BY JULIA BUNCH
Some office market trends rage on, such as increased demand for parking spaces and high-quality amenities, and making office spaces as efficient as possible. Other new factors—namely, a strong interest from institutional and foreign investors—are defining North Texas like never before. We turned to six office experts to decode the most important conversations of 2017 and to set us up for what’s to come. Our panelists are Susan Arledge, president of site selection services at ESRP; Jeff Ellerman, vice chairman at CBRE; Randy Garrett, principal at Transwestern; Ran Holman, managing principal at Cushman & Wakefield; Scott Krikorian, senior managing director at Trammell Crow Co.; and Torrey Littlejohn, senior vice president at JLL.
How was leasing activity in 2017?
Ran Holman: Leasing activity’s been good. In the summer, we hit the doldrums. I think a lot of folks did, and we were concerned. We’ve had prosperity for a long time. We’re all looking at the horizons and wondering, “Is this a bellwether?” But then September and October have been robust for us. So, it’s not all 2015, but activity’s good.
Susan Arledge: September and October have shown us that some of the biggest deals of the year were just announced. So it’s not a matter of, “Will we do well next year?” but “Can we maintain the pace?” I think it’s unlikely that we’ll maintain this same pace throughout 2018 from the standpoint of the huge transactions. But I think we’re going to see a lot of continued growth in the companies coming in.
Torrey Littlejohn: I agree that leasing activity has been really great this year, especially when you’re looking at absorption. I think there’s continued pressure on rates. But, I still think 2017’s going to end strong.
Randy Garrett: According to our research department, we’re about 30 percent lower than we were a year ago, but we expect a very strong fourth quarter. We hope to be about where we were last year. According to our research, 2016 was a banner year, as it has been since 2014. So it’s expected to continue to be good, and primarily because all the basic fundamentals are there.
Scott Krikorian: Job growth is positive. For the previous two years, it was like 5 million square feet of absorption. And we’re looking right now at almost half that, but the fundamentals are still strong. Those Toyotas and [other] gigantic deals seem to be replaced by one- and two-floor deals.
Jeff Ellerman: I agree with everything that was just said.
Holman: Over the last few years, we’ve gotten so accustomed to these market-changing deals. But now you look at it, and it’s just 100s and 50s and 200,000-square-foot deals …
Krikorian: 50[,000 square feet] is a big deal.
Holman: Those are huge deals.
Holman: [DFW has] 20 deals on the horizon that are 100,000 square feet or greater. That bodes pretty well, because we’re not looking at just huge anomalous deals that sway markets. We’re looking at really genuine, kind of organic, and imported growth. That makes me feel pretty good about 2018. I think deals may be taking a little bit longer, but there’s a lot on the horizon.
Why have deals been taking longer?
Holman: We’re seeing rates that we couldn’t dream of even 10 years ago. So, I think there’s a lot to pick from in terms of [submarkets]. For the well-located classic product, it’s just not cheap.
Garrett: There’s really no doubt that this market’s now being demand-driven. We see the demand out there, and we were supplying that demand. At this point in our cycle, everybody’s keeping a good hold on the reins. We think we’re pretty stable going into 2018 in terms of supply
and demand.
Arledge: I think deals are taking longer because it takes a while to pull CFOs off the ceiling when they realize where rates are going over the next three years.
Littlejohn: Right.
Arledge: If you’re coming out of a five- or eight-year lease, or even a 10-year lease, the traumatic shock is so great that it takes a while for us to explain, justify, and really prove what those rates are and why they have gotten as high as they are.
Ellerman: I agree. Dallas has been so reasonably priced for so long. And then all of a sudden, we get to 2010, 2011, and the fundamentals are solid, and the job growth is there. And then rents start creeping up and have been going up ever since. We’re seven years into rent growth, and things are priced at perfection. We’re just now, from a city standpoint, getting competitive with the other cities that are in our peer group—the Chicagos and Atlantas and Los Angeleses.
How about office sales?
Ellerman: There’s been a lot of capital that’s been placed in the last six or seven years. It’s a lot of value-add capital. There just aren’t a lot of deals left that fit that criteria. There’s a tremendous amount of capital waiting to get placed, but it’s a very picked-over market.
Garrett: Our investment team would echo that sentiment exactly. They said the activity is strong, but these big deals are not there like we had last year with CityLine and Liberty Mutual. And some of the major Class A buildings in the core submarkets have sold already. We’re at that point and cycle where there are no more value-add plays.
Krikorian: Capital wants Dallas. It’s an incredible, diversified economy, has incredible job growth, but there’s no place to put capital in the core. It’ll be interesting to see what happens. We saw last year that ceilings broke at $500 a foot in Uptown, and $400 in suburban [product]. And then now we have these rents of $32 to $36 a foot. It gets back to sticker shock on rent. In order to build new product, it costs more, and rents are higher …
Holman: Land is high.
Krikorian: … and land is impossible to find. So I think capital wants to be here, but there’s a lack of product.
Ellerman: Dallas has been validated. Forever, Dallas was just another city that would overbuild itself every 15 years. It was a terrible investment market, and people would come here and get killed, and leave with their tail between their legs. Now, it’s finally been validated.
Holman: It took a generation to work out all the overbuilding we did in the ’80s and the crash we had. Now Dallas is a highly desirable investment market.
Ellerman: We’ve got some sectors here, like Uptown and Legacy, that are as good, from a fundamental, demand, and investment standpoint, as markets you can find anywhere. These Uptown sales—between 2000 McKinney and 1717 McKinney—were the type of core buyer every market wants.
What types of activity are you expecting in 2018?
Ellerman: Eight years into this recovery, a lot of transactions have already occurred. There’s not an endless supply of new, large deals. The only thing on the horizon that we’re looking at is where these deals are coming from in 2018 and 2019, outside of typical lease churn.
Holman: Since the recession, we’ve been growing at over 100,000 jobs a year, so that’s 150,000 people, something like that. That’s Waco. We grow by Waco every year. Probably half or 40 percent of those are office jobs. We’re starting to see that this market no longer supports conventional commuting patterns. It’s really hard if you live in Frisco to commute to the CBD. Ten years ago, you could do that easily. So it’s no wonder we’re seeing these areas node and create CBDs of their own.
Littlejohn: I think we’re going to see a lot of expansion activity. A lot of the companies we’re working with have operations around the U.S., and they’re looking to expand or relocate some operations to Dallas. We’re going to have some growth from companies already here, just as we’re going to have some companies relocating to the area.
Arledge: For years, Dallas was a plan B. Ten years ago, when someone graduated, they looked at going to Austin, San Francisco, Boston, and Chicago. Now, Dallas is becoming a plan A. That’s going to continue. We’ll end up with pockets where people work and live by necessity.
What projects have gained a lot of momentum this year?
Garrett: You’d have to say The Star in Frisco. Just a superb project, and it leased up well at good rental rates.
Arledge: The Campus at Legacy West project. The vision Sam Ware had and how that building could be divided and defined as two separate entities is a pretty amazing deal.
Holman: Between [Craig] Hall, [Jerry] Jones, and then what folks at Frisco Station are doing, you’ve got some real heavyweights that have the ability to create something that other developers would have had a heck of time doing.
Garrett: Hall’s planned redevelopment of that HALL Park facing The Star, and the great amenity package going in, is worth mentioning.
Ellerman: The other spectrum is downtown and Uptown. Our iconic Dallas buildings—Trammell Crow Center, Chase Tower, Fountain Place, Thanksgiving Tower, Ross Tower—they’ve all gone through massive capital expenditures, and they’re taking great old buildings and converting them into spectacular 2018-2020-quality buildings. But that’s what they need to do to be able to compete against the new construction in Uptown, like Park District, The Union, The Crescent, McKinney & Olive. Those are world-class buildings that have shown just how deep our Class AA market is.
This was the first year that we saw a wave of corporate relocations deliver. How did that impact the market?
Littlejohn: One thing that I’ve seen from my clients is the fear of the unknown. What is traffic going to do to my employees and their commutes? What is the impact on the fight for labor? People are taking a step back and wanting to make sure they have a stratgey going forward.
Ellerman: I think that it’s caused other users to go to different submarkets. If you’ve got people that say, “Do you ever want to look up the [Dallas North] Tollway?” the answer is, “No, I don’t want to go up there. That’s where Toyota and Liberty Mutual are hiring. I want to go to Richardson, Irving, Lower Tollway.”
Arledge: It’s a challenge to overlay drive-time metrics with where talent is. The thing that’s important right now is not only the real estate—it’s finding people [clients] need to hire. And are they going to get tired of spending 45 minutes on the tollway to get to work and go elsewhere?
Littlejohn: Let’s say an average of real estate cost might represent $30. Your labor costs might represent $300 of the equation, and so you can’t screw up the $300 piece for the $30 piece.
Have we reached the height of feeder tenants coming in to service the Toyotas and Liberty Mutuals?
Garrett: It’s to be determined. Once they get stabilized there, you’ll see other people come in.
Ellerman: There are two types of users that are dealing with the campuses. One is the back office service-type operation, and they don’t really have anybody coming to see them. Versus the Toyotas, who has everybody coming to see them. Those types of users are going to bring all kinds of customers, and clients, and vendors to our market.
In site selecting, what necessities are you hearing from tenants?
Littlejohn: Higher parking ratios, without a doubt.
Arledge: Doggie day care.
Littlejohn: There’s also a difference of who’s in the room helping to make the decision. It’s not just the CFO. It’s the HR component of it that’s really into the decision-making process. There are intangibles that give your company that stickiness, again relating to employee retention and attraction.
Garrett: As millennials increase and baby boomers retire, the forward-thinking companies are looking for those amenities that the millennials want.
Holman: When I got out of school, it was graduates chasing jobs. Now it’s jobs chasing graduates. If you’re going in a high-tech, new age company, there’ll be different drivers, and that’s where you get into dog walking and fun stuff. Google and Apple and all those firms are teaching us how these millennials occupy space.
Krikorian: We’re always solving for parking. But it seems like there’s a lot of parking that’s not being used.
Littlejohn: We’ve done a lot of parking studies with clients that think they need the six or seven [parking spaces] per 1,000 square feet. When you really assess what they’re using, it’s nowhere near that.
Krikorian: But we’ve got to provide it to get the deal.
Littlejohn: The existing buildings can become a real challenge. Buildings that were built earlier on weren’t solving for five or six per 1,000.
Ellerman: Parking is the No. 1 issue that we solve for in almost every transaction. Unlike other cities that have really good rapid transit—we’re just not there yet.
Let’s talk about supply and demand in a few hot submarkets.
Arledge: In the CBD, I think we should change that to So-Ro, South of Ross, and No-Ro, North of Ross. They are two different markets.
Littlejohn: Pricing along Ross is definitely more in line with the Uptown market.
Holman: How much are the existing parking ratios in the CBD? Is that the major impediment?
Ellerman: No, it’s the cost of parking. If you’re going to add a lot of people, if you’re going to go four to five per 1,000 square feet, your parking costs in downtown Dallas are going to be $5 to $8 a foot. Even though the rent in the core is very inexpensive, you add the parking cost to it, and it gets up there in a hurry.
Arledge: And you can’t expect employees to pay for that.
Ellerman: If you would’ve asked the question a year or two ago about the core downtown, I would have said, “Wow, it’s been a game of musical chairs down there for 25 years.” But I’m seeing some signs of life on some recent occurrences down there. I actually think downtown might make a comeback in some of these core buildings.
Krikorian: At Park District [in Uptown], activity’s really good. They’re smaller deals. They’re one-floor, two-floor deals, but we’re 50 percent leased [as of late October].
Garrett: In the North Platinum Corridor north of U.S. 190 along the tollway, the absorption has been 300,000 feet per year over the last several years. Two years ago, it was 700,000 feet. Last year, it was 1.3 million square feet, and net absorption in 2017 should be around 1.3 million as well. The demand is very strong, and the net absorption is strong as well on the North Platinum Corridor. Many of those companies are seeing the rate get too high, so they’re coming down to the South Platinum Corridor, because it’s less expensive.
Krikorian: I’ve been surprised by the Lower Tollway, at the activity going on there at Lincoln Centre and The Galleria.
Is that because tenants are priced out of different submarkets?
Littlejohn: Location-wise it has to work, right? But when you come down to Preston Center, the pricing is very expensive. Then when you go north of 190 for comparable buildings, the pricing is very expensive. Some of those buildings have some momentum now with the lease-up. I don’t think that’s going to be the case forever, but I still think there are a couple of options there that you can be in a great building with great access and signage.
Holman: Several large move-outs from that market—JPMorgan is one, Fannie Mae is another—essentially created vacant buildings.
Garrett: With the Lower Tollway or the South Platinum Corridor, they’re hoping for the Cotton Belt Rail to come through so they’ll have a direct rail line into DFW.
Holman: I think DART is going to be a big factor. When State Farm came, they told us first thing that they wanted to be on rail. And every developer with a site that had rail, all of us chased them. And at the end of the day, where’d they go? They went on the rail.
Ellerman: But we really need that east-west connection on DART. I mean DART’s great, but it’s really a north-south connection. And that Cotton Belt is really going to make DART a real transportation system, because 80 percent of our population lives up there. I think it’s more important than the D2 Alignment.
Garrett: One other area that doesn’t really get much play is Southside on Lamar. When the bullet train does come to fruition, it will bring increased retail, housing, office. That whole area’s going to be just booming if we can land [high-speed rail] and get it through and approved.
What potential disruptors will you be watching in 2018 and onward?
Littlejohn: I think everybody has a close eye on what’s going on in Washington. I think there’s some potential tax changes that could or couldn’t happen.
Garrett: We as an industry are going to be watching what happens with the WeWork concept and how that will or will not affect our overall industry, positively or negatively.
Littlejohn: It’s amazing how many blue-chip companies are taking advantage of the flexible working space. It’s not just the mom-and-pop startup operations using the space. It’s a lot of blue-chip companies that are using [co-working spaces] as real estate.
Ellerman: A lot of what they propose from a value standpoint is, that they take your variable work force, and they can lease space for the very short-term. Yes, there is going to be a saturation point, and I don’t know what it is.
Arledge: I think the concept of remote and at-home working did not become as successful for companies as they thought it would. So co-working has become a better solution, especially for that variable work force.
Holman: I think it’s an augmentation to the office market. It may take us [brokers] from leasing a satellite office. They may go with a WeWork concept, but as they grow that office, they’ll eventually go into conventional space. To me, I think it’s a real positive thing.
Littlejohn: There are so many companies that want to play with the idea of having satellite offices up in the Legacy area, per se, because they have a lot of employees there. So, before they have to kind of jump into a three- or five-year lease, they can see how [co-working] works out.
Holman: And you’re seeing that like with what [Bill] Cawley [CEO of Cawley Partners] has done with [spec] offices, and you’re getting a ton of activity with people who, for healthy reasons, don’t want to commit to long-term leases.
What kinds of innovations in technology are already impacting your industry?
Ellerman: Autonomous vehicles do not impact anything today. I kind of thought, “Yeah, it’s going to happen,” but in 10 years. It’ll be here before we know it, and that has a million implications on real estate. It’s not going to happen overnight, but there are a lot of thought leaders that think it’s going to happen sooner than we think.
Holman: I agree. And when you’re building office buildings, those parking spaces aren’t cheap.
Ellerman: I’m assuming you guys are building parking garages today with the thought that you might have to convert them.
Krikorian: The thought is, do you make them a little taller, so if it’s above grade, you turn it into a data center. It’s difficult to spend the extra money for extra clear heights. The sub-grade is tough. What happens with the space? But can you imagine building something without parking?
Where in the cycle are we?
Littlejohn: I think we’re at the peak. But I don’t think it’s going to dip immediately. I think we’re going to ride this wave for another year or so.
Holman: I just watch jobs.
Garrett: We’re not seeing any bubbles forming. The data says there’s nothing we need to freak out about. It’s going to be another strong 2018 and 2019.
Krikorian: If you look at the last 20 years, we had two events when the market dropped: 9/11 and CMBS in 2008. We don’t know what it is this time.
Arledge: The standards we’ve always used—supply and demand, cap rates—are going to become relics for evaluating property. As Ran said, it’s going to be job growth and migration.
Garrett: You have to think about NAFTA and our trade. NAFTA affects Texas and DFW tremendously. We’ll see how that works out.
