Everything is bigger in Texas, and that includes logistics real estate.
The Dallas/Fort Worth (DFW) logistics real estate market hit an all-time record of 81.4 million square feet under construction during the fourth quarter, a 43.1% increase year over year, according to data from Cushman & Wakefield (NYSE: CWK), a leading real estate services firm. What’s more, DFW’s construction pipeline, which stands at 47.2 million square feet, was the most robust of any market in the country. DFW is far and away the nation’s market leader in developments under construction.
Occupancies rose in the fourth quarter, but vacancies did as well to 5.3% due to the large number of speculative deliveries of vacant space. Spec deliveries are backed by developers’ assumptions that they will be able to quickly lease the space once it’s available. That assumption is alive and well in DFW.
Unlike coastal real estate markets, DFW is not space constrained. Unlike Chicago and Northeast U.S. markets, DFW has better year-round weather and solid population growth. Eight million people called DFW home at the end of the year, the most in its history, said Cushman.
For the past 11 years, David Eseke has ridden herd at Cushman over the expansion in DFW industrial real estate. Eseke, currently Cushman’s DFW executive managing director and Dallas industrial team lead, sat down with FreightWaves to discuss macro trends, DFW’s positioning in the market and how the market can continue to grow despite higher interest rates and a slowing in industrial starts activity.
FREIGHTWAVES: What are DFW’s characteristics that set it apart from other big industrial markets?
ESEKE: Central location–geographically and from a time zone standpoint–the ability to service the Texas Triangle which makes up the majority of the state’s population, massive population growth for North Texas which means more toilet paper and toothpaste for incoming residents, availability and relative affordability of land compared to coastal markets, generally flat terrain without significant trees, less restrictive entitlement processes, substantial highway infrastructure and a strong labor pool that is generally less expensive than other core industrial markets across the country. DFW has a lot going for it from an industrial perspective.
FREIGHTWAVES: DFW has always been at or near the top for development volumes. Why is that?
ESEKE: Primarily the abundance of land and the lack of any real geographic barriers that would limit future development. I would say that development follows demand. Population growth is the main driver for commercial real estate development and is directly tied to industrial development and leasing demand.
As the fastest growing metro area in the U.S., the accompanying demand makes development much more attractive. Lastly, I will say our market is graced with world-class industrial developers. Names like Trammell Crow — and subsequently Crow Holdings, Billingsley, Trammell Crow Co. — and Hillwood immediately come to mind.
FREIGHTWAVES: How has DFW been affected by higher interest rates over the past year?
ESEKE: You could argue it’s been hit harder than other markets because, when rates were at their lowest, “cap rates” were tumbling at record pace. (Note: Cap rate is a capitalization rate and is a measure of a property’s value. It’s calculated by dividing the net operating income — NOI — of a property by the sales price. The lower the cap rate, the higher the purchase price. Cap rates reflect a market’s perception of a property’s profitability.)
In a sense, DFW has been hit harder because we’ve had a higher platform to fall from, whereas infill cap rates for industrial products in markets like Houston never got in the sub-2-3 cap rate range. However, like every market, the higher cost of capital results in less sale transactions, whether it be land or existing buildings. Buyers can’t pay as much as they could, and they can’t confidently underwrite cap rate compression even if they are forecasting rent growth.
FREIGHTWAVES: Most markets have seen a drop in construction starts in the past two quarters. Has DFW been immune?
ESEKE: Many land sites were dropped as interest rates increased rapidly last summer. That, coupled with the reduction in leasing demand, has led to a drop in construction starts. However, we still have some more than 70 million square feet so there’s plenty in the pipeline at the moment. But if leasing demand continues, we could see a material drop in vacancy and increase in rents in 2024 as the new deliveries get leased. There will be a gap on the deliveries side that would potentially yield higher rental rates and lower vacancy percentage.
FREIGHTWAVES: Can you talk about the impact of nearshoring on development activity in DFW? Is demand from nearshoring in the early innings and how do you compete with markets like New Orleans, LAX or Houston?
ESEKE: Nearshoring and even full onshoring are definitely trends we are seeing, and I think they are here to stay. Markets are efficient … until they’re not. That’s what happened with COVID. The massive disruptions of global supply chains have left some groups realizing they never want to manage through that again. To some extent, it’s impossible to insulate from global supply chain risk, but nearshoring and onshoring can help offset some of that.
DFW is competitive in that real estate costs, labor costs and the cost of power are all relatively cheaper than the coastal markets. Additionally, DFW is a great central distribution hub and there can be significant transportation savings as compared to other cities that might offer cheaper real estate and labor. Ultimately, it varies significantly by user.
However, one thing we need to address is the tax on business personal property (BPP). Since Texas does not collect an income tax, it is one of 10 states that collects a tax on BPP, (generally on inventory and equipment. Many communities offer the Freeport exemption, which exempts companies for paying taxes on inventory that leaves Texas within 175 days. However, this is particularly punitive for manufacturing companies since their expensive equipment is bolted to the floor. Companies can negotiate abatements on some of those taxes for bringing a project to a particular city, but those generally expire after 10 years. If Texas wants to attract more manufacturing users, we may need to reconsider our tax landscape and how we can make it more tolerable for these businesses.
FREIGHTWAVES: Are tenants in the region still holding too much inventory?
ESEKE: I don’t believe so, not in a general sense. Certainly this could be the case for consumer products groups–think furniture, electronics, appliances, etc. But not generally. Those groups that have decided to sublease their space represent a small minority of the tenant composition. Given the low vacancy rate, I believe those will be absorbed quickly with minimal impact on market lease rates.
FREIGHTWAVES: Subleasing is a growing trend as tenants get caught with too much inventory. Is DFW high up on that list?
ESEKE: No, not generally. The population growth is still such that many groups can find customers/consumers that will buy their product so they can turn it quickly. If population growth slows or stops, then we might see more sublease activity. But even in a recessionary environment, I still expect to see an influx of people relocating to North Texas due to the relatively lower cost of living, home-buying power, good schools, strong job market and access to two major airports with direct flights to nearly anywhere you can think of.