It could certainly be argued that Texas’ big cities are a ragtag band of siblings. Impeccably groomed, the eldest is an investment banker. While the middle child toils in the sun on an offshore oil rig, the youngest holds court at the local coffeehouse, extolling the virtues of flash poetry. But when push comes to shove, they all unite under one banner with a lone star. These competitive brothers and sisters know what’s good for any one of them, is good for the group. In this spirit of communion, the Austin Business Journal recently sat down for a panel discussion with industrial real estate leaders from the cities of Dallas, Houston and Austin.

Participating in the discussion were Cody Bailey, VP, Gordon Highlander; Otto Swingler, Co-founder, Balcones Real Estate Group; Brian Jarrett, Managing Director of Project Management, CBRE; Clayton Strolle, Director of Commercial, Westwood Professional Services (Pacheco Koch); Travis Hicks, SVP, Colliers; Sam Owen, Managing Director/Partner, Stream; Mo Green, KBC, and Keith Holley, Partner, Method Architecture. Gordon Highlander President Greg Gordon served as moderator.

GREG GORDON: As you may know, Dallas has been the market leader in industrial development, and then the pandemic hit, and it was like pouring gasoline on a fire – it just totally took off. Meanwhile, Austin seems like it’s gotten white-hot, really fast. So I’m just curious – at what point did that start heating up? Looking back over the last couple of years, what did that sprint look like during the pandemic, and what were the things you learned?

MO GREEN: I think all of us service providers, we’re propped up on leasing demand. I remember being at Hill when I first started in January 2018, and we had a 30,000-foot tenant and it was like, “This is the best deal ever!” We were thinking, “We’ve got to make this deal!” and now that tenant is an afterthought. It’s more a case of “We’ll give you a bay once we figure the rest out.” So I would love to hear your opinion on this leasing philosophy, with the historical tenant size moving up, and how that has affected your business in this pre-leasing environment.

TRAVIS HICKS: We used to have a couple 100,000-square-foot tenant deals a year if we were lucky. Now it’s tough to track this. It’s amazing, this growth in tenant sizes in general, and that’s just the tip of the iceberg. We’re seeing sizes that we never, ever had in Austin – not that we’re a million-square-foot market – or that it will ever make sense, but people are actually kicking tires in that size range.

KEITH HOLLEY: From an architectural standpoint, the formula has changed. The base building square footage has increased. We were doing the standard 180-190-foot depth front Parker loaders, but we’re doing 220 now. The site formula is changing, so we’re having to respond to that. We’re pushing NFPA rules, but there are ways to get around that – there’s a little fluidity in the code for some of those things. But yeah, it’s been a really interesting shift to see how some of those rules have been rewritten.

GREG: I think when the average reader thinks about growth, like with manufacturing, it just means more widgets. But the growth isn’t about more volume. The widgets have actually gotten bigger, and a lot more complicated. We got into this Class A office finish-out because we saw that some of these guys had warehouses in one location at three bucks a foot, but their office was downtown in the CBD. They started realizing they could be fully integrated and have a double Class A office finish-out right there in their manufacturing facility. So the way the deals have changed has been phenomenal.

SAM OWEN: 2020 was the scariest year and also the best year. It was actually a “timeout.” Everything needs to be close to the consumer, manufacturing needs to come back to the States, and oh – by the way – everybody wants to live in Austin. So it was a perfect storm, and then you throw in a giant EV auto manufacturer, and the semiconductor buildings, right? Everybody showed up, but the problem is, it’s hard to get into the party.

TRAVIS: Which is why the party is spreading out there further – outside of the border of Austin.

OTTO SWINGLER: You’ve seen developers from Houston, Atlanta, Chicago, Dallas, Los Angeles – they come here for the first time and do really well. If you really boil it down, you’re looking at a pretty small industrial market compared to most other major cities. San Antonio is more of a distribution hub than we are. It’s really important to build, ultimately –not just what capital markets want, and what you can get financing for, but what your tenants need. In a major way, Austin is very different. Look at EastGroup, or some of these groups that are building for 30,000-foot tenants – Majestic Realty or Northpoint, for example.

SAM: Also, it’s an international market now. You have more people interested in this city because of everything that’s going on. So you see Samsung and others willing to make a huge investment.

TRAVIS: I think the other thing to think about is industrial square footage per capita, compared to other inbound supply markets that are similar to Austin. If you look at that data, Austin is at the very bottom. The numbers are very miniscule. I feel like we’re an underbuilt market, it truly points to that. You have all of these demand drivers and growth, so we need the new product.

CLAYTON STROLLE: Almost every project that we’re doing that’s all spec, it’s pre-leased, at least a portion of it.

CODY BAILEY: So Greg, you guys get this because it’s your world, but we’re seeing a lot of clients that have a tenant before the shell is done, and we’re seeing this lease remorse. People sign up a lease to get the deal done, but then realize that the construction costs have gone up and logistics of the project have been drawn out taking longer to execute. Some tenants are trying to get out of their leases and the developers are okay with that because they are able to capture a higher rate. Also, these surrounding communities may not understand some of the new types of construction coupled with the existing codes that are in place that are not applicable.

GREG: I’ve seen the lease remorse thing on a couple of deals where they just didn’t contemplate the possibility of a cost increase. How is the cost situation working out here in Austin? How much can you really rely on rent rate growth?

SAM: If you think about it, you have two big headwinds: cost increases and capital cost increases. And that was unforeseen. There’s a gigantic pipeline, but how many of those people have made friends with the bank? Not everybody. You can’t make friends with the bank until you know how much it costs, and we don’t know how much it costs because you won’t tell us. (Laughter) The bank asks “Is that a GMP?” What can you say, “Yeah, sort-of”? The question is, will demand continue in a recessionary environment? In Austin, I’ll take that bet.

GREG: You know, I lived in Austin for a year. I could never figure out how I was going to have a career here, so I went to Dallas for that. But now that’s changed a lot. So now corporations are saying hey, we want to come to Texas, and we love Austin. I’m not much of a gambling man, but I think the odds are pretty good for Central Texas.

CLAYTON: In many of the cities, we’re moving 1,000 miles an hour, but the municipalities are walking. So they hold the keys, but are they ever going to release them so you guys can get what you need on the ground?

TRAVIS: Site development and permitting has always been a big barrier to entry in the Austin property market. It hasn’t changed a whole lot.

SAM: Ultimately, that behavior cost tenants and businesses money. At some point, you worry that those businesses are going to say, well, I’ll take my business to Nashville or Denver or Raleigh.

CLAYTON: It’s a big hindrance at this point.

GREG: Sometimes it feels to me like the code was invented by an engineer in a dark room with a hammer and chisel. But I think data collection is going to help with the code, and the way the laws are written in regard to how things get built – like parking garages, for example. They’re more automated now, and they actually know how the facilities get used instead of relying on a theory. So the code has to get more intuitive. Hopefully these things become a way for the municipalities to understand how important they are to the process.

KEITH: Honestly, the people in this room need to do a better job of educating municipalities. There’s been a lot of movement in the market, and it reflects what we’ve seen in the Great Resignation of 2020. We’ve seen that with city staff, as well. So that institutional knowledge that was there, where you knew who you were talking to – we lost some of that. So then you need to reestablish those relationships while at the same time encouraging them to pick up the pace. There are some that I think are a little bit ahead of the curve. They’re the ones who got out a couple of years ago, they got their bonds passed and invested in schools and infrastructure. Those are the ones that have the large contiguous parcels next to them that are selling off for multiple-scale and multifamily housing. That will start to create a little bit of density for a labor force to come in.

GREG: How could we encourage the readership – or the municipalities – to think about what we’re talking about? We all know, when speed is slow, cost is really high. There’s a lot of great stories right now where the city messed up, deal slows down, rates went up, deal got killed.

BRIAN: I want to throw something out there that’s very much in line with what you said – both in the design and in the brokerage communities. So in 2020, the city approved street improvement fees. It became effective two months ago. There’s a lot of revenue in permit fees, so why wouldn’t you be incentivized to process permits by applications? So right in the middle of what everybody assumed would be a massive economic downturn with covid, the city passes this street improvement tax – and what does that mean? It means all of a sudden, you’ve got a tenant looking at this 18% fee that nobody knew about until a few months ago. That applies to any building that was platted after June of 2020, right? So this could have a huge impact on the brokerage market, or frankly, the development market – particularly if it’s speculative development.

CLAYTON: Do you know what adds to that? In 11 years in DFW, I did two TIAs – 400 projects.

CLAYTON: Well, they all have their fees, which covers that. So I don’t need to do that, because I’m getting all my impact fees and everything I need for it. Here? We have a person dedicated to TIAs here in Austin because of that.

BRIAN: So that’s one set of fees, and now you’ve coupled that again and said, “Okay, well the developer will have a development that’s maybe a GRMU with potentially a lot of different uses. So the developer can’t anticipate what tenant will be in there on a speculative type of use. So these fees then fall on the tenant, and it’s all brand new, right?

GREG: Do you know – with your average tenant – how much their rent is relative to the total P&L? In other words, to what degree is the rental rate part of their decision matrix?

TRAVIS: On the industrial side, labor and transportation costs are the highest.

SAM: Rent was less than 10%, right? The reality is rent has gone up significantly. But at some point, you wonder how much compounding of these problems needs to happen before tenants say “You know what? I’m going to San Antonio. I’m going to Nashville.” Then, that’s a problem. How do you communicate that, and get buy-in from the anti-development crowd or the old guard? The growth is happening, so let’s embrace it and support it. Let’s maintain the costs, and it should be better for everybody. Let’s fund our parks and our schools and those types of things.

CODY: So, just to bring it back to what Brian was saying, maybe this will shed a different light on things. We have a client that was moving into a first-generation shell spec building. This city, which is just outside of Austin, is very proactive in bringing in new clients from other parts of the country and giving a lot of incentives. In our role as the contractor for the tenant improvement, we apply for a new permit, that is based on the construction cost of the improvement, but now there’s a substantial road impact fee for the site that no one knew about, and this actually swallowed half of the economic development incentive that they were given to close this city as their new site. So they are blindsiding tenants. As the contractor we’re hearing “Well, it’s the new policy, you should’ve known about that,” but they didn’t, and it’s made it pretty difficult. In some cases we have been able to negotiate it down.

GREG: I tell my team, culturally, don’t tell me about the problems. That’s just the baseline. Everyone should know the code, that’s just the first hurdle. The question is: what is your unique value proposition? What distinguishes you? So what is the good news? When I hear you guys, fundamentals tell you that absorption is really good, right? That should lead to more development. Is there a good story to tell, or are there just too many headwinds?

OTTO: If you take a long-term approach, whether you’re growing a civil engineering firm, architecture firm or brokerage firm, you can take a long term bet on Central Texas over the next couple of decades. I think it would be pretty hard to mess that up. I think you’ll be able to look up in 20 years and be in pretty good shape, regardless …

GREG: …of what the short-term highs or lows look like?

OTTO: Right.

TRAVIS: We have a ton of good news in Central Texas, and in Austin, specifically, on the tenant-demand side. We have so many demand drivers. The typical ones are population growth, ecommerce and nearshoring. But who else has had an automotive manufacturing market show up overnight? There are macroeconomic headwinds, but we have a ton going on as far as the tenant demand side goes.

CLAYTON: I don’t think the developers in town are getting the respect and the notoriety that they deserve – for bringing services out to these other communities. They’re working with the cities, trying to make deals with EDCs to improve roadways, extend utilities, bring sewer and water. Eventually this can expand to other things that are not associated with their development. But they’re the ones trying to make those deals and taking the risk. They’re not getting enough credit for helping expand the cities as a whole.

SAM: It’s a whole PR problem.

CLAYTON: Agreed.

SAM: In Central Texas, if you rest on your laurels and think you’ve arrived, guess what? You haven’t. So how do you take on long-term growth, both on the development side and on the city side? Think about it, if you’re a city planner, and you’ve got little kids – what is their city going to look like? They’re not going to live in Austin when they grow up if there are no jobs. So we have to think of long-term growth as constant evolution.

CLAYTON: You guys always seem to get the short end of the stick, for all the risk you take.

GREG: Contractors get a bad rap because of some homebuilding or remodel experience a person had, and they just clump every contractor in one category. Insurance gets a bad rap because of the way your dad talked to you about what would happen to your insurance policy if you got in an accident when you were 16 years old, but I love insurance. You know why? I’ve got really amazing assets that are worth protecting. So when you can make little paradigm shifts, it’s not a cost – it’s protection, right? Developers get a bad rep because everyone remembers how they screwed up the little thing they loved as a kid or something, and it’s just not fair. Development is what creates a rich, diverse ecosystem for a city.

KEITH: Yes, but it’s incumbent upon us the people at this table to help sell that vision.

GREG: Responsibly, not out of greed. I’m hoping that some of the obstacles get us back to good fundamentals. I think of you guys as leaders. It’s the people who stack it for all the wrong reasons–they’re going to see some attrition. There are enough obstacles – it’s going to gobble some people up.

SAM: There’s just tons of opportunity out there. I need to hire like we’re open to grow. I’m eager to grow, and I think all of you would say the same thing. Do you need more people? The answer is: yes.

CODY: All of us in this room were given an opportunity. We all care about the product – that’s why we’re sitting here. At the end of the day, we’re all challenged with making something better than it was when we got there.