Texas Real Estate Business

OCT 2017

Texas Real Estate Business magazine covers the multifamily, retail, office, healthcare, industrial and hospitality sectors in Texas.

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36 • October 2017 • Texas Real Estate Business www.REBusinessOnline.com O n a national level, industrial is currently considered one of the hottest real estate classes for investment, development and broker- age activity, and Dallas is renown as a powerhouse of job and population growth. Little surprise, therefore, that the metro's industrial sector is thriving. CoStar tracks key metrics for Dal- las-area warehouses and flex proper- ties, the latter defined as industrial assets with a given amount of space — usually about half — dedicated to office use. Vacancy rates for both of these property types clocked in around 6.5 percent at the end of the second quarter, a 15-year low for both. Those figures are a shade higher than the national average, mainly due to the heavy volume of completed deliv- eries — 4.4 million square feet across 36 properties — throughout the sec- ond quarter. The number of buildings delivered includes all sub-types of in- dustrial assets. Rent growth of nearly $2 per square foot between the first half of 2016 and 2017, per CoStar, has fueled investors' bullishness on the space. In addition, compression of cap rates from rough- ly 10.1 percent in 2016 to 8.5 percent in 2017 has incentivized sellers to move product and investors to buy while the getting's good. On the leasing front, net absorption of industrial space declined from the five-year high established during the third quarter of 2016, when the mar- ket absorbed nearly 10 million square feet. Still, the 5.7 million square feet ab- sorbed during the most recent quarter suggests healthy demand bolstered by continued job growth, expanding e-commerce opportunities and waves of relocations of corporate outfits, including coffee producer Farmers Brothers, Toyota Motors North Amer- ica and Jacobs Engineering. All of these firms targeted DFW for the relocation after years of operating in California, each bringing hundreds of new jobs to the metro. Texas Real Estate Business sought out SIOR members who are active in the Dallas industrial market to try to pin- point specific trends and key practic- es emerging within the space. Included in the following Q&A are Steve Berger, senior vice president of the industrial brokerage group in CBRE's Dallas office; George Bill- ingsley, partner at Dallas-based de- velopment firm Billingsley Co.; and Ken Wesson and George Tanghongs, co-managing principal and principal, respectively, at brokerage firm Lee & Associates. Their edited responses follow: Texas Real Estate Business: Can you identify a couple industries in Dallas within which companies are really clamoring for industrial space, and are those companies primarily newcomers to the market or preexist- ing operators? Steve Berger: We've seen a mix of both organic local growth as well as by relocations or establishments of operations new to this area. Our growth has been driven by manufac- turing, the supply chain that supports it, e-commerce — which is more prop- erly now described as omni-channel — and retail, as well as demand cre- ated to supply basic consumer goods. We've been firing on all cylinders for the last three years or more. George Billingsley: We've recently seen a number of marble and granite companies, as well as cabinetry firms, begin to grow their footprints in the metro. These are mostly preexisting companies that have begun to expand during a strong mar- ket. Ken Wesson: E-commerce tenants are by far the largest net users of in- dustrial space in Dallas. Companies associated with the construction in- dustry are also absorbing large blocks of space. A good example of this would be Kohler, a manufacturer of bathroom appliances that doubled its Dallas footprint earlier this year. The company now occupies more than 1.2 million square feet in the metro. George Tanghongs: While we are seeing a variety of new industrial tenants enter the market, preexisting operators also continue to exhibit a healthy demand for space. The new- comers are predominantly smaller e- commerce companies, not giants like Amazon or Walmart. TREB: What is the approximate breakdown between manufacturing and distribution deals your firm is currently seeing? Berger: About 11 percent of our base of industrial deals in DFW is what we consider manufacturing- specific, while around 84 percent is distribution-related. However, manu- facturing has a much larger impact on our industrial activity than that would imply. A significant portion of our occupied space serves to directly support those manufacturing opera- tions through just-in-time delivery, as well as through sub-assembly or light- manufacturing functions that happen within buildings designed primarily for distribution. Billingsley: Recently, we've seen about 25 percent manufacturing deals and 75 percent distribution deals. Wesson: To give a rough estimate, about 80 percent of the deals we've completed within the last 12 months have been distribution-oriented ver- sus about 20 percent that are manu- facturing-oriented. Tanghongs: The deals we're seeing in the Dallas area are still a relatively even mixture of manufacturing and distribution, with a slight lead going transactions that favor distribution uses. TREB: The market is undeniably bullish on industrial assets. Realis- tically, how much longer do you see this high degree of confidence in the performance of industrial properties lasting? Berger: We don't see the trend changing in the foreseeable future. There are several factors that support larger allocations in the industrial sec- tor. The fundamen- tals, particularly for DFW-area industrial assets tend to be less volatile than those that drive other as- set classes. There is also less capital re- quired to re-tenant spaces. Finally, the macro-trends in om- ni-channel delivery to retail consumers support ongoing demand in this sec- tor. Billingsley: We expect the e-com- merce trend to only become more pronounced with each passing year, which will prolong the bullishness of the current industrial market. We ex- pect Dallas to remain a strong indus- trial market for at least one more year. Wesson: Certainly it's difficult to predict how long a given property type will remain the No. 1 favorite. But given the trends we're currently seeing, industrial could easily remain atop the list for a couple more years. Tanghongs: This is hard to predict. Several indicators, like the announce- ments of corporate relocations, the length of time needed to construct and relocate to new headquarters and the strong demand for a limited supply of houses suggest that our local econo- my will remain strong for the next 24 to 36 months. TREB: From a broker's perspective, how have the practices of develop- ers and lenders contributed to the strength of the market? Berger: Generally, there seems to be a reasonable amount of restraint being exercised in the marketplace. Devel- opers and lenders have become more sophisticated in their thought process- es and more diligent in their market analyses. All space is not alike. More homework is being done to determine the competitive set for a particular project and to at least make an effort not to build into a particular target set that already has too many options available. Wesson: Overall, as the industry be- comes more institu- tional, more checks and balances are be- ing introduced. This has taken the form of developers and lenders both exer- cising "prudent op- timism" during this most recent cycle. Tanghongs: De- velopers and lend- ers are definitely proceeding with more caution during this cycle than in previous ones. We attribute this primarily to the rising price of land, as well as to higher costs of construction materials and labor. TREB: Other than the tradition- al drivers of job and population growth, are you seeing any key fac- tors that are bringing industrial ten- ants to Dallas? Berger: Job and population growth are absolutely the leading drivers of our industrial growth. That being said, trends in retail buying and sup- ply chain management have made the DFW area and its 7 million or so peo- ple a prime target for serving those trends. There are more than 25 million KEY DRIVERS OF DALLAS INDUSTRIAL MARKET REMAIN ROCK-SOLID HEADING INTO 2018 The Dallas industrial market may be nearing its cyclical peak, but a slowdown isn't necessarily imminent. Interviews by Taylor Williams George Billingsley Billingsley Co. Steve Berger CBRE Ken Wesson Lee & Associates

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