by Brent McElreath
Graphic by Gary D. Schenck

Beneath the self-perpetuated (and often tongue-in-cheek) image of Texas, there lies one of the nation’s least understood yet most powerful economies. At the end of the 1980s, the Texas economy was a disaster, yet it rebounded in the 1990s, claiming the No. 2 spot behind California in some rankings. It zoomed past New York to become the nation’s second most populous state, and—perhaps more surprisingly—it also shot ahead of Pennsylvania, New York, and Ohio to become No. 2 in manufacturing employment. The state that began the 1990s with its economic tail between its legs ended up adding more jobs during the decade than any other state.

What are the forces driving this blossoming economy? And what is the magnetism of Texas cities, enabling them to suck in huge flows of capital while simultaneously raising the eyebrows of financiers and federal bureaucrats? For example, the Federal Deposit Insurance Corp. recently placed Dallas on a watch list for overbuilding, drawing howls from the local business and media establishment that the East Coast power structure simply didn’t understand the city’s economic dynamics.

Economic hostility between Texas and the Northeastern capital markets is hardly new. In the 1800s, the state’s agrarian populace was notoriously wary of the Northeastern bankers and railroad barons they perceived as controlling their commodity markets. An individualistic and inward-looking culture was already in the making, and a populist society, overwhelmingly rural in those days, was about to be born. It was skeptical of any outside economic or political power, even from Austin, the state’s capital.

Through the years, the local commodity markets in Texas have shifted from cotton to cattle to crude oil to computer chips, but the same economic tension between state and nation persists. Even in the real estate markets, this relationship holds true, as Texas commands a huge share of the nation’s real estate development talent while the Northeast still controls a disproportionate share of capital flows.

At its core, Texas is a western frontier state, linked far more closely to the culture and economy of the Great Plains and the Rocky Mountain West than to the Old South. The sheer physical size of Texas (about the same land area as France) is startling for almost anyone who has ever driven across it on I-10. This landscape has allowed Texas’ major cities to develop with some degree of autonomy from the rest of the country and from each other.

A few large U.S. metropolitan areas, such as Washington, D.C., and New York, sprawl across multiple state boundaries, creating difficult political environments that require compromise and cooperation among separate legal and budgetary regimes. The major metropolitan areas in Texas are well within the state’s borders and have never been confronted with such complications. Further, Texans’ early skepticism of faraway power yielded a minimalist state government. By default, municipalities in Texas assume a surprisingly large share of power. In states that are dominated by a single primate city, such as Georgia or Massachusetts, it can be tempting for state governments to evolve into de facto metropolitan governments, heavily involved in everything from public transportation systems to sports stadiums. However, this level of state involvement is practically unheard of in Texas. The result is a collection of nearly self-governed, but highly decentralized, metropolitan areas that set their own agendas and chart their own futures. Each has developed its own urban structure.

Texas grants municipalities the right to zone and to annex, powers not bestowed upon the state’s 254 counties. Outside incorporated areas, regulation is largely absent. As one might expect, over time this has led to leap-frog development, followed by annexation battles and later lawsuits. Thus arose the arcane legal concept of extraterritorial jurisdiction, or ETJ, as it is better known within the state. The ETJ gives municipalities regulatory powers a specified distance beyond their political boundaries (although they still cannot tax beyond their borders). The ETJ has created a complex legal world in Texas that only a land-use attorney could love.

Within this legal environment, each of the state’s metropolitan areas has faced special challenges. The City of Dallas is hemmed in by its northern suburbs. Like other Sun Belt cities facing similar restraints, notably Los Angeles, it is now choosing to redevelop itself and grow denser, embracing urban transit for the first time and promoting inner-city living, shopping, and working so as to shore up its tax base. Houston, frequently at odds with Dallas, has taken a different path over time, annexing unincorporated areas as the city sprawled outward. It thus commands a much larger share of its metropolitan population and more centralized control over its own destiny, but it has faced major annexation battles along the way.

Austin and San Antonio have also run into jurisdictional problems. Both cities straddle the Balcones Escarpment, an inactive fault line that marks the sharp boundary between the fertile Gulf Coast Plain and the rugged Texas Hill Country. The Edwards Aquifer lies beneath these hills, gushing out along the fault line in cold water springs and rivers. Development atop this aquifer has brought tensions that both cities have had to contend with. San Antonio, with its growing population, has sparred over water-use rights with rural Uvalde, a major agricultural area that taps the aquifer for crop irrigation. Austin, too, under political pressure from its residents, has battled with developers in efforts to protect water quality and endangered species linked to the aquifer’s ecosystem. For each of these cities, annexation and the ETJ concept have figured into growth patterns in one way or another. It is a legal regime that keeps the ultimate power over land use in the judicial rather than the legislative branch of government.

To sort all this out, investors need to focus on the economic and real estate dynamics of the state’s major metropolitan areas—Dallas-Fort Worth, Houston, Austin, and San Antonio.

DALLAS-FORT WORTH

In Dallas, to help meet the housing demands of a growing populace, loft conversions and inner-city apartment construction have emerged mostly just beyond the central business district in Deep Ellum to the east of downtown and State-Thomas and Oaklawn to the north. The enthusiasm, though, for this type of denser, mixed-use urban living has spread outward to the suburbs. Duany Plater-Zyberk, one of the pioneer firms behind the “new urbanism” movement, is now involved in bringing its brand of urbanity to new communities planned and underway in Plano, Las Colinas, and North Richland Hills.

As for the office market, Dallas over the past decade or so has cemented its position as a major corporate relocation center. Often when companies choose to relocate, they are in flux, sometimes internally troubled, and frequently in industries that have matured or become hyper-competitive. This has added a high degree of turnover to the corporate landscape in Dallas. As its regional banking empire, clustered in the central business district, was slipping away several years ago, the greater economy was simultaneously diversifying into telecommunications manufacturing, regional corporate offices, national distribution, and consumer finance. This all pointed the way toward a new kind of office market in Dallas—heavily suburban, largely Class A, and with an ever-shifting center of gravity.

The central business district (CBD) was no longer the city’s anchor, but neither was any other submarket. In Dallas, new Class A submarkets can quickly trump yesterday’s trendy locations. Suburban submarkets, such as the LBJ Freeway Corridor that arose in the 1970s, may now suffer negative absorption as leases roll and tenants hop further up the North Dallas Tollway to the new Class A towers of the Far North Dallas submarket.

The Dallas CBD office market has some parallels to Los Angeles, where forgotten downtown buildings are beginning to find new life as converted telco facilities. Also like Los Angeles, this may present a mixed blessing for the city itself. As buildings lease up, they are more likely to fill with machines than with downtown workers, confounding the people-oriented goals of downtown revitalization.

In the retail sector, however, the entertainment-oriented, open-air fad that has swept through Southern California and other parts of the Sun Belt has not been as quick to catch on in Texas. Weather may be a factor. In Dallas, with its blazing summers and often icy winters, climate-controlled regional malls and mall renovations still dominate most large-scale retail construction.

Dallas-Fort Worth is a metropolitan area that embraces chains and chain competition with enthusiasm. Compe-tition is especially intense among grocery stores; every major chain retailer in the country, it seems, tries to saturate and dominate this fast-growth market. Among the newest competitors is San Antonio-based HEB, which for years has dominated the South Texas market and has now begun to move into Dallas-Fort Worth.

Austin, San Antonio, and Dallas-Fort Worth all lie along I-35. This is the “NAFTA Highway,” so named because of its burgeoning convoys of truck traffic that connect the industrial districts of northern Mexico to the traditional manufacturing belt of the American Midwest and Ontario, Canada. When the North American Free Trade Act took effect on January 1, 1994, San Antonio was expected to emerge as the great bulk distribution center for the new continental trade. The city is still waiting. Today, the bottle-necked border crossing at Laredo has a larger warehouse inventory than Austin and San Antonio combined. And a day’s drive north from Laredo gets a trucker about as far as Dallas-Fort Worth. Bingo! NAFTA has allowed Dallas, whose intermodal capacity links two major railroads, four interstate highways, and two international cargo airports, to further consolidate its stature as a true crossroads. It would seem that little has changed in this part of the state since the 19th century, when the Butterfield Stage handled east-west traffic and the Chisolm Trail handled north-south commodity trade. Today’s infrastructure may be more sophisticated, but Dallas-Fort Worth’s role in transportation and logistics is more or less the same as it has always been.

HOUSTON

In the early 1990s, Houston made a Lazarus-like comeback after being left for economic dead. As its economy rebounded, government data showed a shrinking mining sector replaced by booming services, manufacturing, and trade sectors. The city had been saved by a newly diversified economy, we were told, but pioneering research at the University of Texas (corroborated soon after by the Dallas Federal Reserve’s branch office in Houston) quickly debunked this myth. When the bloated and inefficient energy industry collapsed in the late 1980s, it not only consolidated itself geographically into Houston, but it also streamlined operational structures. It shed drilling and exploration jobs (classified in the mining sector) while adding a new layer of technical-services firms that specialized in things like assembling international geological databases and developing horizontal drilling technologies for hard-to-access locations. Awak-ening to the realities of a global industry, Houston embraced the world more than before.

Houston has been perhaps the most aggressive and successful of the state’s major cities in renovating warehouses and other structures into loft-style residences. Until recently, Houston had been a sprawling city without a vital mixed-use urban center. Its new downtown trend offers an opportunity for residents to live in a more concentrated urban environment. Unlike other Texas cities, high-rise living is not new here, but urban living is. Most of Houston’s existing high-rise apartment and condo towers rise Le Corbusier-like from expansive manicured lawns outside the city’s central core. The recent wave of downtown residential development has added a new component to the city’s rental inventory.

As offices in Tulsa, Oklahoma; Midland, Texas; and Denver were closing, the once-vacant towers in Houston’s CBD began to fill up. And today, new towers are on the rise once again in the CBD. High finance may cluster on Wall Street and venture capital on Silicon Valley’s Sand Hill Road, but, as the Los Angeles Times recently wrote, the world view of the energy industry emanates from Louisiana Street in downtown Houston. Still, this is not a city lacking in substantial suburban submarkets. There is the Energy Corridor to the far west, and The Woodlands in the far north. And there are few business addresses more prestigious in Texas than along suburban Post Oak Boulevard in the Galleria area near San Felipe and Westheimer, a location favored, along with the CBD, by Houston’s foreign consular corps.

AUSTIN

After World War II, Austin was still the sleepy capital of Texas, with an urban economy propped up by the state’s government offices and its flagship university. With Dallas and Houston already growing into regional urban centers back then, boosters looked for ways to promote Austin while not upsetting its contented residents, who have never been keen on following in the footsteps of the state’s other cities. Even back then, one thing was clear. There would be no Houston smokestacks in Austin … period! Instead, the city attracted an IBM plant in the 1960s and supplied it with a steady stream of engineers. Other companies followed quickly. By the 1980s, a collection of chip fabrication facilities had emerged—branch plants sent from centers of power to this low-cost outpost with plentiful skilled labor.

But during the 1980s there also came MCC and Sematech, two high-end research consortia that selected Austin after national searches, citing a quality of life that could attract the industry’s best and brightest. This was the city’s turning point. Both of those institutions were born out of the fear of Japanese competition that swept the nation in the 1980s. Ironically, Sematech, the product of industrial policy if ever there was one, was delivered to Austin with Pentagon backing during the Reagan administration. Its mission was to advance American techniques for producing semiconductor-making equipment (SME). Soon it was no longer just chip makers coming to Austin. The SME firms came to town, too. California’s Applied Materials soon had more employees in Austin than in Silicon Valley. Then came Steag Microtech, a German SME firm, and shortly thereafter, Tokyo Electron, the primary Japanese competitor of Applied Materials, set up its U.S. headquarters next door to Sematech.

Today federal money no longer flows to Sematech and this inter-industry consortium now welcomes members from other countries. A failed experiment? Not for Austin. The experience catapulted it into arguably the world’s most vertically integrated city in

the production of semiconductors. Homegrown Dell Computer may be the company that garners Austin the most publicity, but the city’s fortunes have also been tied to the volatile world of chip production.

After Boston’s minicomputer-propelled, high-tech economy sputtered in the late 1980s, Austin rose in the 1990s, eager to claim that vaguely defined title of the nation’s No. 2 high-tech center. It is true, in fact, that Austin is no longer the branch-plant city it once was. Its research institutions, next-generation technical expertise, and entrepreneurial culture converged in the 1990s to spawn successful software firms and ride the crest of the Internet wave. In the late 1990s, Austin began calling the shots for the first time rather than relying on corporate recruitment. Instead of luring companies, the city chased cash to finance its own creations, snaring ample sums of California’s venture capital and even establishing its own mini venture-capital complex. Yet it never came close to knocking Silicon Valley from its perch. Like Boston in the 1980s, Austin remains entrenched in volatile aspects of the high-tech industry that could quickly be wiped away as technology changes. But also like Boston, it has a wide range and depth of technical talent (and an institutional infrastructure to keep it regenerated). As Boston slowly bounced back from its fall, so too could Austin if such a fall should happen. For now though, Austin poses no serious threat to Silicon Valley.

While it is rarely mentioned in the press, there is an oddity to Austin’s economy that has nothing to do with high technology. With 20 million residents in Texas these days, this capital city presides over not only a vast physical territory, but also one of the nation’s largest populations. Over the years, the offices around the capitol complex have grown full of increasingly sophisticated law firms, lobbying organizations, and trade associations representing every occupation and special interest imaginable. This is exactly what one might expect to see in a state of this size, but what makes Austin different is that unlike most state capitals, it lies more than an easy day-trip away from the majority of the state’s population (the isolation factor keeps popping up). This has spurred surprisingly strong retail, hotel, and small-scale convention activity that takes place just beyond the radar screen of the media and of most economic analysts who have been blinded by the city’s high-tech glow.

Austin, too, has successfully encouraged downtown housing. New structures are rising in and around the downtown core, and several existing buildings have been rehabbed. With its young population and a packed inventory of downtown clubs, bars, and restaurants, Austin was in many ways already close to being a 24-hour city, with a penchant for awakening at night like a small-scale Buenos Aires or Madrid. Adding a rental housing component downtown has been an easy sell, so far. At just 53 percent, Austin has one of the lowest homeownership rates between the East and West Coasts. The 1990s brought a rapid escalation in home prices that essentially strengthened the city’s apartment market, even as the city itself grew wealthier.

A rapid shift in economic structure explains Austin’s surge of office demand in the CBD, which, at a mere 2 percent vacancy rate, was possibly the tightest office submarket in Texas as of year-end 2000. This demand shift surprised many, as the driving forces of the high-tech economy had been, until recently, almost exclusively suburban manufacturing enterprises. After all, the CBD vacancy rate in Austin was still above 20 percent as recently as 1995. In short, CBD office demand is a wholly new phenomenon in the city. Austin’s center city has been driven indirectly by government (lobbyists, law firms, trade associations) throughout most of its history. An economic boom in the 1970s and 1980s, as high-tech manufacturing took off in the suburbs, led to a speculative construction party downtown that, in retrospect, seems at odds with the city’s growth patterns at the time. The city changed, and its academic and political institutions spurred the growth not only of high-tech companies but, inadvertently, it also would appear, sophisticated business services firms that were able to pluck the city’s creative and artistic talent right along with its technical talent. Firms such as GSD&M, a hip ad agency, built a palm-studded palace for itself on the edge of downtown, and filling up those empty office towers in the CBD were firms such as Public Strategies, the leader of a new generation of outside-the-Washington Belt-way public relations firms. Poised on the cutting edge of the Internet revolution in 1995, Austin released a burst of economic energy on its CBD, with high-tech services and high-brow business services filling every nook and cranny of available space. Only after the dust clears from the dot-com bust will it be clear whether the downtown office market has emerged with minimal damage.

Shopping mall construction is less frequent in Austin than in Dallas-Fort Worth, despite Austin’s phenomenal population growth and above-average retail sales per capita. Popular locally based retail outlets in small infill shopping centers are often more likely to draw traffic than chain-store-dominated malls. On the fast-growing suburban periphery, however, power centers and grocery-anchored centers dominate as much as in any Sun Belt city.

SAN ANTONIO

This major U.S. military outpost still regularly trades residents with Washington, D.C. In theory, this is a wash in terms of net in-migration, but San Antonio’s status as a preferred residence for military retirees keeps the migration flows with Washington tipped in San Antonio’s favor. More recently, inflows from St. Louis have become more common, an ongoing byproduct of SBC Communication’s decision to move its headquarters and consolidate operations here in the early 1990s in order to be close to its investments in Mexico’s privatized Telmex monopoly.

Will this economy evolve? SBC Communications, an oddity on the economic landscape, has entrenched itself here, despite the exit opportunities that have accompanied its Fortune 500 acquisitions of Baby Bells in San Francisco and Chicago. Will the tech-driven growth of Austin, just an hour up the road, ever spill into San Antonio’s venerable stock of old buildings the way Silicon Valley’s techies marched into San Francisco’s SoMa? There are no signs yet that will happen.

The downtown development experience in San Antonio has been entirely different from its cross-state counterparts. Without question, this city has the most beautiful CBD in Texas, possibly one of the more appealing in the United States. This was a primary birthplace of the American historic preservation movement, and when urban renewal swept the nation in the 1950s and 1960s, San Antonio’s 19th century facades of sculpted local limestone and West Texas sandstone emerged largely unscathed. Like a Western movie set, complemented by its Alamo and its Paseo del Rio, the San Antonio CBD is a magnetic draw for tourists—and therein lies its downtown housing dilemma. It has become a Disney-like place that locals readily support for its economic payoffs but largely avoid except when they have out-of-town relatives visiting. Further, San Antonio is largely a Class B apartment market and has the lowest income levels of the major Texas cities. It is not a city where luxury apartment complexes in the CBD would be likely to find extensive demand.

And here we have it. This is the real Texas—an urban state with few, if any, hints of the Old South. It is a state that is reluctant to look eastward. Instead, it looks inward, westward, and increasingly abroad for its economic strengths. Surrounded by eight states with much lower standards of living (four in the United States and four in Mexico), Texas bursts out onto the economic landscape as a regional population draw and a job generator for the south-central part of the continent.

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