Cap Rate Compression in DFW Market Assisted by Local Developers

I spent some time yesterday afternoon reading “Colliers International’s 2013 Retail Outlook”, and there were a couple of items that really stood out to me. I thought I would take a minute and share my thoughts…

First, Colliers notes an influx of institutional money seeking core assets in secondary markets. This is primarily caused by strong demand and competition in core markets due to today’s risk-averse investment strategies. Dallas/Fort Worth and Houston are both labeled as secondary markets for their research purposes.

Secondly, Colliers contends that the two main drivers of cap rate compression in single tenant net-leased deals are lack of quality assets on the market as well as a lack of other risk-averse investment options (CDs, mutual funds, etc.) that return a decent yield.

These two perspectives, when reconciled with market data that the researchers at Colliers were generous enough to share with, led me to an interesting analysis.

Dallas/Fort Worth developers brought more than 470,000 square feet of space in new supply in 2012, second only to Minneapolis where almost 680,000 square feet of space was added. The key difference is the level of market vacancy. DFW dropped market vacancy from 14.2% to 12.8% whereas Minneapolis dropped from 7.7% to 7.5%.

Theoretically, developers should only add new supply when the demand in the market can accommodate it, unless the developer is a single tenant build-to-suit developer. Despite the typical supply verses demand theory, the DFW market remained one of the highest in regards to market vacancy, yet we are adding almost twice as much new supply as Pittsburg, a market with a vacancy rate of 5.7%.

To sum up that confusing diatribe filled with numbers and real estate lingo:

If local developers feel that it is time to build when the market vacancy hits 14%, then cap rates for single tenant assets in the DFW market will either stay flat or continue to compress. If we are adding new supply when the rest of the market is only 85% occupied, then stabilized deals will be hard to come by, and multi-tenant properties will continue to be passed over by investors. From there, the competition amongst institutional groups and local buyers for risk-averse assets in the DFW market will drive prices up and cap rates down.