The combined forces of population growth, increased online shopping and demand for last-mile fulfillment centers are driving development of and investment in industrial assets in major markets.
Natural population growth translates to more aggregate demand and consumption of goods and services. The rise of e-commerce has guaranteed that a growing percentage of those products will be ordered online and delivered to end users within a few days, hence the need for more fulfillment and distribution facilities near major population centers.
The metropolitan statistical areas (MSAs) of Dallas-Fort Worth (DFW) and Houston are home to a combined 13 million or so people and counting. Both MSAs have seen major upticks in industrial development over the last several years while also posting record absorption numbers.
And despite some vast differences between the industries and users driving demand in DFW and Houston, both markets reflect how sweeping changes in consumer behavior have elevated the fundamentals of their industrial real estate inventories. Regardless how different their economies are, demand for space in both markets should remain robust in 2019.
By The Numbers
According to CoStar Group, DFW posted positive net absorption of approximately 20 million square feet in 2018, a year in which inventory grew by 2.4 percent. Year-over-year supply growth was even stronger in 2017 at 3.5 percent, but the market absorbed about 24.5 million square feet in 2017.
The metroplex closed 2018 with a vacancy rate of 5.7 percent and posted annual rent growth of 5 percent. Hefty volumes of new supply coming on line in 2019 are projected to increase the vacancy rate by a few dozen basis points and hold the pace of rent growth steady at about 5 percent. Overall, DFW’s industrial rents have risen by roughly 23 percent from $5.12 per square foot to $6.32 per square foot over the last five years, per CoStar.
“The DFW market has pretty much absorbed what’s been delivered during this cycle,” says Jim Brice, partner and managing principal of Dallas-based Holt Lunsford Commercial. “The volume of construction is slowing down, so as long as we maintain our current level of job growth, the metroplex’s industrial market should remain strong through the next 24 months.”
“We’ve seen little change in vacancy over the last couple years,” adds Adam Curran, director of logistics and industrial services at Cushman & Wakefield’s Dallas office. “Absorption has moved in lockstep with new deliveries, so if absorption remains positive and vacancy remains below 7 percent, you should continue to see year-over-year increases of 5 to 6 percent on asking prices.”
The story is similar in Houston. The market posted positive net absorption of roughly 10 million square feet in 2018, but heavy new construction is expected to increase the vacancy rate from 5.2 percent to 5.8 percent over the course of 2019, according to CoStar. However, the pace of rent growth is actually expected to rise by 2.4 percent in 2019, compared to just 1.8 percent in 2018. This difference would appear to be a testament to the quality of new supply coming on line.
Housing Helps DFW
DFW has some of the nation’s hottest housing markets. According to Zillow.com, the median value of a single-family home increased by 13.4 percent over the course of 2018, a year in which the metroplex also added 20,000 new apartments. As such, brokers are keeping an eye on housing development as an indicator of industrial demand.
“You hear the term ‘clicks to bricks’ a lot in our industry, but it’s really ‘clicks to houses,’” say Curran. “New homes need everything from irrigation supplies to shingles to drywall, so homebuilding is a major driving factor. Retailers that sell goods that can be delivered to homes in a few days are scrambling to get warehouse and distribution facilities set up to accommodate those needs.”
With well over 100,000 people moving to the metroplex every year, and many residents buying or remodeling homes, industrial users that specialize in home goods, furnishing, décor and/or improvement are driving significant amounts of absorption. To that end, many users in DFW are exclusively targeting spaces close to hotbeds of single- and multifamily development, such as Plano, Frisco, Carrollton and Lewisville.
Given the scope of DFW’s job and population growth in this cycle and vast array of suppliers involved, it’s hard to imagine a single industry that’s having a greater impact on DFW’s industrial market than housing development. Consequently, some of the biggest deals of the last 18 months have featured retailers and suppliers tied to homebuilding.
Home Depot made the biggest splash among these users when it committed to roughly 2 million square feet of distribution space in southwest Dallas in the fourth quarter of 2018. A build-to-suit project is underway for the Atlanta-based chain, which could assume occupancy toward year’s end.
Several other national tenants have taken down large swaths of space in the metroplex over the last 18 months. In November 2017, Illinois-based FCL Builders Inc. broke ground on an 877,000-square-foot distribution center for Ashley Furniture in the eastern Dallas suburb of Mesquite. California-based furniture provider Living Spaces is in the process of opening a 500,000-square-foot facility in Grand Prairie, and local décor retailer At Home has committed to 550,000 square feet of industrial space in Garland, a northeastern suburb of Dallas.
The metroplex’s thriving housing industry has also generated numerous smaller deals for suppliers of building materials. Examples include Chelsea Building Products, which signed a 130,816-square-foot lease in the northeastern suburb of Greenville in October 2018; Builders First Source, which leased 117,072 square feet in Irving in September 2018; and Cowtown Materials Inc., which took down 64,249 square feet at Crosby Business Park in Carrollton in August 2018.
Blake Kendrick, managing director at Stream Realty Partners’ Dallas office, notes that much of the metroplex’s industrial absorption stems from firms in the housing supply chain looking to grow their existing footprints in tandem with the development boom.
“HVAC, plumbing, electrical supply, building materials companies — most of those users are in expansion mode right now,” says Kendrick. “And it’s not just due to housing, as many of these users supply commercial construction projects as well.”
DFW is also fielding strong demand from third-party logistics (3PL) users. According to Kendrick, these tenants are often taking larger spaces than their current volumes of business require, because they expect their workloads to grow with the population influx and rising demand for last-mile distribution services.
As it does to some degree in every primary market, e-commerce is also contributing to tighter vacancy in DFW. Amazon alone occupies approximately 10 million square feet throughout the metroplex. Other nationally known e-commerce firms, such as pet products supplier chewy.com, which opened a 600,000-square-foot fulfillment center in South Dallas in 2018, are establishing sizable footprints in DFW as well.
“Part of the reason you see demand for e-commerce facilities of such large sizes is because those users are turning over their inventory very quickly,” says Brice of Holt Lunsford, who adds that 38 percent of all industrial transactions across the nation involve e-commerce users.
“The square footage that e-commerce users take down is one thing,” says Kendrick. “If they absorb 3 million square feet in a year, that activity is probably contained to a handful of transactions. But having a high volume of sticky tenants serving industry demand within the metroplex — whether for housing or consumer products or whatever — that’s a better indicator of the health of the market.”
Distribution Drives Houston
Houston is the oil and gas capital of the country, and the fundamentals of its industrial and office markets are never far removed from the performances of these commodities. After rebounding to more than $70 per barrel in fall of last year, prices of West Texas Intermediate slid below $50 per barrel to close 2018. Oil was trading at $57 per barrel at the time of this writing.
When oil prices are low, it’s the manufacturers in Houston’s industrial market that take the hit. Demand from users that produce piping, valves and other pieces of equipment that service the upstream side of the industry has slowed in recent months despite a major rebound looking imminent.
“We saw a lot of manufacturers get back into the market during the first half of 2018, showing positive sentiment and looking for large blocks of space,” says Nick Peterson, SIOR and partner at NAI Partners’ Houston office. “If prices stabilize and creep up we should see some manufacturers re-enter the market, but even so, the distribution side of the market is as strong as we’ve ever seen it.”
Josh Gold, an industrial tenant rep broker at Houston-based Finial Group, notes that innovations in fracking and energy extraction have lowered oil and gas firms’ thresholds for profitability. Thus consistency in oil prices, rather than a sweeping rebound, could spur more demand from Houston’s manufacturing base.
“Even though the price has come down from $70 per barrel, if it holds at $50 per barrel, there will still be strong profit margins and ramped up investment,” says Gold. “We know that natural population growth and logistics users are driving some of the absorption in our market, but oil and gas companies should still be comfortable investing at $50 per barrel.”
Houston has seen its economy diversify in recent years via growth of healthcare, plastics manufacturing and expanded cargo handling at Port Houston. The distribution needs of the latter two have contributed to heightened demand for industrial space among 3PL users in particular.
“Most of the true growth and excitement surrounding Houston’s industrial market is tied to distribution deals,” says Walker Barnett, principal and director at Colliers International’s Houston office. “We expect demand from oil and gas users to remain relatively flat in 2019, but there are numerous companies looking for greater efficiencies in their supply chains by hiring third-party logistics firms.”
Both Peterson and Barnett pointed to large-scale distribution deals from major retailers as another rising demand driver in Houston. Best Buy, which announced a 600,000-square-foot distribution center in the southwestern suburb of Missouri City in late 2017, has become the success symbol for these kinds of deals. Two other national retailers, IKEA and Costco, have also acquired 150-acre tracts in Houston for the development of large-format distribution centers.
These deals are likely to materialize in suburban areas, where land is slightly cheaper and more available. These sites can appeal to 3PL users for similar reasons, as well as for their proximity to air and water transit, which is critical to shipping much of the freight handled by 3PL companies.
For example, in September 2018, Forward Air Solutions, a division of Tennessee-based logistics firm Forward Air Corp., signed a 289,200-square-foot lease in Humble, a northern suburb of Houston. The site offers convenient access to George Bush Intercontinental Airport, as well as Interstate 69.
The Houston brokers interviewed for this piece expressed different concerns for the market’s health in 2019 — skyrocketing property taxes, oversupply in certain submarkets and a low inventory of infill sites. But all agree that industrial absorption and rent growth are unlikely to worsen in 2019 due to the growth of the metro’s population, jobs and infrastructure, all of which have contributed to Houston’s rise as a regional distribution hub.
— By Taylor Williams. This article first appeared in the March 2019 issue of Texas Real Estate Business magazine.