How was leasing activity in 2017?
Al Sorrels: It’s been very good. There was some disparity in the statistics through the third quarter between CoStar and CBRE—4 million feet almost. That’s kind of a head scratcher. We’re on pace to do close to 20 million square feet in 2017. The fact that there’s about 20, 21 million square feet under construction, that bodes well for that. There are some submarkets that raise the brow, South Dallas obviously. But I’m very optimistic based on the pure statistics. I just hope a lot of that wasn’t backlog that had been in the pipeline for a year, and now it’s just happening, and we’re going to have an empty pipeline going forward. Professor Hagewood?
Bob Hagewood: I happen to agree with you, Al. If you look at the CoStar numbers, it was like 3.7 million square feet of absorption in the third quarter. It certainly felt busier than that. I would be interested to see how those numbers play out in the balance of the year. We continue to see these large deals really gliding those numbers. Smaller requirements seem to be slowing down.
Rick Medinis: I felt like as the year turned from 2016 to 2017, there was a flurry of activity in the market. Some of it closed in ’16, some of it pushed over into ’17, so the first quarter was quite robust. I think we caught our breath a little bit in the second quarter. You said the third quarter numbers were off a little bit from the previous pace. That may have been because activity slowed down just a little bit in the second, but it’s definitely sped up again since the middle of the summer. Things seem really busy right now.
Bill Burton: Would y’all agree the second quarter was the slowest quarter?
Burton: If we end up nominally in the 5-million-square-foot range in the third quarter, that’d put us at about 12 million square feet for the year. The second quarter concerned me, [but] the third quarter was a lot better, and business is good. We built three speculative buildings last year in Alliance. We sold one, we leased one, and we have activity on the other. So that feels pretty good.
George Billingsley: We absorbed 8 million square feet in the third quarter, according to CBRE. That was the second biggest in a very long time—a decade, or something along those lines. I was very impressed with absorption. From my perspective, demand continues to be very strong. We’re 99 percent leased [at Billingsley Co.], thankfully. A lot of our competitors are similar.
Susan Singer: I have been very pleasantly surprised by 2017. I think 2016 was so strong, we were all sitting around expecting things to slow down a little bit. We’re getting over the top of the crest in the market, and I’m very happy with how 2017 has been going. There is still a demand for the smaller deals in the market; it’s just very hard to find space for them. Everything being built on a spec basis is the big box stuff.
Are you expecting ’18 to be slower?
Singer: I still have high expectations going in to 2018. I was expecting the slowdown in 2017 and that didn’t happen, so I’m gambling the other way this time. I think unless there are some unforeseen circumstances in the market or with the economy, we’re going to continue to roll on in the same manner.
Billingsley: I agree. The indicators are positive. Interest rates remain low, which really boosts the economy. People continue to migrate to Dallas from all over the country. As a microcosm, I think we’ll continue to do well.
From where is demand coming?
Hagewood: There’s a little bit of everything happening. An interesting trend we’re seeing this year is an influx of furniture e-commerce companies. There have been a couple of big deals related to furniture e-commerce. On the heels of this big Nebraska Furniture Mart going up—the biggest retail center we’ve ever built here—all of a sudden, people are buying their furniture online.
Sorrels: I agree. I think it’s across the board. You’ve seen a structural change in just the way people buy—which is online. Companies are not combining their e-commerce and their traditional retail distribution operations; they’re separate. I think the numbers that I’ve seen project 50 to 60 million square feet of additional demand in e-commerce across the country. We’ll get our reasonable fair share of that. That has a direct impact, not just on e-commerce, but on smaller distribution.
Are you seeing that the size of deals has shifted this year?
Sorrels: The big deals are out there. Everybody wants to make those and talk about them. But I’ve seen a shift in the 100,000- to 300,000-[square-foot] range.
Burton: Those have been challenging to build because of construction costs. Rent growth is in that smaller size building, as opposed to your big, single tenant.
Sorrels: We’ve seen a trend [towards] a higher finish—not just because construction costs have gone up, but just a higher concentration, higher quality of finish. I don’t know if that’s because there’s a trend of companies putting their office back into their industrial facility. That’s fueled a lot of the rent growth.
Medinis: Different from years past, there seems to be more manufacturing demand, and around that, in supporting manufacturers, tenants that support manufacturers. You’ve got [General Motors] with the planned expansion there [in Arlington]. There’s a ton of demand around supporting that facility.
Singer: I’m seeing a lot of demand in the support for e-commerce from logistics companies coming in from Canada and all over the U.S. and opening operations here. The demand for trailer parks and container storage has just gone through the roof. All the companies doing last-mile delivery are driving that.
How are supply and demand in your various submarkets?
“We’ve got a real dichotomy of submarkets. We’ve got some that are very healthy and some that probably are going to need some CPR.”Al Sorrels, Majestic Realty Co.
Billingsley: We’re in six or seven submarkets. Rental rates vary significantly due to factors like the age of the building and things of that sort, but it’s pretty robust demand across the board, thankfully. We’re in pursuit of land opportunities right now. We are limited in supply. We’d love to have more industrial land right now. We have a fair amount of land; it just has higher and better uses. There’s some land that was formerly designated for industrial, but it’s not anymore. We’re looking, but it’s just expensive out there.
Burton: North Fort Worth and South Dallas have the land. I love the north DFW submarket, but there’s no land there. In south DFW, you’re starting to see redevelopment. North Fort Worth still has some good land, and we’ve been trying to put our spec [product] on the ground as we see a need for various sizes. That’s why we picked the buildings we built last year. Rolling towards the end of this year, the Alliance region is close to 97 percent occupied. We have more competition than we’ve had in the past. As a submarket, North Fort Worth is still in a healthy zone from a demand and supply standpoint. There’s only one 1-million-square-foot building under construction there. I think there are five or six others under construction or about to start in South Dallas. Those customers tend to be able to float around the market, so we will measure when we’ll move forward with our next 1-million-square-foot building.
Hagewood: Wouldn’t you think it’s a welcome addition to have some other developers show up to do those smaller projects to fill that need for that I-820/I-35W area as more rooftops are coming up?
Burton: There’s clearly a need for it. We controlled the land up there for so long that other developers went into other markets. Then the developers and the brokers were saying, “Hey, here’s the place.” Having them up there, it shows that market has long legs. If you look at Alliance today and compare it to the next 50 years, it will be more middle of the market as opposed to on the outside because the residential growth coming from I-35E over to I-35W is so strong. I agree with you, having some other companies out there bringing a different type of product has been a positive.
Medinis: How much longer do you think before Denton becomes a viable market other than a destination for big regional guys?
Burton: I don’t have an answer for that. But again, if you take the population growth that you’ve seen on I-35E pushing hard to the west, as that continues to go, it’s going to improve Denton as a marketplace.
Hagewood: I agree.
Sorrels: I’ve got a 220-acre park in Lewisville. I have a couple of vacancies there that haven’t moved in this cycle that I still kind of scratch my head on. That market typically stays in pretty good equilibrium, and there’s really no land left except for some ground lease opportunities at [DFW] Airport. We used to say all those markets were land-constrained, and people from places like California would [laugh]. Now you can say the airport, [Great Southwest], and Northeast Dallas/Garland are land-constrained. There’s a little different paradigm that this cycle created. And then there’s South Dallas, where you can keep building all the way to Galveston. And everybody is building. There are going to be some bloody deals down there. We’ve got a real dichotomy of submarkets. We’ve got some that are very healthy and some that probably are going to need some CPR. Including me—with 100 acres down south.
How does South Dallas look for 2018?
Sorrels: There’s 10, 11 million square feet under construction. There’s another six empty on the ground. We counted the other day, there were 10 or 12 new developers in this cycle who came and built in South Dallas who have never built in DFW.
Burton: Where’s their capital coming from?
Sorrels: All over. Some of it is institutional. Some of it is private.
Hagewood: South Dallas continues to amaze me. But I do think we’ve reached that tipping point now where there’s so much money coming online. You have so much product already on the ground. And you combine that with the build-to-suit activity where you can get a more attractive rate—it can get ugly.
Medinis: We’re going to see a dramatic slowdown in development activity once this wave of buildings gets finished down in South Dallas. There’s going to be a gradual lease-up of those spaces. And lease-up is going to eventually happen because there’s very little space available in Garland. The North DFW Airport market has one vacancy over 300,000 square feet right now. Congratulations, Al. You’re wearing the big catcher’s mitt right now.
Sorrels: When you have a deal over 600,000 square feet, usually it can cross submarkets pretty easy. It can go up to Alliance or it might go down to South Dallas. It’s looking for a rate. So probably the biggest constraint about South Dallas right now is the labor.
What submarkets are you bullish on in 2018?
Singer: Northeast Dallas/Garland is land-constrained. There’s a lot of demand going up further north along U.S. 75 to Allen and McKinney. Allen has no industrial land available so I think everybody who’s interested in that submarket is looking at the next ring out, which is McKinney, or Bob can speak to Sherman. Do we ever think we’re going to be building a big industrial park in Sherman? That’s where the land is available and there is a continued demand up there. I’m still very bullish on the Northeast. If you look at all of the job growth and the population growth going that way, there is still a big demand for industrial space. It’s never going to be someone going up there and building a million-square-foot box, but there’s a huge demand for spaces 20,000 to 50,000 square feet, and they’re just not there.
Hagewood: I could see McKinney delivering a mini Valwood. A lot of people would support those rooftops going up there.
Singer: It’s the next ring out. We always say the pioneers get scalped and the settlers get rich. Allen is settled and the next pioneering move is going to be McKinney and Sherman.
Hagewood: If you look at all the corporate locations going up to Legacy, you have to think there’s ancillary industrial uses that support that. To Susan’s point about the rooftop growth, we’re about to start a project in Frisco. There’s almost no land in Collin County—period. Even in McKinney, you have to get creative. No land in Allen to speak of. In Frisco, there’s a new park that we’re going to be developing in, but the land is so expensive and the demand is in that smaller tenant range, which is difficult to construct.
Singer: Very expensive to build.
Hagewood: Yes. It’s difficult to justify the rental rates.
Billingsley: I’m also bullish on McKinney. You have so many people and new businesses up there, and they don’t want to drive an hour to get to their warehouses. Like all of us, they like convenience. On top of that, the zoning is not easy to come by up there, which makes it scarce. The land’s actually not very expensive. I’ve seen land up there, that I think is still available for $2 a foot.
Medinis: One thing that’s gone somewhat unnoticed in our industrial market here in the last year or 18 months: air cargo at DFW Airport is up dramatically by 15 or 20 percent. DFW is continuing to add international flights and that’s a big part of our transportation network. All the un-tarmacked cargo space at DFW Airport is 100 percent leased. All those users are very busy. I think there’s a need for more cargo space at DFW Airport and in those surrounding neighborhoods.
What’s the biggest challenge you faced in 2017?
Billingsley: My biggest challenge has been land supply. We’re pretty particular about being disciplined and holding out for a good opportunity. As a result, we’ve been gratified with our recent developments, but we have virtually no pipeline as it relates to industrial land. It’s too expensive, and maybe we’re too picky at the end of the day. But we kind of want the full package of location, and value proposition, and cost. And we just haven’t been able to find something that checks all the boxes as we go.
Sorrels: I’ll second that, George. We’d like to buy a tract where we can develop for a while. It’s hard to find those sites. If you go south, the big flat sites that don’t have wetlands, topographic, or environmental challenges—they’re hard to find.
Medinis: We all have good problems because demand continues to be so high across the board. But one of the biggest challenges has been construction costs for shell and interior construction, and the ability for lease rates to keep up with that.
Hagewood: My No. 1 challenge was tenant improvement construction. You represent the tenants, the costs are a constantly moving target. There’s a potential for shortage with the allowance provided by the landlord and the actual construction costs, and the tenant’s sitting there holding the bag—and they’re generally not very happy about it.
Medinis: Projects on the ground now were designed 18 months ago when prices were different. They put budgets in place, and those budgets have gone up 15 to 20 percent. That has a real impact on making the deal.
Burton: The timing of when you make your decision and when you start [construction] is really important. Construction cost changes are a big issue today.
Have any new trends surprised you in 2017?
“We always say the pioneers get scalped and the settlers get rich.Allen is settled and the next pioneering move is going to be McKinney and Sherman.”Susan Singer, Bradford Cos./Corfac Intl.
Burton: We seem to say every year that we need more car parking spaces, we need bigger trailer lots, buildings are getting taller, and they need more power.
Medinis: For a while there, we built for the future and it wasn’t being fully utilized. Today, you see that they’re squeezing every ounce of efficiency out of a building.
Hagewood: It’s the users that have all the technological advancements. We’re just trying to figure out how to furnish them the proper amount of space both inside and outside.
Burton: An interesting one coming forward for us is food. Only 1 percent of $700 billion in sales is done online right now. If that grows to 10 percent or 20 percent, what does that mean for food? That’s an opportunity for someone closer in, in those infill sites.
Billingsley: There seems to be more extreme weather in the country, and the world, this past year. That has implications for warehouses. Perhaps we construct our buildings differently to anticipate more 100-year floods. The coasts seem to be more vulnerable, so there might be a migration to the center. It’s not good to be exploitative, but it might move towards the center.
Singer: An interesting trend to watch is the transportation logistics delivery business with autonomous driving cars, with drone delivery, and with Uber being applied to the trucking industry.
Burton: It’s more cost-effective to have fewer buildings in more places around the country, but that’s not the way we humans are shopping. So it’s causing this shift to last-mile. I don’t know how that manifests right now, but I think it’s a good opportunity for second-, third-, or fourth-generation Class B buildings that are closer in.
Medinis: Our market had lagged some of the other major markets in the past. But we’re starting to look a little bit more like Chicago or Los Angeles, where it’s going to make sense to start sending a lot of the regional distributors outwards. That’s going to bring Denton, Terrell, and Forney into play. We’ve already talked about McKinney. And at some point, you’re going to be infill, Bill.
Hagewood: But it’s going to leap over to you to Decatur or something.
Have you seen a lot of smaller industrial properties being traded to the tenant?
Hagewood: Oh yeah. It’s been crazy. Our shop is executing probably seven or eight user sales every month. We’re seeing buildings that just three or four years ago were trading for $35, $40 a foot, trade for $55, $60. You are starting to see a number of developers entertain the sale along with the lease.
Singer: I’ve noticed that too. A lot of spec buildings finished are being marketed for sale before lease.
Medinis: With no asking price. Make me an offer.
Has built-in rent growth changed over this cycle?
Medinis: Definitely. Coming into this cycle, we were basically a flat market. We would do three- to seven-year deals that were flat. And as we’ve worked through this cycle since 2012, gradual rent bumps have been built into the leases. But we’re not getting as much pushback as we did three or four years ago.
Singer: It’s becoming more accepted that they’re going to have to do that, regardless of the building.
Sorrels: If you’re a seller, capital markets want that.
Medinis: A lot of that’s being driven by the institutional ownership of the assets.
Burton: They don’t want to hear about rent growth; they want to see it.
Which deals in 2017 stick out to you?
Burton: We sold a spec building to UPS for their second hub in Alliance. They also bought another one just south of DFW Airport. That was important for us, but it was also important just because of what it says about where the market is going from an e-commerce standpoint.
Medinis: You’ve got to mention the collection of Amazon deals. I’ve lost track of how much space they have.
Billingsley: And some is not even under the Amazon name. We have a wholly owned subsidiary that’s 170,000 feet.
Any potential disruptors you’ll be watching closely in 2018?
Billingsley: In the event that we withdraw from NAFTA, that will have implications for warehouses.
Singer: I’m just going to watch Amazon.