Messing With The Magic: Why DFW Might Not Outperform This Cycle
The end of 2007 was a tense time for commercial real estate. The subprime mortgage crisis had spread worldwide, the lending market had dried up, and the Federal Reserve began to cut interest rates in a bid to stop turmoil in the housing and financial markets from tanking the economy.
Brokers and developers in Dallas were on high alert, uncertain of what the future may hold, and for several years, the industry proceeded with caution. When a 122K SF office building at 1717 McKinney Ave. in Uptown opened in 2010, no one thought it would lease up, but to everyone’s surprise, it did.
“Everyone worried about that building,” said Brooke Armstrong, CBRE’s president of advisory services for Texas, Oklahoma and Arkansas. “It filled, and once we recovered, it sold at a high-water mark price for Dallas.”
The unexpected success of 1717 McKinney underscores Dallas-Fort Worth’s reputation as an above-average performer during periods of economic distress. Strong population and job growth, a centralized location and a pro-business environment have kept the Metroplex insulated in past downturns.
But this time around, an existential crisis in the office market is messing with the magic.
“We’ve never seen a disruption like this before,” Avison Young senior insight analyst Walter Bialas said. “I hate using the word unprecedented, but we’ve not really seen this.”
Like many cities, DFW’s office market has grappled with record-high vacancies in the wake of the pandemic. Only about 55% of DFW’s office buildings are more than 90% leased today, which is less than the nationwide average of around 66% at that level, per new data from CBRE.
DFW office vacancy currently sits at about 26%, per Avison Young, the highest level since the mid-1980s, when rates climbed above 30%. The market has been plagued with negative absorption since 2020, and more than 7M SF of office occupancy has been lost due to the global shift to remote and hybrid work, Avison Young found.
“While there are green shoots out there, and there are tenants moving and tenants expanding and new players coming to the market here and there, we still have never seen vacancy creep up like this,” Bialas said. “We’ve had a combination of really strong job gains in a really weird market because people are working from home … It’s different, and I struggle with my colleagues to figure out where this all goes.”
Property sales have also taken a hit. After notching historic gains in early 2022, the Federal Reserve’s interest rate hikes brought CRE transactions to a near standstill, causing year-over-year deal volume in DFW to plummet by 68% in the first half of 2023, per new data from MSCI Real Assets.
The recent nosedive looks eerily similar to the 72% drop seen in the second half of 2008, but drawing a comparison may be short-sighted, MSCI analysts said. Unlike today, Global Financial Crisis declines “did not come on the back of an economy that was shut down and then excessively overheated,” they wrote in their report.
Put simply, DFW was operating at a record-high level prior to this downturn, Armstrong said, which makes the decline in sales look more dramatic than it really is.
“We were more active following the pandemic and throughout the pandemic,” Armstrong said. “Texas in general did not shut down like the rest of the country did, so we maintained a higher transaction volume, and I could see this economic environment causing a bigger halt than you’re seeing in other markets because we had a higher baseline.”
More than $8B in sales were recorded in the first half of this year, second only to Los Angeles, but a precipitous decline from the $42.5B sold in DFW a year prior, per MSCI Real Asset’s data. By comparison, DFW sales totaled $4.4B in the first six months of 2008 before dropping to $1.9B in the second half of the year.
More than $4B worth of transactions completed between January and June were concentrated in multifamily. By comparison, only $827M worth of office properties changed hands, per The Dallas Morning News.
Despite this grim scenario, new offices continue to be built. Deliveries in the first two quarters of this year totaled 1.2M SF and another 4.8M SF is in the pipeline, per CBRE.
“In 2008, pretty much every transaction that I was working on at the time in Dallas froze,” Armstrong said. “Today, people are making decisions and they’re going all in.”
Developers are responding to the wealth of demand that exists for high-quality, well-located office space, said Grant Pruitt, co-founder, president and managing director of WhiteBox Real Estate.
Desirable submarkets with walkable amenities like Uptown/Turtle Creek are about 18% vacant, per CBRE, whereas older, more suburban areas like Far North Dallas are grappling with vacancy levels upward of 27%.
“I would be really careful to generalize and say, ‘Well, the vacancy rate is high so we shouldn’t build new product,’” Pruitt said. “Because if you look at the lease-up on new product in core markets, it’s been exceptional.”
At the end of 2008, office vacancy hovered at 20% for seven straight quarters. Deliveries remained negligible between 2010 and 2013, but not for lack of demand, Pruitt said. Rather, it was due to a dearth of capital driven by the failure of financial behemoths like Freddie Mac, Fannie Mae, Lehman Brothers and AIG.
“We weren’t building anything because there weren’t any loans,” he said. “They’re still making loans [today], albeit much slower and at a lesser rate. Nobody was going to build anything in 2008, 2009 or 2010 because nobody knew what was going to happen — it was a complete and utter collapse.”
Earlier this year, the failures of Signature Bank and Silicon Valley Bank threw commercial real estate into a tailspin. The sector was already pressured by elevated interest rates and high levels of vacancy. With more than $2.4T worth of debt scheduled to mature between 2023 and 2027, banks with high exposure to CRE began to fear the impact troubled loans could have on their balance sheets.
Back in 2008, many distressed properties were foreclosed on and sold at basement prices, but Pruitt doubts banks will react the same way today.
“The difference today is that the lenders don't want the buildings back, at least right now,” he said. “They will do whatever they can to keep it in the hands of the borrower — that wasn’t necessarily the case in 2008.”
About $1.1B worth of commercial property loans in Dallas are classified as distressed, and another $4.7B are at risk of distress due to delinquent payments, forbearance or slow lease-up, per MSCI Real Assets.
DFW’s strong fundamentals and recent commitments by Fortune 500 companies should give lenders the confidence they need to seek resolutions for troubled loans rather than pursue foreclosures, said Maher Maso, former mayor of Frisco and principal at Ryan.
Major corporations like Wells Fargo, Goldman Sachs and Caterpillar planning massive office presences in DFW prove the job market will only continue to grow, he said.
“It’s really critical that banks tread cautiously and take into account that corporations are still relocating to North Texas, people are still moving here, and the growth is still vibrant,” Maso said. “Cities are doing all they can to keep things moving forward … and we have a strong foundation that was built through good governance and planning to withstand these cycles.”
Property distress and loan maturities could unlock opportunistic acquisitions in the coming months, Pruitt said, and sales should pick up in the latter half of the year as the bid-ask spread narrows.
“I’m anticipating the data over the next six months to tell a very different story than what we saw the last 12 months,” he said. “You have buyers and sellers that have tax implications, 1031 money and investor demands … eventually they have to start placing that money, and we’re starting to see that reconciliation.”
Some economists agree that the U.S. is headed toward a recession, if it isn’t in one already. It’s too early to tell how long it may take for DFW to recover, Maso said, but the fundamentals are in place for a soft landing.
“Ultimately, North Texas is healthy,” he said. “There’s obstacles and challenges, but overall, if left alone, growth will continue, and most will make it through.”
