Anyone looking to divine the prospects for the U.S. industrial property sector in 2011 and beyond could do worse than to examine the market known by the acronym DFW.
The Dallas/Fort Worth region—which locals refer to either by its acronym or as the "Metroplex"—embodies the opportunities and risks ahead for the industrial segment as it digs out from the worst downturn in memory. The region is home to 6 million people and growing; Texas has led the nation in net job creation for the past decade. Solid economic fundamentals have kept down foreclosure rates for industrial properties. Dallas/Fort Worth's central location and proximity to Latin markets make it an attractive warehousing and distribution hub to support domestic and North American trade.
Add to that a temperate climate, a muted union presence due to Texas's status as a right-to-work state, and the absence of natural barriers to expansion (like seacoasts), and it is hardly surprising the Metroplex has been a powerful magnet for industrial development. The region currently boasts more than 600 million square feet of industrial space, a figure that doesn't include owner-occupied properties.
According to a quarterly survey by developer Jones Lang LaSalle Inc. (JLL), Dallas/Fort Worth recorded nearly $900 million in industrial transactions through the first nine months of 2010, making it second only to Los Angeles in total transaction volume. DFW's volume through the 2010 period was more than triple what it recorded for all of 2009, the JLL report says.
But for the region's developers, it's not all wine and roses. While transaction velocity has accelerated, there has still been no significant new development for the past 12 to 14 months as developers struggle with overcapacity, falling rents, and a buyer's (or lessee's) market for warehouse and DC space.
Currently, the DFW vacancy rate stands at 12.2 percent, down from 14.5 percent at the bottom of the downturn. In normal times, a 12-percent vacancy rate would be a trigger point for development. However, these times are anything but normal; leery lenders burned by bad loans have virtually shut off the credit spigot, and Dallas has not been spared the impact.
"You don't have the availability of debt that you had in previous cycles, and it will handcuff the current development cycle," says Terry Darrow, who runs JLL's DFW practice. "A lot of underwriters have been stung and they will underwrite tougher than before."
Darrow says that asking rents from local developers have barely budged in the past two years and that current rental rates are in many instances well below what developers projected when they built the facilities several years back. What's more, buyers continue to demand and receive generous concession packages that include free rent for a period of time and very attractive—for them, at least—lease renewal terms, he says.
"The deals that are getting made are very bloody," Darrow says.
For example, Darrow had been marketing a 760,000-square-foot facility in south Dallas at $3.15 per square foot. When he was unable to find a taker at those prices, Darrow dropped the rate and eventually signed a lease with Continental Tire to occupy about 40 percent of the space. He is currently working on a separate deal to lease the remaining space.
Darrow would not disclose the final rate offered to Continental or the rate on the pending deal, but he says both were "significantly below" the developer's original levels. Still, JLL never took the property off the market, he says.
Developers in DFW can take solace in the fact that they're not alone. Especially for so-called spec investments, "there is little—close to zero—debt financing available," says Stephen F. Blau, senior director at Newmark Knight Frank Smith Mack, a Wayne, Pa.-based real estate consultancy. Blau says lenders remain very cautious about the economy's prospects and are loath to finance development where a property's asset value and rental rate have declined so much that the cash flow projections don't justify the cost of construction.
"My hunch is that development will continue to be constrained until there is a more robust national recovery," says Blau.
Another issue facing the market is that trends in commercial real estate—which includes industrial properties—usually lag behind residential sector trends by one to two years. As a result, Blau forecasts that trillions of dollars in potentially distressed industrial mortgages—many of which were bundled into the kind of mortgage-backed securities that became the bane of the residential market's existence—will need to be worked through by debt restructuring, foreclosure, or other methods.
Darrow is optimistic the DFW property market has found a bottom. Due to falling vacancies and little new supply, rental rates have begun to stabilize, he says. Rents are starting to show marginal improvement, and landlords are more reluctant to offer concessions to lure or keep tenants, he adds.
Darrow says that while 2011 will be a "firming year" for DFW industrial property, he doesn't expect the pendulum to swing the sellers' way until the very end of 2011 or the start of 2012. He advises companies looking to make a deal in the market to act sooner rather than later.
"If you are ever going to consider a move, now is the time," he says.