Lack of Locales for Smaller Tenants

DALLAS-Pick up a real estate or business publication in the DFW arena and you might find news about massive build-to-suit and speculative industrial projects going north in submarkets including South Dallas, Coppell to the west and Lewisville, to the northwest. What's conspicuously missing in these headlines and stories, however, is that little, if any, is being built for the smaller users, with "small" being defined as 200,000 square feet or less.

In other words, while these 500,000-square-foot projects and above are being announced and developed, experts tell GlobeSt.com there is little in the way of smaller space either on the drawing boards or under construction. The result of that lack is predictable. "A trend I think we're seeing now and will continue to see in the near term is upward pressure on rental rates for users in the smaller spaces," remarks Tim Vogds, vice president at CBRE.  He goes on to say that the average ask for space in the DFW area has ranged around $3 per square foot. "But for smaller spaces, we're starting to see quoted rental rates in the high $3 to low $4 per square foot range, all due to supply and demand."

On the demand side, according to Michael Spain, smaller industrial users are moving into the market in greater quantities. "The economy is getting better, and we're starting to see the folks who previously officed out of their homes, or had a small warehouse somewhere taking it to the next level," explains Spain, who is senior vice president and managing partner, Great Southwest, for Bradford Commercial Real Estate. "If they were working from home, they're looking for space between 5,000 square feet and 10,000 square feet. If they were previously in a 5,000-square-foot facility, they're looking for larger space."

Spain, who has begun to market 24 acres in the Great Southwest submarket located in Grand Prairie (directly southwest of the CBD), says he's received eight offers on the site already, which can hold 400,000 square feet. A couple of the offers, he notes, involves possibly a duplex building, or even a quad building with 100,000 square feet available. "To me, that's the sweet spot," he says. "If you look for 100,000 square feet of space, especially in Great Southwest, you won't find much in the new product category. It wasn't built in the last cycle, and it's not being built yet."

Vogds supports Spain's assertions by pointing out that, in the previous cycle (between 2000-2006), plenty of industrial space was built. The problem, however, is that what came out of the ground was the big bulk buildings rather than those geared for smaller use. "Fast-forward to late 2012, early 2013," he goes on to say. "People are starting to talk about building spec again, and that spec is big, industrial stuff."

The obvious question, therefore, is if the demand isn't there, why aren't developers building the smaller spaces? The answer: economies of scale. Developers aren't seeing much of a return in building the smaller stuff – at least, not yet. "The cost to build wasn't justified by market rental rates, and there hasn't been financial incentive for anyone to build spec in that size," Vogds says. This is especially true of the REITs who are, as Vogds points out, taking a wait-and-see attitude. They're pushing rents to the low $4 per square foot, and if they can get those rates, Vogds says that will be the time for the REITs to determine if there is opportunity in the marketplace for the 50,000 square foot or 100,000 square foot buildings.

But the focus on large developments to the exclusion of the small stuff isn't likely to change anytime soon, Spain predicts, noting that, for example, Prologis, which is building a 653,500-square-foot warehouse in Lancaster, in the South Dallas submarket and IDI, which is going north on 530,000 square feet in Lewisville, aren't chasing the 200,000-square-foot user. "In the initial phase, we'll continue to see those developers chasing the big deals. During the second phase of the cycle, we'll see someone coming in who might target the smaller users," Spain says. "But it won't happen in the near term."

To combat this trend, Vogds suggests that tenants in today's market need to expect the higher rents, and to be a little more flexible than they might have had to be in the past. "If you're more flexible in one submarket versus another, it provides an opportunity for us to find more buildings," he comments.  "If you can be more flexible, we can open up more opportunities and leverage the marketplace on their behalf."