Dallas Office and Industrial Re:Cap

Everything is bigger in Texas, especially business, ranking Top 10 in total GDP if it were a country. So it is no surprise why many corporations have uplifted and begun to plant their roots here. The lone star state offers low business expenses, a talented labor pool, access to global markets, and good barbecue. In addition, its diverse industry provides an industrial warehouse investor's dream, as it supports many foreign countries, with China and Japan as two of the top 5 importers from Texas.

The future of the office and the workplace is gloomy nationally. But a well-established trend is taking hold around major markets as tenants downsize and relocate to quality. The team at Rockval was curious about the Dallas-Fort Worth metro (DFW) industrial and office conditions, so we spoke with Garrison Efird , a Director at Newmark. Efird specializes in tenant representation for office and industrial assets on a national level.

Industrial Boom

According to Newmark's2022 Q4 National Industrial Market Report, national absorption was over 100 million square feet for the seventh straight quarter. Efird expects this level of absorption to continue over the next 4-6 quarters but would not be surprised to see a slight slowdown as hundreds of million square feet are expected to come online in the first half of 2023. The markets with the most demand, such as Inland Empire in California, maintain vacancy levels below 1%.

Dallas-Fort Worth is among the top 5 national industrial markets. In Q4 of 2022, Dallas recorded 7.1 million square feet of absorption and vacancy levels settling between 5% - 6%. Landlords here (and in most markets) have the upper hand due to the astronomical demand. According to Efird, the hot pick of space in DFW used to be 150,000 - 250,000 sqft, but now landlords have gotten greedy and are unwilling to break up space under 300k sqft. Leaving the tenant with no choice but to lease up the larger inventory, as it is better to have more than not enough space. Efird said he has yet to be in a transaction that hasn't had at least two other tenants competing for the same space. As cliche as it is, he emphasizes the importance of the relationship with the broker. Generally, the more established relationship usually wins the bid.

Dallas Office

Anecdotally, Efird had noticed a substantial increase in traffic as opposed to five years ago when there was no such thing as "rush hour." Even throughout the pandemic, Texas was very much open for business. However, the companies here are transitioning, and the volume of full-floor or +100,000 sqft leases has decreased by over 60%. Most of the leasing happening today is between 5,000 to 12,000 sqft, primarily because many businesses do not anticipate the need for additional space. Efird argues that this has become the baseline for many major markets, as he is witnessing this trend in D.C. and New York.

The chart above depicts the square footage of office space secruritized by CMBS loans in Dall since 2000. The peak amount of debt securitized occurred in 2006, recording 25.6 million square feet. Since 2020, the amount of securitized space has fallen below the yearly average. This may indicate capital markets are remaining cautious towards the future of the asset class.

Even though most companies are downsizing, Wells Fargo recently announced they are building an 800,000 sqft regional campus in Irving. The new campus expects to add 650 jobs to the area, costing $445 million. Texas's ease of doing business continues to attract Fortune 100 companies; most notable was Tesla's move to Austin in 2021.

Efird comments on how the Dallas office market is highly segmented; a single road can bifurcate the market. Efird said, "Historically, the downtown CBD is the high-price market, but in Dallas, you've got the downtown CBD broken up between Klyde Warren Park, and then you've got uptown. So that vibe is the difference almost between double. You've got buildings 200ft across a park with $40 - $45 net, operating expenses on average $20 to $25/SF, versus a downtown building in the teens to low twenties triple net." The downtown CBD has one of the highest vacancy rates of 31%, compared to 17% in Uptown. Newmark’s Dallas Q4 Office Market Report recorded rising rents in Q4, signifying the long-term demand for space. The Q4 average asking rent was $29.12/SF, compared to $28.78 the previous quarter.

Re:Cap Key Takeaway

Utilizing CMBS loan data provided by Trepp, Inc. , we can see how the average Loan to Value (LTV) of securitized office transactions has fallen over time. At the end of 2022, the average LTV was 62.6%.

Although lending has tightened in the office market, there still has been a significant compression of cap rates. The market's robust economy and the continued influx of business have kept the demand for investment sales high.

The post-pandemic investment mania has subsided and now that interest rates are elevated, cap rates are expected to rise. In addition to the influence of rising rates, a lot of the inventory is dated and undesirable. We expect cap rates for office to rise over the next few quarters on a national level. Even through a downturn, Dallas will remain one of the market leaders. It was resilient during the Great Financial Crisis and is even better positioned today. Dallas's diverse economy and ever increasing desirability to live will help drive this market for years to come.

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