of it has started to expand to Stemmons because they need more space. But quality healthcare is something that companies consider when they’re looking to come to town, too.
Q. What’s the biggest challenge the office market will face next year, and where do the greatest opportunities lie?
BIGGS: I think the biggest challenge is going to be traffic, with all of the new development and new companies coming to town. The bicycle shops are going to do very well.
STENER: I read that an average of 360 people move to DFW every day. It’s exciting, but these people need to find a home. Growth can also be very taxing.
FOWDEN: The perception of a tightening labor force is going to be a challenge as well. We haven’t even seen Liberty Mutual or Toyota infiltrate the city yet. So that’s going to be a challenge. But, you’re right, there are great opportunities in the housing market.
Q. Are companies having problems finding employees?
DEPTULA: I think the new companies are prepared; they have a benchmark of California or another market where they are paying higher salaries. It’s the companies that have been here and can’t bring themselves to pay an administrative aide $55,000 a year to start.
STEFFEN: The biggest challenge from the development side is just going to be having discipline when it comes to new projects. Investors are calling us and saying, “Why aren’t you doing more in Dallas?” There are a lot of reasons for that. But when you look at pricing, there are a lot of reasons why we want to be cautious. We remain optimistic, and we want to be a part of it all, but we don’t want to be foolish.
ZOGG: Another big concern is property taxes. The politicians talk about how great it is that they’ve not raised taxes; well, they’ve doubled, actually, through increased values. A lot of buildings have seen their property taxes double over the last 10 years. That is a pretty big challenge, and I think we’ve got to look at that.
Q. How will 2016 compare to 2015 in terms of leasing activity and absorption?
DEPTULA: As Celeste said, 2015 has beaten 2014. So how long can you continue to have this growth? It can’t be sustained forever—it’s mathematically impossible. There will be a slowdown, but a slowdown from a benchmark that couldn’t have been maintained long-term.
BIGGS: Our average for so many years was 1 million square feet per year absorption. This year we’re at 4 million-plus. A big piece of that was State Farm. Looking ahead, Toyota is going to move in at some point. … Dallas-Fort Worth is still going to be considered in either the corporate relocations or big regional operations. We just have to show off and do the same things we’ve been doing, right? But it’s the other companies that infill after those guys, companies like those Sabine is targeting right now. If we had organic growth in Dallas of just 10 percent, all the buildings would be full. The momentum is going to continue, just because of the momentum we’ve built. When you have an announcement of a Toyota, it has a huge impact to companies throughout the rest of the world. They know where Plano is now. I think we’re still going to see an influx over the next 10, 15 years, as long as we continue to do the right things—taking care of the roads, doing the things we need to do to build our community.
STENER: Our community has grown so much over the last two decades, our benchmarks of absorption also are growing.
DEPTULA: I’m starting to see oil impact Dallas. It didn’t for a long time. In fact, it helped, because of all the money pumped into our consumer economy. We are certainly seeing it impact things in our Fort Worth office. In Dallas, you’re starting to see the mailbox money in the Park Cities disappear. Those checks aren’t coming in every month anymore.
ZOGG: Yeah, everybody says Dallas [office occupancy] is 4 percent to 6 percent dependent on oil, but what everybody forgets is that many people have invested in oil as individuals and consumers. Going back to Greg’s point, I’ve never seen the trickle-down from relocations like I’m seeing in this cycle. I’ve never seen this many follow-on companies looking at Dallas for relocations like we’re seeing today. We’re seeing it in Uptown. The big relocations are in Richardson and Plano and Frisco, but a lot of their service providers are moving to Uptown. We leased space to the law firm for Toyota, and we’re working on a couple of others that are direct responses to relocations. I don’t think that’s going to change in 2016. … I don’t think it’s any secret that we were very close to winning GE’s headquarters. But for one issue, we probably would have. That’s a pretty strong statement.
