Here’s the good news. greater downtown Dallas is seeing a surge in popularity, with tenants streaming in from suburban markets and the urban core to fill office properties in Uptown and the Arts District. And there’s no chance that activity will slow anytime soon. In the next five years, according to local real estate sources, nearly 170 downtown leases representing 7.2 million square feet will be up for renewal.

Many of those tenants will have no choice but to stay put or take space in a building south of Ross Avenue. That’s because Dallas, a town that’s flush with bold developers and famous for its “If you build it, they will come” mentality, has seen very little new construction. Reined in by the banks, most developers will need at least 50 percent in preleases before breaking ground.

Six new projects in the Arts District and Uptown are actively vying for tenants. (See chart on page 42.) But office buildings of that magnitude typically take three or four years to develop. Meanwhile, the two micro markets are running out of Class A space—and tenants are running out of time.

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Along with the churn in leases, the situation is being complicated by relocations from outside of greater downtown. “More people are looking at the city center today than I can ever recall,” says John Crawford, president and CEO of Downtown Dallas Inc. Crawford has been active in the downtown market for three decades, not just as a booster, but as a commercial real estate exec. He helped develop, for example, Bank of America Plaza, a 72-story, 1.9 million-square-foot tower at 901 Main St. “Thirty years ago, companies were leaving the city core,” Crawford says. “But mindsets have changed, especially among 25- to 34-year-old workers. They don’t want to be in the suburbs.”

The greater downtown market itself is in the midst of a seismic shift. For decades, the center of downtown was considered to be Main and Akard streets; today, many believe it’s Ross Avenue. The deck park spanning Woodall Rodgers Freeway is, as expected, binding Uptown and the Arts District. That’s where the bulk of leasing activity has occurred in the last few years.

Phil Puckett of CB Richard Ellis is an expert on the downtown and Uptown submarkets. He and his tenant rep team have developed an
impressive “dashboard” program that has up-to-the-minute information on properties and tenants within the districts. Puckett says the 30 million-square-foot downtown Dallas office market currently has a vacancy of about 27 percent. He expects that number to climb to 30 percent by the end of 2012, due to some planned relocations to Uptown. The 10 million-square-foot Uptown market, meanwhile, has a current vacancy of 18 percent. It will drop to 10 percent or lower when tenants move into space they’ve already leased. (CBRE measures absorption based on when tenants take occupancy.)

Last year, Uptown saw a whopping 1.6 million square feet in new office leases and renewals, according to CBRE. Many tenants relocated from downtown Dallas. The law firm Winstead, for example, traded in 198,000 square feet in Renaissance Tower for 140,000 square feet at 2728 N. Harwood. TM Advertising moved about 200 employees from four floors in Comerica Bank Tower to 48,000 square feet at Victory Park.

“The migration from the downtown core and the west side of downtown into the Arts District and Uptown clearly has been the trend,” Puckett says. But new Uptown tenants are coming from North Dallas, Las Colinas, and outside of the region, too, putting even more of a squeeze on supply.

“There’s not enough space in either Uptown or the Arts District to support this kind of activity level,” Puckett says. “It’s an unprecedented situation.” The largest blocks of space that remain available are in Trammell Crow Center in the Arts District and Granite Properties’ 17 Seventeen in Uptown. Both buildings are seeing strong interest from multiple tenants.

Downtown tenants in Class A buildings are paying about $18 to $20 per square foot, Puckett says. Existing Arts District buildings are getting rates in the high $20s and low $30s. New construction will be priced in the high $30s and into the $40s. But lease rates aren’t the only consideration. More efficient floorplates in newer buildings mean tenants can downsize, offsetting the price-per-foot expense.
Still, paying an additional $10 to $15 per square foot for office space is going to be a tough sell for many users, says Crawford of Downtown Dallas. “It’s a time, in my mind, that we’ve never seen before,” he says of the dearth of recent construction. “We may get one new office building, but I will be shocked and amazed if we get more than one, just because of the costs, at this point.”

John Amend, founder and president of The Amend Group, says the situation isn’t complicated. Large downtown tenants have the choice of pulling the trigger on new space, or staying in the inner core and paying half price.

The biggest winners, as things stand today, are landlords with existing Class A space in Uptown and the Arts District. “Lease rates have increased $4 a foot at the Crescent in the last 45 days,” Amend says. Lacking a transformational development, conditions aren’t likely to change for a while.

One such event could occur, but it’s at least a decade away. Amend says he was talking recently with a minority owner of the Texas Rangers, who intimated that moving the baseball team to downtown Dallas when its Arlington lease is up in the early 2020s was a strong possibility. “It’s a renaissance activity that would change the entire face of downtown,” Amend says. “Everyone in Dallas would go to the ballpark, everytime there was a game. It would be a really big deal.”

Although office leasing activity may be light, there’s plenty of other action going on in the urban core. Crawford points to Tim Headington’s $80 million expansion and renovation of The Joule, the success of Main Street Garden, the looming renovation of the Hilton Statler Hotel, and the burgeoning downtown residential population. “Fourteen years ago, we had 200 people living in the CBD; today, looking at the broader downtown, there are 37,000,” he says. “We’re not yet where we need to be—I’d like to see 50,000 to 60,000—but we’re on our way.”

Part of the problem in downtown Dallas is perception versus reality, says UCR Urban’s Jack Gosnell, who tackled the subject in a recent blog post for D CEO’s commercial real estate blog: “When I am able to convince people that I meet or know to venture downtown with me, the result is stunning. These folks become almost evangelical about the energy and excitement of what they witness. On the other hand, those who have not been downtown for a decade, knowingly or not, are caught in the cultural bias, without even being aware of it.”
Some office properties in the core are likely to benefit from ownership changes in the future. And, given the bargain rental rates and large chunks of vacant space, they’re ideally suited for back-office operations.

Sarah Hinkley with Peloton Commercial Real Estate oversees leasing at Bank of America Plaza. It has a current occupancy of 74 percent—and 420,000 square feet to fill. Hinkley expects to see “a lot of swapping going on,” among tenants in the core. One strength many of the inner-city assets can tout: high-quality space, having been built during the go-go days of the 1980s. And it’s doubtful that the market will ever see such tall towers constructed again, at least not under current economic conditions.

The Arts District has received a lot of attention in recent years, but Hinkley expects to see more of a balance toward the southwestern edge, too, with projects like the Margaret Hunt Hill Bridge, Omni Dallas Convention Center Hotel, and Belo Gardens. “We think we’re in the next wave of where downtown is going to go,” she says.