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Dallas Office Market Outlook 2014

It's expected to be a banner year for North Texas—as long as external forces cooperate. (Are you listening, Washington?)
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D: Bill, you’re building out there, right?


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CAWLEY: Yeah. I agree with Moody. But another  market where I think we’ll see great growth in rents is the Dallas North Tollway. A lot of people are coming down the tollway from Legacy to look for rent relief, and there are several big blocks of space that are about to get gobbled up, so there’s just going to be very little space there. Stanford Corporate Centre is close to making a deal. Galleria North is about ready to fill up—I think it has another 80,000 square feet or so—and then there’s just going to be some pockets. That’s why I think there will be great rent growth on the tollway, from LBJ up to Legacy. We’re building an office project at Westgrove and the tollway, and we need $27 rents, growing from there. I’ve been amazed at the acceptance of the rents in the market. We leased 20,000 feet yesterday. We’re at about 70 percent leased, before breaking ground. I told our partners I wasn’t sure if we could get $27 rents, but we’re getting them and growing.


COOPER: Are you still okay with agreeing to do five-year leases? 


CAWLEY: Yes. 


COOPER: Okay. Because a lot of landlords, especially going back to the bigger cities, you try to do that, and they say, “We’re not going to do a five-year deal in a million years.” It doesn’t seem that landlords here are forcing long-term rents. 


CAWLEY: Well, it depends on the strategy of your building. With our Legacy building, I think the market there for me is 20,000- 30,000-square-foot tenants. The big tenants can go build a building, and they can get somebody to do it for a fee and get a real aggressive quote. The 23,000-square-foot tenant doesn’t have as many options, because nobody is really focused on them. If it’s a five-year lease in a multitenant building, you’re still okay. You’ve got to get some seven-years, some five-years and some 10-year leases; in three years, I’ll let you know if I’m right. 


HOGAN: I’m going to go out on a limb, and I’m going to say LBJ is going to be the biggest submarket winner. They’re at 25 percent vacancy today, and I predict they’ll be at 18, which will be a huge move, maybe more, because the freeway is going to be finished at Preston to Central here in the next few months. I think we’re going to see a big difference after that. The market will still have rate, and it’s still a central location. 


COOPER: You’re right. There are going to be people looking to make a cheap, cheap deal. 


HOGAN: The whole problem with all the buildings up and down the toll road, along LBJ, the older facilities, is the parking ratio. If you’ve got a building that’s 3.5 spaces per thousand, you are dysfunctional. Providence Tower, where we office, is wonderful. But there is no way to expand the parking. It is what it is. And so it can never do that dense, squeeze-it-down, pay-the-higher-rental-rate client. 



D: When companies from other states are looking at Texas, how does Dallas compare to Austin and Houston and San Antonio?


YOUNGER: You’ve got energy driving the Houston market, and it has been off the charts for several years. There’s a lot going on down there. Dallas, I think, is second because of its size, and there’s a much more corporate presence here. The economy mirrors the national economy more closely in Dallas than it does in Houston. And then there’s Austin. It’s a market everybody is interested in, because there are geographic barriers to entry. But it’s a small market still, and it goes in cycles. 


COOPER: I spent a little time in Houston earlier in the year. I came back to Dallas, and it was like we were in Abilene compared to Houston. As great as everything is here in Dallas, in Houston, your head spins. It’s hard to get your arms around it. 


HOGAN: It’s on fire. 


“Rents in some buildings have gone up 20-30 percent in the last year; others are still trying to stabilize. As usual, the cycle has turned on a dime overnight.”

Brad Selner
SELNER: It’s one of the primary job growth engines in the country right now from an oil and gas standpoint. From a cost standpoint, Dallas is the cheapest of those three markets by far. Houston has had unbelievable growth in the energy business that has outpaced developers, in terms of their ability to get buildings up. That has pushed rental rates up in the market comparable to what you’ll see in Chicago and other major markets. Austin, as Moody said, is geographically constrained to some extent. And because of the political environment—they just don’t build at the pace that we build up here. So that market is about 30 percent  to 40 percent more expensive on a comparable basis. In Dallas, the big difference this go-round is disciplined capital. Although we’re not constrained from available sites, we’re not constrained from municipal entitlements, this time around we have been constrained by the financial markets being very cautious in their investments in new product here in Dallas. Kim, you can speak to that,  with what you were able to accomplish with KPMG and Jackson Walker at Hall Arts, the struggle that you had to get financing and the time that that took. We’re seeing that in a few other projects right now as well. The one exception to that seems to be far North Dallas and Legacy. 


BUTLER: But even then it’s difficult, on a speculative basis. At Hall Office Park, which is 98 percent leased with 15 buildings on the ground, the construction loan on our new building out there, according to our lender, was the first speculative office construction loan since the downturn, anywhere in the country. The development hold-up is not coming from the developers, it’s coming from the lending community.


CAWLEY: I agree. I think the capital is smarter, or much more cautious. I’ve been amazed at how hard it has been—and I’m a small player in the market—to get a deal done from the debt and equity side. With this deal in Legacy,  we’re getting it done, but it has taken two years. Overall, I think it’s good. I think it protects the market. 


SELNER: Oh, sure. 


BUTLER: It’s great for the existing landlords. 


HOGAN: One way that Houston and Austin has affected our market is with triple net leases. Houston was always triple net. Austin was triple net way before we were, and now we’re starting to see triple net leases. It’s a whole new ballgame with the landlords, how they’re going to structure things. What’s interesting when you talk to tenants, they’re always concentrating on the rental rate, and they never think about the operating expenses and the nets. So it’s going to be a new world for us as we’re trying to explain everything to our clients that do business in the Dallas area. Companies that do business all over, national tenants, they’re used to it, but not your core, Dallas-based tenants. 


SELNER: Yeah. Trammell Crow Center seems like a good deal at $25 a foot, but it’s net. 


HOGAN: It is. It’s a game-changer for us. The landlords may continue to maybe lower the rental rates a bit, because they’re going to say, “Well, we will do a $20 or $23 deal, but we’ve got the triple nets on the backside.” So it’s going to be a different spin.



D: What are some other surprising or interesting trends that you’re seeing out there? 


DICKENSON: The dramatic rent spikes in certain submarkets; and really within submarkets, in certain buildings. You’ve got the haves and have-nots. Rents in some buildings have gone up 20-30 percent in the last year; others are still trying to stabilize. As usual, the cycle has turned on a dime overnight. 


BUTLER: I don’t see that stopping, for a couple of reasons. One, there’s still a constraint on supply, primarily coming from the lenders. It’s still hard to get a deal done, and construction costs have gone up. So even if you add to the supply—Bill, you know this better than anybody. You’ve got to get certain rates that we just haven’t had before on new construction. And when you have that, you have nowhere to go but up. 


HOGAN: All of these new investors are coming into the market. We’re now considered, believe it or not, a coastal area, an inland coastal market. Buyers are paying prices we’ve never seen before. And the new owners are charging higher rents, which is allowing everybody else to charge more. Buildings that we could do a deal in at $23 in June now are at $32, with new ownership. Tenants that need to expand are getting sticker shock, but they’re paying it. 


SELNER: You’re 100 percent right. But there are definitely winners and losers. If you look at the hotter markets—Uptown, Preston Center, and Legacy/Plano—where, historically, quoted rents have been 25 percent of real effective rents, that’s exactly what has happened. The quoted rents haven’t gone up as dramatically, but there has been a huge move in what landlords will ultimately take. 


CAWLEY: So you’re saying they’re getting quoted prices. 


SELNER: They’re getting closer to quoted. We’ve seen in submarkets like Legacy Plano—the typical stats would show you that it’s up maybe 20 percent. But the real effective rents, they’re up 40 percent, almost 50 percent in certain buildings. 


CAWLEY: All the new deliveries up there are moving rents, like seven bucks. Every new delivery that’s going on in Legacy is moving rents way beyond where they’ve been. And those buildings are leasing, from what I’m hearing. We’re doing a tilt-wall building in Legacy; we’ve got the money, and we’re going to build it. But initially, everybody was more worried about the exit valuation, because it was high—$200 a foot. It’s a tilt-wall building, for that kind of money. Everybody’s kind of just adjusting to these new values in rates. 



D: Like higher gas prices. You just get used to it. 


HOGAN: What’s interesting is that we’re at the low part of the cycle. I can’t imagine what the numbers are going to look like in the next three to five years.


COOPER: Another thing about the investors that are coming here—they have a lot more staying power. So when the markets are testing and pushing rents, the new owners have the ability to do that. They’re more legitimate. At one point, we had absolute nutballs buying buildings in Dallas. It didn’t make any sense. You’d have meetings with them, and it was ridiculous.


HOGAN: Tenants want different things today; that’s a contributing factor, too. I mean, who would have thought that we’d have wine bars in buildings.


COOPER: That’s a very good trend. 


HOGAN: Yeah. A very good trend. And the big conference rooms. They also want to have the walkability, and bike racks. Companies are demanding more, and landlords can charge higher rates because they’re giving them more. 


CAWLEY: But if you really look at it, the rates in Dallas, even at the current rents, are so much lower than—I mean, in California, northern California and San Francisco—you’re leasing a two-story tilt-wall building for $35 a foot, at least. 


COOPER: Net. 


CAWLEY: Right. Net. So now we’re getting $30 rents or getting into the $40s. We think of it as high, but compared to other markets, it doesn’t matter. 


COOPER: At the end of the day, the rent, although it’s important and it’s a line item, it’s more about labor and people and finding the right employees, and the stability to go build your business in a place that you’re going to be able to have that steady stream. For companies, rent is important, but it’s not the be-all and end-all. 


CAWLEY: Dallas used to be a market where institutional investors would cautiously invest. It was kind of redlined. They would look at the coasts. They would do anything but come to Dallas. But now, Dallas and Houston and Austin have become markets of focus for investors. Money is flowing into here. People want to buy. They believe in this market. In the past, they were always worried about the barriers to entry, because there’s land everywhere here. But the view of Dallas has dramatically changed. It’s being proven by the prices people are paying and the volume of money coming in to look at deals. 


COOPER: I think we’re going to see, for the first time, true international buyers. They think that the fundamentals are here. 


DICKENSON: In the past, if you’re an investor, ideally there was a three-year to four-year hold. If you held too long, you got beat up. We’ve all been through that. And now more people are looking at it as a core-plus investment. There’s still a value upside, with the rent increases, but that might be a five- to seven-year hold instead of three- to five-year hold. But I still think for us to be really considered a core market, kind of a third coast, we’ve got to have a great downtown. Investors look at the sprawl of the area, the different submarkets and opportunities for tenants to look at space long-term, and they still look at a world-class city having a great downtown. 



D: So what’s it going to take to fill the empty office buildings in the Dallas CBD? 


COOPER: It’s going to take big back-office service centers to lease that space. Not the new buildings, but a lot of the older buildings. When you get into the valuations and talk to investors, they get all excited because they can buy the buildings for about one-third of the replacement costs. 


CAWLEY: A third? Try 10 percent. 


COOPER: Customer service, call center, large back-office operations. That’s the future of where the big vacancy is. For those type of tenants, it’s fantastic. You get DART. You get large floors. You get the ability to load up the density to whatever it needs to be without having to worry about parking ratios because you have a lot of DART riders—higher in downtown than any other part of the city. You get terrific amenities, and you get a little bit of that extension of the work day, where you can have shifts that can go to 8 p.m. or 10 p.m. With DART service, you can still get people back home and get two or three shifts out of the day. There’s certainly a market for upper end, AA and Class A space, but for the majority of the vacancies, you’ve just got to re-think about how it’s going to be used and how it’s going to get leased. 


SELNER: As more dense users come in and fill up these big chunks of space, though, it’s having an effect that candidly could be counter to the overall occupancy of the building. Because other tenants, particularly the professional services firms that have been in these buildings, have been and will continue to react negatively to a repositioning of the building. So the real answer is: It’s going to take time. We are a few years away from seeing, in my opinion, any meaningful occupancy gain on those core buildings. 


“Every other big city across the country has old, inefficient buildings in their downtowns that are full. It’s not the buildings that are the problem.”

Bill Cawley
DICKENSON: It all comes down to residents living downtown who are happy to stay there, live there, work there, and hang out after work. Buildings are being transformed, repositioned to where they have fitness clubs and lounges and wine bars and all that, but I think most successful buildings need to connect to the community. The downtown that I want to see is a place where people are living down there, the population is growing and it supports retail, supports arts, open green spaces. It’s more secure. Companies will then want to be next to that. They want their people to be living near the office and enjoying the work environment. 


COOPER: You’ve got to make downtown for the every man, for the hourly-wage worker that’s riding DART to want to be downtown. North of Ross, there’s plenty of money and great tenants and great restaurants, and it’s all accessible and all that. But I think you’ve got to do things to fix downtown and make it more attractive for companies that are looking to capture huge space, like another AT&T. When you look at downtown and see buildings boarded up on Main Street, you think it’s just not going to work. You’ve got to get the corporations to agree that that’s a decent place to be for their employees, and they’ve got to feel comfortable there. 


SELNER: We also need to bring down some of those old buildings that can’t be converted to residential. They’re not good office buildings anymore because of the core issues we’ve talked about. Bring them down. Create that open space. And as Mayor Rawlings recently said, create a coolness, a vibe of downtown.


HOGAN: The back-office people can’t afford to live downtown or in the Uptown area. So we have that dichotomy going on right now.


COOPER: They don’t need to live there. They’ve just got to be able to get there. 


DICKENSON: There are companies downtown that may not stay there. So the vacancy may continue to grow—unless there’s a reason for people to stay. It’s all about retention and recruiting.


CAWLEY: I think downtown has made great progress. If you look at downtown Dallas today from 10 years ago, it’s dramatically better. And everyone in this city who’s passionate about the city and a person of change is focused on downtown. We recently went to a party at The Joule. I could not believe the activity and the people out and about. We’ve also packed our kids in the car, and driven from Plano to go to Klyde Warren Park. It’s awesome.


BUTLER: You’ve got to be able to get employees here on DART, but not everyone wants to use mass transportation in a big way. People want to work near where they live. That’s why the suburbs have done so great. That’s why the value office has done so great. It’s because it’s close to work. 


COOPER: But at different price points. 


BUTLER: Well, the price points that we’re talking about to fill the vacancy is similar to the price point for value office out in the suburbs. It’s putting those people into an environment where they can succeed and they can live. They can work near where they live. And we’ve made a lot of progress downtown in that arena. 


YOUNGER: If you’re coming into downtown, once you cross Ross, it starts getting uncomfortable. And the streets aren’t on a grid. You’ve got two grids that run into each other. It doesn’t feel the same as some of the other cities. The streets aren’t as wide. The sidewalks aren’t as wide. If you go to Manhattan, you know the north/south streets are wide. East/west aren’t.


CAWLEY: Every other big city across the country has old inefficient buildings in their downtowns that are full. It’s not the buildings that are the problem. 


COOPER: I agree. 


CAWLEY: You can go to Chicago, New York, San Francisco and find old buildings are selling at record prices. It doesn’t matter. People will adapt the use to the building. You’ve got to get more people to live downtown; that will take care of the problem. 


SELNER: But, Bill, there’s really three legs to the recovery; flight to quality, stabilization, and then it trickles down. Downtown Dallas has never gotten off first base, right? 


CAWLEY: I agree. 


SELNER: A real issue with Dallas in the past is that every time we got to the first leg, flight to quality, the development cycle kicked off and everybody went to the new set of quality. A lot of the existing downtown buildings have just been totally abandoned. Tenants today, with their new technology requirements and other efficiencies that they’re wanting to pick up, they would rather go to new product at higher prices than settle in existing buildings. There are a handful of law firms that are in the thick of that right now, and that’s where the developers like Hall and Billingsley and Crescent and others are sitting in great positions. At some point, however, those sites will fill. Then you’ll move into the stabilization, and then into the Class B. That’s why I say for a downtown, it’s all about time. And it’s not going to be two years. It’s going to be five, six. 


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BUTLER: I was in the Arts District about 11 a.m. last week, in the middle of the work week. There was a woman walking two dogs. There were kids from Booker T. There were businesspeople. There were young professionals. As we’ve talked about, it’s where downtown needs to go. So it’s there in certain parts of the city. It just needs to continue to move further south.


SELNER: We’ve got about 6.5 million people here in Dallas. We’re adding a new person every four minutes. We’re going to look up in a few years and we’re going to have 9 or 10 million people here. Driving from Frisco to downtown today is 40 minutes, right? Well, you add another 3 million people to this marketplace, that’s going to fuel the market up north and fuel the downtown market, too. People aren’t going to live in Frisco and work downtown. They’re going to live in Frisco and work in Frisco and Plano. And people who are living downtown, they’re going to work down here. I’m excited about watching this city go from a suburban community to more of an urban environment, a Las Colinas urban environment, a Frisco/Plano urban environment, an Uptown urban environment. We’re going to have these really cool interesting urban environments within a much larger North Texas region.


COOPER: On national site selections, other cities talk about their infrastructure and their loop system, and inevitably, there will be a gap missing. You’re sitting in a conference room and talking about access to labor, and they’re like well, “We’re hoping in the 2017 bond election we can get the money to complete our loop.” These are big cities. Companies are not going to wait for that. People who come here from out of state, they just can’t believe the roads that we have. And they just can’t believe the activity. 


BUTLER: What’s different about Dallas and why it’s so important that we invest in the southern part of the city, is because if you look at other major cities, you have growth in multiple directions. Our growth has been north and west. Once downtown becomes more of the hub again, as opposed to further and further out on the spoke, then downtown will win.



D:What are the biggest challenges the Dallas office leasing market will face in 2014, and where do the greatest opportunities lie? 


YOUNGER: This year should be better than 2013, especially for the core markets—Preston Center, Legacy, and Las Colinas. I think LBJ will rebound; it will start this year, as the new freeway opens up. Stemmons is a challenged market, but you’ve got the Medical District and you’ve got DART. For Dallas, it would have to be some external factor affecting the United States for things to slow down. We’ve got momentum. Everybody’s looking at us.


BUTLER: It’s about labor, it’s about people, it’s about jobs. We’ve got all that going for us. Our biggest challenge is in Washington. I heard Tom Friedman speak recently, and he said, “Thank goodness there are people who are still creating things, building things, producing things, servicing things.” We’re just sort of ignoring what’s going on in Washington, and thank goodness, because that’s keeping the economy going. So we’ve just got to hope that they don’t screw it up for us. 


YOUNGER: Well, they seem to be incompetent enough to do anything. We want that. Just let them keep their distance, not do anything. That’s fine. 


CAWLEY: I think 2014 is going to be a really good year. I think the B buildings are going to flourish, because they’re kind of the last ones to lease. I think we’ll see rent growth. I’m excited.


SELNER: Moody and Kim hit it—our challenges are not within the area. Our challenges are at the federal government level. This marketplace wants to grow. It’s natural tendency is to grow. It has been constrained, to a certain extent, by what’s happening at the federal level. The opportunities are across the board. We’ll see Class AA buildings reach new highs. We’ll continue to see tenants in markets like downtown that will choose to go to new developments. I believe the new development market, because of the lack of supply we’ve put on the market today, will be a big winner in 2014. 


DICKENSON: In 2014 I think the story is going to be the rent increases. You haven’t seen anything yet. 


HOGAN: Stop it. 


DICKENSON: That creates other opportunities for new development and getting certain rents. You’ll see people knocking around looking for sites. A big story to me is The Richards Group, picking up and moving to a build-to-suit in Uptown, West Village. You talk about a perfect location. It’s next to DART. It’s next to the trolley line. It’s next to West Village. It’s next to all the residential. It’s near the Katy Trail. They’re making a 15- to 20-year bet, and it’s all about what office workers are demanding. I think we’ll see more activity like that, whether it’s Uptown or the Arts District or the Urban Center in Las Colinas or Legacy. It’s about the quality work environment. 


HOGAN: I agree 100 percent. Employers are more concerned about the environment they’re providing for their employees than ever before. For me personally, the challenge I see is finding the buildings tenants want, the location they want, at the price they want. Expanding tenants that have term left on their leases are at the mercy of the landlords. It’s not going to be a happy time for them. Tenants that miss their renewal dates are not going to be very happy. And they need to be very aware of what their leases say. In the past, they didn’t really care. Now, those renewal clauses are going to be a big issue. I’m doing a deal with Kim right now, and she’s just grinning because she’s got me. 


COOPER: We’ve still got isssues in Washington. Politically, they’re just a bunch of lunkheads. They could never survive in the Dallas real estate business. 


HOGAN: The government and Obamacare is still causing a lot of uncertainty. Unfavorable taxation in Illinois and California is going to be a gold mine for us. As a man in the Bible named Moses said, “Let my people go.” Yes, let them go from other states. Here in Texas, we say, “Welcome to paradise. We want you here.” 


COOPER: Nationally, we kind of want things to get better, but not too much better, because that uncertainty in other states is huge for us. So we selfishly don’t want the government to operate efficiently and do the right things because it will impact the real estate market in Dallas. I’m sorry. 


CAWLEY: Obama didn’t mean to, but he has helped Texas in a big way. 


COOPER: When I go to some of our national meetings, the way a lot of our folks up in the northeast are, and they kind of give us a hard time and are a little bit jealous. I say, “You guys keep voting the way you’re voting; it’s great for us.” That’s what’s making our economy here work. 



D: The United States of Texas. 


HOGAN: And I don’t think Gov. Perry has to worry about a job when he’s through; I think anybody would hire him as a business development person. 


COOPER: He’s going to be the new Longhorns coach. 


SELNER: That’s all Texas needs, an Aggie as a coach. 


COOPER: Well, like Brad was saying, I think that owners of buildings in Uptown are going to see fabulous rates; there are enough tenants in the market to get three or four of those new buildings leased up. They will be very successful, as Hall has already seen.


BUTLER: I think everybody is going to win. 


CAWLEY: I do, too. 


HOGAN: It’s one of the most exciting times to be in Dallas, and in the Dallas commercial real estate market.  

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