Dallas-Fort Worth (DFW) has been among the top metros for industrial development and investment alike, with net absorption and leasing rates holding strong for the past several years.
With the bulk of industrial development in DFW being big box product over 100,000 square feet, there’s been minimal development of smaller assets. So far in 2020, roughly 4.3 million industrial square feet has gone under construction in the metroplex.
Adam Abushagur, Marcus & Millichap
Approximately 10 percent (362,000 square feet) of that total centers on industrial projects under 100,000 square feet — the result of higher construction costs for smaller assets that don’t justify market rents. Current market rents do not satisfy yield requirements for developers to construct smaller assets. However, the general investment outlook for existing smaller industrial product is much more secure due to minimal new competing properties.
Roughly 15 million square feet, or 40 percent of North Texas’s industrial pipeline, sits within five miles of DFW International Airport or Fort Worth Alliance Airport, according to CoStar. Approximately 3.3 million square feet of new product is expected to come on line by the second quarter in the DFW Airport region.
Over half of the 30.9 million square feet of product under construction in DFW lies within Fort Worth (almost 19 million square feet, the bulk of which is in the Northeast Tarrant/Alliance submarket). With an average vacancy rate of 6.2 percent, Fort Worth is just slightly under the average of 6.5 percent for the DFW metro, with slightly higher average market rent ($6.85 per square foot) to match.
With about 300 people relocating to DFW daily, and the jobs to match, the market boasts somewhat of a shield from the recession — whenever that will be is unclear.
Investor sentiment has been bumpy due to volatile marketplace trends like elections on the horizon. There’s also been much talk about the inverted yield curve and its correlation to recessions. Historically, there have been inverted yields without a resulting recession and vice versa.
Many predict a recession will hit in 2021 or 2022, yet economic professionals largely agree that timing the market perfectly is impossible. In fact, when analyzing historic recessions, shorter periods of economic growth preceded more intense recession activity compared to longer periods of economic expansion like the one we are experiencing now.
The industrial asset class is slower than other property types to see an impact on net incomes in the short term, with hardly any impacts at all in the long term. With interest rates near all-time lows, there has been no better time to secure new debt and purchase industrial assets.
Industrial deal volume slowed slightly in 2019. However, the sector is simply leveling out after drastically high activity in recent years. Naturally, the market cannot sustain those record-breaking vacancy and delivery numbers, but it can maintain a consistently high new normal.
Deal Specifics
Overall, cap rates have gone down by about 50 basis points on new deals we’re transacting due to rate cuts by the Federal Reserve. Interest rates are catching up, and we are now seeing aggressive debt options for buyers, including ambitious interest-only options. As an example, we helped secure a 10-year, interest-only loan with a fixed interest rate of 3.9 percent for a buyer acquiring a value-add shallow bay industrial asset from us.
Average market cap rates in Fort Worth come in around 6.1 percent, just slightly below the 6.25 percent for the metroplex as a whole. Cap rates are compressing in Fort Worth, creating a seller’s market with the increase of price per foot.
The Alliance submarket in North Fort Worth remains a leading area for industrial development and absorption. Callaway Golf’s leasing of a 783,465-square-foot distribution center at Alliance last August speaks volumes to the submarket’s strength.
Industrial properties continue to boast some of the highest returns, averaging leveraged yields of roughly 11 percent in 2019. One new trend we are seeing is the emergence of high-net-worth investors from alternative product types, such as apartments or retail, picking up smaller industrial assets that may not be on the radar of large institutions, thus eliminating tough competition.
Through 2018 and the start of 2019, we saw a slowdown in the flow of out-of-state capital. However, in the latter part of 2019 and start of 2020, we saw a big emergence of West Coast capital due to many factors such as rent control on apartments in California and lowered interest rates.
In Fort Worth specifically, buyers are more local, as they tend to be more familiar with market trends and trajectory for growth, whereas Dallas attracts more out-of-state investors that are looking for a big-name city. However, Fort Worth has developable land at a lower price with many big-name companies adding to growth of the market.
Replacement costs have been a big indicator of demand. Examples of these deals we worked on in Tarrant County include companies such as Elbit Systems Manufacturing, Ashley Furniture Distribution and United Rentals Outside Storage, assets that all priced below replacement cost in 2019. Each Class B property generated multiple offers.
Value-Add Growth
Smaller warehouses (100,000 square feet or less) are in demand, and construction for smaller industrial assets is down due to higher construction costs. This combination has driven average rent growth of 6 percent year-over-year. This is good news for rental rates, which have increased twice as much as rents for larger warehouse spaces. Rents are only expected to increase, driven largely by anticipated growth in e-commerce.
Investors looking for higher-risk-high-return plays need look no further than value-add industrial projects. In the past, assets with physical improvement needs and/or capital constraints were sometimes viewed with uncertainty.
However, the blazing industrial sector is the place to be bullish while the market is secure. With record low industrial vacancy, demand for Class A distribution centers is still spirited. This is true even with tenants’ willingness to pay very high rents for Class B and C industrial properties.
We’re seeing huge big box development in far north and south Fort Worth, including at AllianceTexas. What will be interesting to watch are small-bay, multi-tenant assets with 3,000-square-foot spaces or less. We are seeing vacancy rates for these assets go up, due to the newer buildings being built.
Although rents are increasing, there will be a breaking point. Especially with the drastic increases in property taxes in Fort Worth, investors will need to keep an eye on their margins.
— By Adam Abushagur, senior vice president investments, Marcus & Millichap. This article first appeared in the March 2020 issue of Texas Real Estate Business magazine.