By Nora Hogan, CCIM, SIOR
The immediate future of the Dallas-Fort Worth (DFW) office leasing market is an enigma.
Real estate professionals believe we are near the top of a V-shaped recovery curve. However, many tenants disagree and are being cautious about their office leasing decisions.
Due to the pandemic, tenants became innovative in providing ways to service their customers. They have learned they can operate, survive and even excel under the current business environment, and thus are delaying their lease decisions.
Tenants are learning which employees can work productively without the boundaries of the office. The million-dollar question is whether or not this partial work-from-home model is sustainable. Some employers think not, while others are betting that it is and have placed either all or a portion of their office space on the sublease market.
Today, sublease space in DFW represents 15 percent of the total vacant square footage. This percentage is higher than the volume of sublease space that the market posted during the the dot-com recession of 2002. Currently the total sublease square footage is 9.5 million, which is almost identical to the December 2002 sublease inventory peak. The difference is that in 2002, it took two years to get to that number versus seven months in 2020.
Tenants that have put space on the sublease market include: Thryv (451,000 square feet), Fossil (215,000 square feet), Uber (116,000 square feet), and Club Corp (81,000 square feet), It is anticipated additional large blocks of sublease space will be placed on the market as well in the coming weeks.
This is not necessarily bad news as the sublease market is creating beneficial economic opportunities for companies relocating from other parts of the country, particularly California and the East Coast. Many of the large sublease spaces already have multiple proposals in negotiation or leases pending.
Local economic development groups indicate requests for site information are very high. These companies are taking advantage of the shorter lead time to secure finished space. Normally, these office users would need to plan a lead time of at least 18 to 36 months. But now they are coming to the area and finding beautifully furnished, plug-and-play spaces at a discounted rental rate, allowing them to make quick transactions and transitions.
These companies are not looking for short-term office space, as many of these larger subleases have nine years or more of remaining lease terms. Additionally, many DFW companies whose leases are expiring during this time are downsizing and choosing subleases over designing new direct space due to favorable rental rates.
The most creative transaction of the year was a 105,000-square-foot sublease swap that involved three tenants, one of which was coming out of bankruptcy. This complicated transaction required multiple landlord and lender approvals. The tenants were within a mile of each other and the spaces were in comparable buildings.
In another instance, one company that previously densified its space discovered that by restacking space to allow for social distancing, it lowered employee density from 6 workers per 1,000 square feet to 4.5 workers per 1,000 square feet, resulting in a 25 percent decrease of onsite employee requirements. The company made the decision to provide flexible workstations, which allow employees to work at home and eliminate the need to take additional space for social distancing requirements.
On the flip side, the DFW market has been impacted by the dramatic decrease in smaller transaction velocity. These highly profitable, bread-and-butter transactions normally achieve a higher rental rate than deals for large tenants.
According to CoStar Group, since 2015, 76 percent of DFW office leases have been less than 10,000 square feet. Many smaller companies with leases set to expire in 2020 or 2021 have made the decision to work from home without immediate plans to return. They are choosing to rent conference facilities at coworking sites for company meetings.
These nimble companies are conserving cash instead of signing another lease with the expectation they will return when the business environment is healthier, and maybe with a smaller footprint. Since smaller companies operate like extended families, these companies tend to collaborate very efficiently through digital media, all while maintaining the company’s core values and culture.
Some smaller companies are making lease commitments, but they are requesting one- or two-year extensions, believing history may repeat itself with a substantial decrease in market rates in the next 18 months. These short-term lease extensions are being granted as landlords are charging a slight premium.
For longer lease terms, landlords are hesitant to decrease rental rates due to lender covenants. That being said, they are offering additional concessions such as increased tenant improvement allowances, moving allowance, abated parking charges and free rent.
Over the past five years, landlords had been very discreet about their concession packages. However, now landlords are including incentives in their marketing materials, such as stating free rent periods and moving allowance for specific terms. We believe that this disclosure will have a domino effect that causes other landlords to follow suit.
With regard to smaller tenants, landlords with spec suites in their buildings are experiencing higher leasing velocity than owners whose buildings lack this feature. On recent space tours, tenants overwhelmingly chose a spec suite as their top option versus second-generation space that needed work.
Prospective tenants are not keen to go through the hassle of designing the space layout, finish selections and the unknowns of permitting and construction times. This year, out of 15 clients under 10,000 square feet, four were new clients with predetermined size requirements. Four existing clients decided to close their offices and work from home for a period of time, and seven clients decreased their square footage by an average of 25 to 30 percent during the lease process.
If the last two recessions are any indication, DFW will once again excel over other areas of the country due to its pro-business environment, educated tech workforce, lower taxation and reduced cost of living. The digital transformation is a bonus as it continues to increase the migration of tech experts, as most of them can live anywhere and, for the reasons previously mentioned, find the DFW area very attractive.
The real estate community is very optimistic that DFW will soon enter the recovery period, show increased leasing velocity compared to other cities across the country and capture its share of migrating tenants from the coastal states. These are all positives for the DFW real estate market as we wrap a turbulent 2020 and head into 2021 with a fresh perspective and confident outlook.
Nora Hogan specializes in real estate transaction and consulting needs for national and local corporate clients, including acquisition and disposition, build-to-suit coordination, and other facility management assignments.