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Property Fundamentals Light at the End of the Tunnel When will the Dallas office market recover? by Barry Vinocur |
Taylor and his colleagues, Tim Goebel and Craig Hettenbach, used data from Jamison Research in preparing their report.
"Jamison's second quarter report reinforced the near-term view that the market will most likely weaken further over the next two to three quarters. During this time, approximately 10 million square feet are scheduled for completion. This compares to absorption that is running one to two million square feet per quarter." In short, the vacancy is likely to rise 220 basis points, to roughly 17.2 percent, the Prudential analysts remarked.
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At the same time, Jamison reported that new office starts dropped in the second quarter to 500,000 square feet from 900,000 square feet in the first quarter of 1999 and 2.4 million square feet in the fourth quarter of last year. "If starts remain at this level for another two quarters, the office market could bottom in the second quarter of next year. If demand stays at current levels (roughly 1.3 million square feet per quarter), we could see the market firm in the second half of 2000." Equally encouraging, the Prudential analysts wrote, is the capital market discipline "to stop funding more office projects, unless they are essentially preleased."
Here are some details from Jamison's second quarter report that were highlighted by the Prudential analysts:
• The vacancy rate continued its steady climb as 3.1 million square feet came on line and 1.8 million square feet were absorbed. Including build-to-suit space, the vacancy rate at the end of the quarter was 15 percent. This is 180 basis points above the cycle low one year ago. As noted, based on the scheduled deliveries and historical absorption, the vacancy rate should head north by an additional 220 basis points, to 17.2 percent. Most of that jump could take place in the third quarter, as 5.6 million square feet are scheduled for completion.
• Deliveries in 2Q99 were 3.1 million square feet, or 1.6 percent of inventory, slightly ahead of 1Q99, and the highest level of deliveries this cycle. In Jamison's report last quarter, expected 2Q99 deliveries totaled 5.2 million square feet, suggesting that a number of projects were pushed into 3Q99. In the 2Q99 report, expected 3Q99 deliveries now total 5.6 million square feet, up from 3.1 million square feet as of the 1Q99 report.
• The pipeline now has 9.8 million square feet. Put another way, roughly two years' worth of absorption is expected to come on line during the next three quarters. The expected delivery date, (shown in the Delivery Schedule table on this page) as well as the impact that delivery would have on the vacancy rate, assuming all space is delivered on schedule and assuming 1.3 million square feet of demand per quarter.
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The Prudential analysts added that absorption in 2Q99 did move up. Absorption is now on track to meet expectations, which is 5 million square feet (+/- 1 million square feet in 1999). Absorption in the quarter totaled 1.8 million square feet, or 0.9 percent of inventory, up from 0.9 million square feet last quarter. This puts absorption on a 5.4 million square feet annual pace, which, as noted, is in line with expectations. Again, 9.8 million square feet are being delivered in the next nine months.
The "big surprise," the Prudential analysts underscored, was the drop in starts for the second quarter in a row. Roughly 500,000 square feet, or 0.3 percent of inventory, broke ground in 2Q99. It consists almost entirely of small projects (less than 55,000 square feet and one or two stories), mostly in Far North Dallas and Las Colinas. This means first-half starts were a paltry 1.4 million square feet compared with the 6.4 million square feet started in the first half of 1998. "If starts stayed depressed around these levels for another two quarters, this market could bottom in 2Q2000 and recover in the second half of 2000,'' the analysts forecasted.
Taylor and his colleagues also noted that rents appear to have peaked in most of Dallas' submarkets. "In the quarter, class A rents either leveled off or dropped in all submarkets, except Dallas CBD and East Dallas. Class A vacancy in the former has dropped 150 basis points to 14.9 percent, while the latter is too small and inactive to be significant (224,617 square feet of class A space in the whole submarket and no new construction). The declines in the rest of the market were admittedly small, less than 1 percent. However, this represents an almost complete reversal from last quarter, when rents declined in only four out of 14 submarkets." Overall, the Prudential analysts wrote, class A rents dropped 0.3 percent in 2Q99, following a 0.6 percent rise in 1Q99 (see table on page 50 showing class A rental rate trends). Taylor and his colleagues expect rents to decline further, given the delivery pipeline.
With the exception of Crescent, the exposure of public real estate companies to Dallas and its submarkets (see Dallas Market Exposure table on page 50) is pretty minimal. Combined, the Prudential analysts point out, the companies represent 17 percent of the overall office market. Of the companies with projects under development, the preleasing levels are very high. For instance, CarrAmerica's five development projects total 837,000 square feet and are 86 percent preleased. Prentiss Properties' two development projects total 191,000 square feet and are 85 percent preleased and 89 percent committed. "Both of these companies have effectively limited their exposure to lease rollovers by pursuing early lease renewals and extensions," Taylor and his colleagues wrote.