Healthy Demand Jumpstarts Construction Activity in Dallas Industrial Market

by Haisten Willis

Greg Thurman, Ridgeline Property Group.

The Dallas/Fort Worth industrial market is one of the biggest and most strategically important in North America. With an inventory of more than 500 million square feet of warehouse and distribution space, the DFW industrial market serves a metro area of 6.8 million people and a larger region that stretches to Mexico. More than 70 percent of goods exported to Mexico roll through the metro area, and the North American Free Trade Agreement (NAFTA) has been a huge driver of those exports.

These days, the industrial market is buoyed by a local economy that is outpacing most of the nation’s major metros. In March, Dallas/Fort Worth registered an unemployment rate of 4 percent, compared to 5.9 percent in Atlanta, 6 percent in New York, 6.4 percent in Chicago and 6.6 percent in Los Angeles, according to the U.S. Bureau of Labor Statistics. The GDP also grew by a healthy 2.2 percent in 2014. Dallas/Fort Worth’s economic momentum has heightened demand for industrial space.

The first quarter of 2015 marked the 18th consecutive quarter of positive absorption, according to CBRE. The DFW industrial market has been among the top five markets in absorption over the past several years, and this impressive track record is attracting the attention of developers.

Spec Construction Returns
The rising number of projects in the construction pipeline demonstrates developers’ growing confidence in the Dallas/Fort Worth industrial market. More than 14 million square feet of new projects are in the pipeline. Deliveries in the first quarter of 2015 totaled 8.6 million square feet — a 46 percent increase from the previous quarter, according to CBRE.

It’s notable that speculative construction accounts for the majority of projects currently in the pipeline. The ongoing positive absorption has spurred speculative construction, but there are other factors in the mix. As the market continues to post positive absorption and vacancy rates remain low by historical standards — hovering around 7.5 percent — the market is beginning to experience rental growth.

Strong demand has removed most of the highest-quality space from the market and enabled landlords to increase rental rates at the better properties. In addition, the rise in rental rates has helped to boost the value of the existing building stock, which further serves to heighten investors’ confidence in the market.

Distributors’ need for more modern and efficient space is another factor spurring development.  We are seeing a continued push by credit tenants to move out of older, less functional space into newly developed buildings that better serve their distribution requirements. The facilities that developers are building today offer higher clear heights that accommodate narrow aisle racking systems and greater cubic square footage, and they also feature expanded truck courts for increased trailer storage capacity.

E-commerce businesses are driving many of these design changes, which also include larger parking areas to accommodate the greater number of employees involved in these operations.

High-Flying Submarkets
Dallas/Fort Worth International Airport and North Fort Worth are two of the hottest submarkets, with excellent absorption and a significant amount of speculative construction.  The biggest lease transaction, 950,000 square feet to Uline Inc., in the first quarter occurred in the airport submarket. Proximity to Dallas/Fort Worth International Airport is a key amenity, but space for development around the airport has grown scarce.

This trend has contributed to the expansion of the South Dallas submarket due to the availability of land and the ability for developers to create new product quickly and efficiently. Land is available at a reasonable price, and many properties are already entitled, allowing for facilities to be constructed in a compressed time period.

Ridgeline Property Group (RPG) is one of the developers that has entered the South Dallas submarket. In partnership with Stockbridge Capital Group, RPG is developing Eagle Park 20/35, a 453,600-square-foot distribution facility that will be delivered in the first quarter of 2016.

In addition to providing the modern design features distributors are looking for, the facility offers a strategic location at the junction of interstates 20 and 35.

More Positive Signs
The market’s strong fundamentals are stimulating investment activity, and foreign capital has recently been the most active buyer of properties. Due to the rising value of industrial assets in the DFW market, cap rates are now below the all-time low the market experienced in the 2004-2007 boom years.

We expect this trend to continue because institutional investors have more money allocated to Class A real estate, putting pressure on these investors to place money into hard assets. An obvious question is whether the current level of construction poses a risk to the market.

A trend that bodes well for not only DFW but the overall industrial sector in the U.S. is the fact that banks are making loans available for speculative buildings, but it is not the “easy money” that it was during previous cycles. With the 2008-2012 downturn still lingering in their minds, lenders have tightened loan terms. The days of 85 percent loan-to-cost ratios are gone. Today, the requirement tends to be between 55 and 65 percent loan-to-cost.

The increased amount of equity that now goes into these deals is good for the market. It has created a barrier to entry for new development, as the stricter loan terms have taken a lot of the fee-based and under-funded speculative developers out of the market and created a more healthy development environment.

In the event of another downturn, a speculative building that has 35 to 45 percent equity is much better positioned to weather a drop in values and rental rates than a property that’s highly leveraged at 85 percent.

The tighter lending standards combined with many positive trends ­­— including continued population growth, strong absorption, healthy vacancy levels, increasing rental rates and rising demand from e-commerce and consumer product companies –—create a highly favorable outlook for the Dallas/Fort Worth industrial market.

— By Greg Thurman, CEO, Ridgeline Property Group. This article originally appeared in the July 2015 issue of Texas Real Estate Business.

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