By Taylor Williams
In the eyes of some commercial brokers, especially those who represent tenants, there actually is such a thing as too little vacancy.
When markets are running super-hot, meaning demand is far outstripping supply, tenants have minimal options and often end up paying premiums just to be able to secure space. That’s great for landlords — to a point — because markets can only bear so much rent growth in so much time before tenants start looking for workarounds to physical occupancy.
Enter the Dallas-Fort Worth (DFW) industrial sector, which has been on fire for the past seven-plus years. Explosive volumes of new deliveries, frenetic paces of absorption, stiff competition for space, record levels of rent growth and a national coming-out party as an undeniable Tier 1 market have all been hallmarks of this activity. But such torrid paces of growth were never really sustainable in perpetuity, and although both the supply and demand sides of the market have cooled, the slowdown in some ways reflects a return to healthier dynamics.
Editor’s note: InterFace Conference Group, a division of France Media Inc., produces networking and educational conferences for commercial real estate executives. To sign up for email announcements about specific events, visit www.interfaceconferencegroup.com/subscribe.
True, landlords with well-located, turnkey spaces may no longer be seeing record profits. Brokers who lease and market those buildings for sale may not be raking in the same types of commission payments and achieving the same type of cap-rate-based bragging rights. But the market still remains healthy, and for tenants, the slowdown provides opportunities to get the real estate components of their overhead costs in line with traditional ratios.
“As demand has come down, there haven’t been as many tenants vying for space, which has put less pressure on them,” said David Eseke, executive managing director and head of industrial tenant advisory and leasing services at Cushman & Wakefield’s Dallas office. “Whereas before, it was ‘you need a space in 30 days, here are the three options, pick one and by the way, you’re going to pay 10 percent above asking rent if you really want it.’”
Eseke’s comments were delivered as part of a panel discussion at the InterFace DFW & North Texas conference, which took place at Renaissance Dallas Hotel on Aug. 27 and drew nearly 200 local real estate professionals in its inaugural showing.
According to second-quarter data from CBRE, the current industrial vacancy rate across the DFW metroplex is 9.8 percent. The rate stayed below 5 percent throughout 2021 and 2022, per CBRE’s data, and has trended upward ever since. In addition, 2021 and 2022 represented the only two of the last eight years in which absorption exceeded new deliveries, according to CBRE.
(Note: although there is no definitive timestamp on what constitutes the peak of the market, early- to mid-2022 seems a fair window to which that label could be assigned based on the aforementioned statistics. Shortly after that, the Federal Reserve began aggressively raising interest rates to slow red-hot inflation throughout the economy as a whole, thus causing business activity in general to slow.)
Shannon Johnston, vice president and market leader at brokerage firm SRS Real Estate Partners, was the first panelist to address the growth and success of the market over the past decade via some numerical analysis.
“When I first got in to the business, rates were usually between $3.25 and $3.75 [per square foot], and you could negotiated between there,” she said. “Now we’re seeing anywhere from $9 to $16 per square foot depending on the [sub]market. And they’ve haven’t necessarily plateaued, but we’re seeing the highest rates we’ve seen in my 15-year career in this market.”
Eseke also noted that the pressure that tenants faced to commit to spaces at high and escalating rents translated to unprecedented valuations of buildings and record-low cap rates on closed deals. Once this trend became somewhat entrenched, it began to work in reverse. Cap rates began to influence rents instead of the other way around, even as developers worked overtime to deliver new product and alleviate pressure in the market.
“When the market was on fire, vacancy was opportunity, and it almost didn’t matter what was happening with leasing because cap rates were so low,” he said. “Today, there’s still good demand for functional infill buildings, but there’s a certain profile of deal that’s more attractive right now as opposed to just ‘the market is good, cap rates are lower and capital is back.’”
Eseke’s sentiment on the subject of slowing tenant activity was quickly echoed by fellow panelist and tenant representative Trey Fricke, managing principle at the DFW office of Lee & Associates.
“Decision-making [by tenants] is one of the biggest things that’s affecting the entire industrial world right now,” Fricke said. “When the market was moving so quickly, they couldn’t make a mistake, and it went on for so long that it was easy for landlords. Tenants are driven by sales, and if they can make these decisions, they can really save and get better buildings, but instead they wait and end up not capitalizing on deals that could be had.”
Conrad Madsen, co-founder and CEO of Dallas-based brokerage firm Paladin Partners and the panel moderator, noted that tenants whose leases are nearing expiration could now have opportunities to achieve some savings. They could do so by downsizing to smaller spaces instead of automatically renewing since there is more overall vacancy and less demand for those spaces.
“Especially for tenants that signed deals in 2018-2019 and are now seeing their leases roll, they’re looking at double or maybe even triple rents,” he said. “So it’s now a question of whether they really need the space because they don’t know if they can afford the renewal, and that’s causing some hesitation in the market as well.”
Indeed, at the height of the market, lead times for tenants to take occupancy of space were seemingly always getting shorter, a trend that was compounded by demand exceeding supply. With fewer companies needing and bidding on spaces and less urgency to pull the trigger on leasing decisions, tenants — and their brokers — can more comfortably bide their time and evaluate their options.
“Deals have been more methodical; every decision is more scrutinized,” said Eseke. “As brokers, we’re back to the basics of advising and helping tenants understand how [leasing decisions] can impact their business. We’re less space jockeys now and more actual consultants, which is where we like to be and where we can add more value.”
Fricke cited two other metrics that indicate that deal velocity is slowing, and market conditions are gradually shifting in tenants’ favor.
“[A growing supply of] sublease space and decline in preleasing are probably the two biggest factors that are taking momentum out of the market right now,” he said. “When we’d meet with landlords or tenants [at the peak of the market], we could always confidently say there was almost no sublease space available, and there really wasn’t. But today, there’s probably 180 spaces available for sublease in our market.”
He added that even with adequate supply to work with, sublease deals are challenging to execute.
“Even with as many [sublease] spaces as we have now and as many as we’ve chased with tenants, those deals are difficult to make because tenants that hold the subleases don’t always listen to your coaching the way landlords do,” he explained.
Fricke estimated that today’s preleasing activity — which by definition provides a qualitative measure of the urgency behind tenant demand — on new industrial projects is about a third of what it was at the pinnacle of the market.