The more things change, the more they become alike.
More than 150 years after the old French proverb was coined, philosophy-inclined commercial real estate professionals in Texas could see its application spread in real time.
Although the commercial market has cooled since 2021 and early 2022, when insatiable demand drove record hiring growth, there are still enough positive fundamentals in this sector to counter inflation, interest rate hikes, and geopolitical uncertainty in an election year. In this context, homeowners and agents are reminded how fortunate they are to do business in the Lone Star State.
Thank you very much.
Expanding employment and population are the visitors to Letterman who want no introduction, as they have steadily driven expansion and creation in Texas across all sectors of real estate advertising.
But as tough as those drivers are, they’ve been there. In recent years, as debt market disruptions have slowed the expansion of commercial sources and inflation has put pressure on tenant occupancy costs, other macroeconomic forces have also emerged to help the market. The effects of an increasing concentration of productive activities in Mexico have been especially favorable for commercial demand and state absorption.
“The reshoring of production is genuine and drives the expansion of our market simply because we are on the doorstep of Mexico,” says Conrad Madsen, SIOR, co-founder and spouse of Dallas-based brokerage firm Paladin Partners. from China to Mexico is in great preparation, so all those finished and raw products that are destined for the Texas border are getting to the distribution centers [Dallas-Fort Worth] and reaching their end customers.
“The biggest winner from the reconfiguration of global supply chains over the past two years has been Mexico,” adds Charlie Meyer, president of Houston-based developer Lovett Industrial. “Mexico’s commercial market is more restricted than ever, and the U. S. is now importing more goods. “Texas led the country in terms of trade area absorption in 2023, and much of this activity comes from the expansion of production in Mexico and higher imports in Texas.
Madsen points out that, like e-commerce, the reshoring of production operations is a driving force for growth that was the last market crisis in 2009. However, those trends have skyrocketed over the past decade, as Texas has continued to attract organically. jobs and other people from out of state.
“These points keep the commercial sector healthy despite the excessive fears that existed until [interest rates started rising] a few years ago,” he concludes.
In exploring China’s exodus to Mexico, a 2023 Forbes article cited a diversity of factors: China’s tendency to borrow and hack intellectual property, social resistance on the home front opposed to the country’s infamous hard-labor practices, and the possibility of a showdown with the United States. The article astutely noted that “it’s hard to separate [from China]” and claimed that Mexico had its own problems, but struck a positive tone about the legitimacy of the change.
CBRE has also explored the issue. A late-2023 report from the Dallas-based real estate giant found that the total industry volume between Mexico and Texas was priced at $285. 6 billion in 2022, up from $231. 4 billion in 2021, before declining to $252. 6 billion year-to-date in November. The report also states that the annualized industry between Texas and the country that once governed it exceeds the price and volume of the entire U. S. industry with the U. K. , Spain, and Brazil combined.
Cliff Booth, founder and CEO of Westmount Realty Capital, believes that the basics underlying commercial real estate in the United States (and Texas) are strong enough to hold one company captive: foreign investors.
More than a dozen foreign countries are represented on the Dallas-based investment and progression firm’s list of investors. Booth says that while those capital resources have geopolitical considerations about what’s in the U. S. , they don’t have geopolitical considerations. In the U. S. , fundamental monetary prudence is pushing them to interact in U. S. markets. – regardless of what happens in November.
“The ultimate overarching story that we continually hear from foreign investors is that whatever happens with the [presidential] election, it only lasts four years, and the U. S. still has the demographics, the growth, the legal structure and the economy that have withstood that. “interest rates. in the environment and after COVID,” he says. They just can’t get the same returns because of our demographics and growth. “
Booth agrees that even within this context of preference for U. S. markets and assets, Texas occupies a special position, but admits that this has not been the case.
“We used to go to New York to reach out to capital resources, and there was someone in the room or on the investment committee who was upset about a deal in Texas,” he recalls. “Now everybody needs to close deals here. ” Although there is some nervousness in the short term, but in the long term, nowhere else in the world is there a more attractive position to invest.
Structural Integrity
Digging deeper into Texas’ commercial asset landscape, Booth identifies other macroeconomic points that have helped position the sector favorably in the eyes of investors. They have basic usage models and classic debt structures, which has caused difficulties in other asset classes.
“The commercial aspect is not affected operationally as it is with offices, and you cannot mobilize and borrow as much from industry as from multifamily projects,” he explains. “In multifamily, there’s a lot more distribution in funding, I like equity, mezzanine debt, firm debt, which has created tension [for this asset class]. There’s none of that in the industry.
“While there is some misery in the industry in submarkets where too many products have been delivered at the same time, no one panics,” Booth adds. “And because a lot of those homes are subsidized through well-capitalized institutional groups, I haven’t noticed a lot of miserable sales. “
Meyer says that, overall, his company feels better about the current state of debt markets than at any time in the past 18 months, even as the Federal Reserve takes its time to deliver on its promises of rate cuts. at least to some extent (see the “Thinness” segment below) influenced this sentiment, as did the sector’s decidedly strong fundamentals.
“We’re active in 15 markets, and the most powerful loan pool is for projects in Texas compared to out-of-state ones,” Meyer says. “Texas happens to have a larger group of lenders that make loans within the state, and a lot of the projects we’re doing outside of Texas are [being funded] through Texas-based lenders. The market dynamics in Texas are among the most powerful in the country, making it less difficult to finance projects here.
Thinness
The history of commercial expansion in DFW over the past decade is more than remarkable, and barriers to access to herbs have become more pronounced since then.
Despite the high interest rates on structural loans, there remain plenty of filler sites in the metroplex capable of supporting the seven-figure amenities that have become the models for commercial projects in the e-commerce era. As a result, the average duration of structural loans, new buildings, and transaction needs tend to decrease. But this should not be seen as a sign of a market slowdown, but rather as an undeniable recalibration.
“In terms of the state of the capital markets, lenders and investors are now looking for smaller deals,” says Bill Baumgardner, executive vice president of progression in the Dallas office of Kansas City-based developer VanTrust Real Estate. It’s preferable for investment committees to buy two 500,000-square-foot buildings, or four 250,000-square-foot buildings, than one million-square-foot building because it reduces their threat profile.
According to Baumgardner’s estimate, there are about a dozen million-square-foot commercial buildings in DFW that are currently unoccupied, compared to 15 or 16 at the end of 2023. While many of those projects are attracting interest, until more leases are finalized, the finalists will be very reluctant to give the green light to projects of this scale, he says.
Madsen identifies another explanation for why commercial developers targeting large-scale speculative projects are at a disadvantage in this market: they compete with bespoke structure offerings. Landowners with land that can accommodate such large seven-figure facilities would possibly be scarce at first. According to these owners, they may already be in the midst of negotiations with users of traditional structures that tend to have longer lead times for occupancy.
Madsen says the move toward smaller buildings responds to the existing nuances of tenant demands and how those users view their real estate situation.
“Lately, it’s been hard for small tenants to afford their space,” she says. “The costs of doing business have gone up and interest rates are only a small part of that increase. Many small users signed agreements in 2018 and 2019 that now want to be renewed, and their fees have gone up by as much as 40 or 50%. As a result, many of those tenants decide to stay on-site rather than expand. “
Baumgardner echoes the concept that shrinking profit margins are partly to blame for tenants postponing expansion plans.
“In times like those, the CFO sets the law. If the CFO says the company can’t expand with 3 million-square-foot facilities because of the interest rate situation and because the company wants its capital, the company wants to locate smaller amenities,” he explains. “That’s where some of those tenant decisions come from. “
This trend represents an update from the COVID era, when e-commerce users and retailers were taking up more space than necessary in anticipation of a near-term expansion.
“Tenant demand has stabilized; for a couple of years we had insatiable demand, but everyone looked at their needs and figured out how to scale up and operate the smaller facilities,” says Baumgardner.
Office Conversion Potential
All of the resources interviewed for this article agree that there is some possibility in DFW that former Class B buildings will be converted into commercial facilities. In terms of initial stages, the most important key is to place applicants in submarkets where commercial rents are high enough. to cover the prices of rezoning, demolition, and other redevelopment expenses.
Although the city of Houston doesn’t have zoning, which theoretically simplifies some of those projects ranging from the workplace to industry, Meyer says his company hasn’t noticed many opportunities in his hometown yet.
“Rents in Houston are high enough to warrant those games right now, but the day will come when they will make sense,” he said. “But there are infill submarkets in Dallas where rents are twice as high as in Houston, and conversions are justified in transactions. “
Lovett Industrial has committed to such a task in the metroplex. Addison Innovation Center will occupy the former 12-acre site of a workplace and intermediate complex in the northern suburbs of Dallas in a two-structure, 242,000-square-foot commercial facility. It is demolishing the existing structure to rebuild it into a 140,698-square-foot warehouse and is also structuring a 101,364-square-foot warehouse from scratch in the site’s former parking lot. JLL recently arranged a floating-rate financing structure for the allocation through First United Bank
Baumgardner says VanTrust has noticed five or six such deals materializing in DFW since it became transparent that some buildings had passed the savings point. He cites the Las Colinas de Irving community as a domain with specific prospects for converting domains into commercial domains.
“In Las Colinas, there are a lot of one- and two-story buildings that used to house call centers and now they’re products from 30 years ago, and there’s really no way to make that product enjoyable [for users]. “Las Colinas is part of the Great Southwest submarket, near the airport, and this market has leases that support those projects. The vacuum rate will most likely be around 3 percent; Tenants need to be there and can’t find space, so making a conversion on this domain will likely allow you to get the rentals you need.
As such, Orlando-based developer Foundry Commercial recently purchased a 287,000-square-foot workplace construction at 4000 Horizon Way in Irving with plans to convert the assets into a commercial facility. Foundry Commercial plans to reposition the assets, which were built on 24. 2 acres in 1999, into a three-build complex totaling approximately 337,000 square feet.
– This article appeared in the April 2024 issue of Texas Real Estate Business magazine.
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