Flight To Quality Could Put Dallas-Fort Worth's Older Office Stock On Thin Ice

More than two years after the pandemic brought office activity to a grinding halt, workplace occupancy in Dallas-Fort Worth continues to outperform most of the nation. But within the confines of the Metroplex, the future of older office buildings remains uncertain.

In a bid to bring employees back to the office, tenants are shelling out more money on well-amenitized, high-quality real estate. This pattern is driving up prices in DFW and beyond — a CBRE analysis of 12 major U.S. office markets, including DFW, showed that average rents for Class-A properties increased by 6.7% so far this year, compared to only 1.1% for lower-tier properties.

Landlords of Class-B and C properties have tended to drive occupancy by lowering rents, but in a tight job market, this strategy is not as effective as it once was, JLL Managing Director Torrey Littlejohn said. Decisions about location are more often dictated by employee retention than cost savings because in many cases, it is more expensive to lose an employee than to shell out a few extra dollars per month on rent.

“You don’t want the tail to wag the dog,” Littlejohn said. “If you spend that money correctly on your real estate, it will have a much bigger, more positive impact on the labor that you’re trying to attract and retain.”

Occupancy rates at office properties across the Metroplex tell a more nuanced story about the performance of lower-tier buildings. The 23.8% vacancy rate of Class-B buildings is slightly lower than the Class-A vacancy rate of 24.3%, but experts at CBRE say the sheer availability of Class-A space might be skewing those numbers. There is 144M SF of net rentable Class-A space compared to about 80M SF of Class-B.

Some Class-B owners may attempt to level the playing field by renovating their older properties, but depending on location, this can fall short of the intended result. For office buildings in undesirable submarkets, there is sometimes little an owner can do to attract tenants, said Trey Smith, executive vice president of CBRE’s Agency Leasing Team. 

“If you have a bad location ie., you’re not in close proximity to a lot of amenities — it’s difficult, unless you really go all in,” he said. “A Class-C building, you really can’t fundamentally change that. That’s just not really wanted anymore.”

A Brookings Institution analysis of the top 10 most populous metros found that suburban office markets, which tend to be less dense and have fewer walkable amenities, were two times more vacant than their corresponding downtowns in the last quarter of 2021. In Dallas, downtown had a vacancy rate of about 25%, compared to a 32% vacancy rate in suburban Grand Prairie, according to the data. 

Savvy office developers have caught onto this trend and are making investment decisions based on a building’s surrounding environment. 

“I decided five years ago that I was not going to buy another non-walkable asset,” Cawley Partners Chairman and CEO Bill Cawley said. “If it’s not walkable, I’m not buying it. I don’t think anybody wants them.”

In some cases, older office stock can be converted to another use, Smith said. In Dallas’ urban core, vacant office space has become apartments, which is necessary to support businesses in the area. Woods Capital announced earlier this week that it has tapped Adolfson & Peterson Construction to transform multiple floors in Santander Tower, an office high rise at 1601 Elm St., into 228 multifamily units. 

“We’re seeing a lot of that happen right now,” Smith said. “This is great for the city because it brings life and will probably in and of itself help the overall office market downtown because of proximity to employees.”

But in suburban markets, Smith said zoning restrictions and the general makeup of an office building can make conversions impractical. Those owners will either lose the building to the bank or sell it to a buyer who has the ability to invest in amenitization.

“It will never be a Class-A, but you can make it the best of the Bs or the best of the Cs,” he said. “There is always a spot for those buildings.”

Obsolescence could cost the U.S. office market $1T if older office buildings fall out of commission, according to data from Goldman Sachs Group. Many of these buildings, which make up 30% of the nation’s office stock, are either too expensive to renovate or not worth the investment due to location.

DFW’s office market is at lower risk of widespread obsolescence due to high levels of in-migration and a strong job market, Cawley said. The Metroplex gained close to 295,000 new non-farm jobs in the 12 months leading up to May, which propelled positive net absorption of 556K SF in the second quarter. 

“Dallas is going to fare better than most,” Cawley said. “What’s really going to help us on the office side is all the inbound business — people moving in — and locally based companies growing.”

Still, landlords who want to remain competitive should not rest on their laurels, Littlejohn said. 

“There is always going to be somebody who wants a low-cost option,” she said. “But you can’t combat the flight to quality with nothing.”