BUSINESS: The Sound of Money

GOOD TIMING: Last year’s $250 million Mercantile Bank redo is a sign of things to come.

In three frenetic months last fall, more than 20 entities bid on Lincoln Centre, a coveted 32-acre, 1.6 million-square-foot office complex in North Dallas. MetLife Real Estate Investments had waited more than two decades to put the property on the block, and its patience was rewarded. Assessed at $138 million, Lincoln Centre sold to New York-based Teachers Insurance and Annuity Association-College Retirement Equities Fund in December. The fund paid more than $250 million.

You hear stories like this all the time these days. Dallas is awash in capital from institutional investors and pension funds, each of them snapping up commercial real estate with a zeal, and at a notable expense, unseen in recent years—if ever. Eric Horn, asset manager for MetLife, speaks in understatement when describing what his firm got for Lincoln Centre: “It was consistent with what we’ve seen in the market for the past two and a half years. It’s a seller’s market.”

There’s a word for that. No one in the press seems eager to use the word. We all know where “irrational exuberance” will take us. But we’ll go ahead and say it. Someone has to.

This is a boom.

“Everything is getting better. Lease rates are rising, vacancy is dropping, interest rates are low, and there’s more money competing for fewer assets,” says Russell Ingrum, executive vice president at CB Richard Ellis, the firm that brokered the Lincoln Centre deal. “People in real estate like what they are seeing.”

And when they look out their windows, here’s what they see: cranes frame the downtown, Uptown, and North Dallas skylines, a welcome change from just a few years ago when the recession, the tech crash, and September 11 put a virtual moratorium on new development. Rental rates for newer offices are now pushing $22 to $23 per square foot across the city. Vacancies outside the Central Business District are dropping. The Telecom Corridor—the graveyard embodiment of the tech crash—finished 2005 with a flurry of leasing activity from non-tech companies and a new $90 million development starting at North Central Expressway and Campbell Road. The citywide vacancy rate at the end of 2005 was down from 25 percent to about 22 percent. Inside the city’s core, vacancies remain at about 25 percent—but with $1 billion worth of development in or around downtown, that should change. Despite an uptick in short-term interest rates, long-term rates are still near 30-year record lows and are not expected to climb higher than 6.9 percent in 2006, according to the Real Estate Center at Texas A&M. Job growth is solid. Last year saw the unemployment rate in Texas hit a four-year low of 5.2 percent; this year should see a 2 percent increase in job growth in Dallas—the most since 2000.

All of this gets Anthony Downs excited. He’s a senior fellow at the Brookings Institute in Washington, D.C., the man who once said there are three basic phases to the real estate market: development boom, overbuilding, and gradual absorption. From all indications, he says, Dallas is so deep into the gradual absorption phase, it’s come full circle. There’s nothing “gradual” about it.

“The economy is showing strong growth, and if vacancies continue to fall and prices for acquisitions continue at the pace we saw in 2005 through 2006, you’ll see your shift from an office leasing expansion to a development boom,” Downs says.

Mike Wyatt is an executive director at Cushman & Wakefield of Texas Inc., a full-service commercial real estate firm with offices worldwide. He’s been in the business for 21 years and has seen the fat times and, especially, the lean. “People are optimistic,” he says. “And there’s an enthusiasm there behind the shadows of the buildings that I haven’t seen in years. People are focused on the right things: growth and making money.

“We have the momentum. We have real, organic employment growth. We’re back on the bull.”

Wyatt says expansion is inevitable. More leases mean lower vacancy. Lower vacancy means higher rents. And higher rents mean more development.
“Businesses have gotten so damn efficient,” he says. “They can’t get any more productive with the space they have. And they are growing, so there’s pent-up demand.”

But the pent-up demand could be offset by rising interest rates. December saw the 13th consecutive quarter-point increase by the Fed, and this increase has some brokers concerned. If the rates creep too high, it could put a bit of a kibosh on this real estate party. For John Huff, vice president at Magellan Commercial Realty, the emphasis is on the “cautious” in “cautious optimism.”

“The acquisitions are encouraging, but it’s driven largely by interest rates,” Huff says.

Which is another way to say the acquisitions are driven, to a certain extent, by investors. When investors on Wall Street can’t get a 10 percent return from their pension funds, they look elsewhere for that return. Often they look to real estate. Low interest rates mean investments with sometimes stellar returns. High interest rates mean investors pulling out of real estate.

On the office leasing side, Huff is worried that a large segment of the leasing demand is composed of those businesses associated with the booming home sales and construction industries, whose fortunes likewise rise and fall with interest rates. “And interest rates can’t stay that way forever,” he says.

Most others, though, firmly put the emphasis on optimism. Over cocktails at Primo’s on McKinney Avenue, Grubb & Ellis vice president Robert Fulford—a guy who specializes in industrial leasing and industrial land—is talking with his buddies, all 10-year veterans. Fulford brims with confidence. His company’s research shows that 2005 was a swing year for the North Texas economy. Last year started with net office space losses—negative absorption of 130,000 square feet. But by year’s end, there was a dramatic reversal. More than 3 million square feet of office space was absorbed in the fourth quarter of 2005.

“We’re more excited than we’ve been since about 2000,” Fulford says, referring to the year of the last real estate feast. “There’s so much pent-up demand out there. We had a banner year in 2005, so I think 2006 is the beginning of a new boom cycle. It’s going to break loose in 2006 and into 2007. If you’re in the real estate business right now and you’re not an optimist, you need to do something else for a living. We’re in the midst of an expansion that’s getting louder every day.”

Trey Garrison is a regular contributor to D Magazine.