Josh McArtor, Jack Fraker

Yesterday, the CBRE industrial group led by Jack Fraker and Josh McArtor picked up two new assignments totaling 2.2 million square feet. It’s the latest is a long-running string of successes for the team. In an interview with RealPoints, the two brokers talked about new CBRE partnerships they’ve established, as well as speculative development, rent recovery, and other market trends.

RealPoints: So, how long have you guys worked together?

Jack Fraker: About seven years. When we first got together, it was in the boom days, around 2006 and 2007. We were closing about 45 or 50 deals a year. But then 2008, 2009, and the first half of 2010 came along—2009 was especially horrible. Our volume decreased 85 percent. We did more than $5 billion in 2007; in 2009, that dropped to about $400 million to $500 million. So we had to sharpen our skills. If anything moved—any kind of deal—we jumped on it.

The market is on the way back now. The second half of 2010 and all of 2011 was pretty good—equivalent to about 2004. But the second half of 2011 there was a bunch of bad news, about the U.S. being downgraded, the Euro crisis, etc., and that slowed down our business a little bit. In 2012, we’re doing great volume again.

RP: So what’s driving that, do you think?

Fraker: The sentiment is better, the mood of the country is better, and the economy is gradually getting better. We deal a lot with institutional money; institutions, especially pension funds, want to be in income-producing investments, and real estate provides that—whether it’s office buildings, industrial buildings, apartments, or retail. Real estate provides income for pension plans, which they need to match up with retiring population. Also, interest rates have been at historic lows, and that has helped our sales volume.

Josh McArtor: I look back at this last cycle. We started making deals in the spring of 2010. It really turned the corner. But from March until 2010 until January 2012, we were dealing predominantly with Class A space. The Class B space, although it’s functional space, has remained flat. You’re dealing with smaller businesses in those properties, and for a four-year period they’ve really just been trying to keep their heads above water. This year, though, we’ve seen the small business leaders not only feel better about renewing, but talking about expansion space, to take advantage of the market.

Jack referred to last year’s volume as comparable to 2004. This year, we could an increase in volume, in part because that Class B space is opening up. Investors are feeling better about the economy, so it’s all starting to click.

Buyers are feeling especially more confident in Texas, where we have been so isolated. We’ve got three of the top 10 cities in one state, and we’re definitely reaping the benefits of the Texas economic engine right now. We’re really seeing that influx of companies we had talked about in the past and hoped for. There really is a movement from California into Texas, and from Chicago and the northeast as well. The growing population, the demographics, the no state income Texas. The state also has favorable tort laws, so just from a litigation standpoint, it’s smart to have a headquarters here.

Fraker: It’s a right-to-work space, that’s big deal, and it’s right in the middle of the continent—not just the country, but Dallas is in the center of the continent. From a logistical perspective, that’s why it has been so great for warehouses. We have something like 650 million square feet, between Dallas and Fort Worth, and most of it is modern stock—well over half of it is modern stock, built in 1980 or later.

McArtor: Before I started really traveling around the country, I didn’t pick up on what that central location really means. But we can fly out and have a lunch in L.A. or New York and be back that same night. Although we stay over a lot of times just to do more business, for a high-level executive who wants to get back to my family and had that option, it just makes a lot of sense to be based here.

Fraker: Logistically, it makes sense, too. Companies use this for consolidated warehouse operations. A trucker can drive eight hours in any direction and cover a huge amount of the population—and also the fastest-growing cities. Another thing is, we didn’t have some of the problems that other cities and states had in terms of single-family overbuilding, so we had a much healthier economy going into the recession.

McArtor: From a national perspective, Atlanta was the first ones into that recessionary period, and it looks like they may be one of the last ones out. They’ve turned the corner now and trends are moving in the right direction. Texas is really leading us out of that national recession in a lot of ways. The northeast is recovering, Chicago has recovered, in Los Angeles, they’re already building spec product they feel so confident about the market.

RealPoints: Do you think we’ll see some spec development here? I know Prologis has a project under way.

McArtor: Prologis has that 600,000-square-footer down south, and we’ve heard rumors about additional spec announcements for projects near the airport.

Fraker: The big blocks of space have been absorbed. As Josh said, when the recession hit, it really hurt small businesses. None of them expanded; some downsized or went out of business. Corporate America was better prepared. They just delayed expansion projects. But all of those projects have been kicking off these last 12-18 months, which absorbed the big blocks. We’re down to just a few options in each submarket that could handle a big requirement. So that’s what will be built, speculatively.

There’s another trend worth monitoring. Typically, industrial lease deals are three-year leases or five-year leases. So if a lease was done in 2009, it was done at the bottom of the market. There are a lot of leases in 2008 and 2009 that were made at well below historic lease rates. A concept we’re monitoring now is called rent recovery. If someone renews that tenant this year or next year, they automatically have a chance to bump the rent, especially given current supply and demand. All that excess supply has ben absorbed. So if an investor buys an industrial property today, they can really count on some level of rental rate growth, or rental rate recovery.

RealPoints: That’s good news for a market like Dallas, where industrial lease rates haven’t seen a lot of growth.

Fraker: There are cycles when you can see significant rental growth and appreciation. You just have to time it right.

McArtor: We’re actively monitoring and studying rental rights now. It’s a common belief that lease rates don’t move much in markets like Chicago, Dallas, or Atlanta. But up until this point, there has always been plenty of available land for development. Today, if you draw a line from Allen over to Lewisville and down to Arlington and over to Mesquite—90 percent of that 650 million square feet Jack mentioned is inside of that box. Inside of that square, there are only 16 sites where you can build an industrial building that’s 400,000 square feet or larger.

There are sites around I-45 and I-20, but that’s a 45-minute commute for an executive who lives in Flower Mound. So we’re keeping a watchful eye on what could happen when space within that box gets absorbed. Last year we did 12 million square feet in net absorption. And we’ve had at least 6 million in net absorption in the first half of 2012.

Fraker: Demand is exceeding supply. After the RTC days, the first new building that came out was in 1992. From 1992-1997, we had a 10 percent increase in rental rates each year. I think we’re going to see something like that this time around, too. We haven’t had any speculative construction—there were a couple of projects in 2008, but nothing in 2009, 2010, 2011, and halfway through 2012. No new supply. So you will have rental rate growth, and rental rate recovery. What’s more, construction prices have gone up, land has gone up. All of that pushes rents, too.

RealPoints: Where will developers go, after all of the infill spaces are built out?

McArtor: South Dallas or Fort Worth, or some people would argue, Denton. It’s going to be a dramatically new world we live in on the industrial side. The Allen Group—I think they were just 10 years ahead of their time. If they had bought that property today, they’d be sitting pretty. Jack and I are taking calls on two to four build-to-suits a week.

Fraker: Developers call us to talk about exit cap rates. And they’re all down in South Dallas. That’s the only place for the big 1 million-square-footers.

RealPoints: What is the attitude right now of industrial property buyers and sellers?

McArtor: Well, the buyers are wishing they would have bought more in 2009, I know that. The sellers are feeling very good. The pendulum has absolutely swung back to their side. At the same time they’re struggling now with, do they sell it now, while rents are depressed, or do they hold it another two to three years with the rent recovery that’s going to happen. It’s a struggle between selling now and taking advantage of the cheap interest rates. At the same time, you know the rental rates are going to go up 20 percent, maybe 25 percent, from this point going forward.

RealPoints: And they’re generating income, right?

McArtor: They’re generating income, they’re leased, the owners have gone through the difficult part. Do you sell now and take advantage of very good cap rates, very good interest rates—the demand is certainly there, from the equity side—or do you hold it?

Fraker: In terms of the buyers, 2009 was such a traumatic time period, the typical acquisitions officer is still a little shell-shocked. They don’t want to go to their investment committee unless they’re really got an iron-clad case for why that property should be purchased. As a result, they have really strict parameters on what they’re specifically looking for, and very rarely do they deviate outside those parameters. And they’re the same parameters that everybody has—brand new, Class A, certain clear heights, strong credit tenants. If it doesn’t fit in that box, they’re not as aggressive going after it.

That has had an effect on some properties that are really great properties. They may be infill or a little older and may have some regional companies as tenants versus IBM. There’s a lot of good deals in that sector—great pricing on a per-square-foot basis and better yields. Plus, if the economy continues its recovery and small businesses continue bouncing back, that’s the property type you want to be in.

RealPoints: Do you see any kind of nontraditional buyers emerging to take advantage of those opportunities?

Fraker: There are a few funds that are smart and have experienced ups and downs in cycles and realize these are good opportunities.

McArtor: There’s more private equity willing to come up to $20 million or $30 million, where before they might hold it to $10 million. But there are a number of families that have been burned by the stock market. With real estate, as long as they can feel it and touch it and believe in the submarket …

Fraker: Josh is making a great point here, because private investors, they do those kinds of deals like that. They don’t have an investment committee they need to go to and they’re experienced enough to see that it’s a good deal. Heretofore they have been in smaller deals, $5 million to $10 million. Now, as Josh said, they’re looking at $20 million and as high as $30 million.

RealPoints: Let’s talk about your group now, and how your specific business is doing. The group is expanding, right?

Fraker: We have two partnerships. We have one here in the Texas office, with Russell Ingrum, Gary Carr, and now John Alvarado, whom Josh was instrumental in bringing over to CBRE. We share the same resources and are all working here together. We’ve helped them on some office deals and they’ve helped us on some industrial deals. We have clients in common. So the Texas partnership has been great.

Then we have another partnership with other CB brokers who focus on industrial real estate. We have someone in Los Angeles, Chicago, New Jersey, in Atlanta. We all cover different regions; here, we cover the South Central markets and all of the Southwest.

For years, we covered everything ourselves; we’re the national guys. We’ve sold more than 600 million square feet. But we like this new partnership a lot.

RealPoints: How long has the partnership been in place?

Fraker: Since March of 2010. If we make a $1 fee, each one of the five partners gets 20 cents. Even if its a deal in Dallas, Texas, and Josh and I found the deal, made the deal, sold the deal—did everything, we’d get 20 cents. It’s real egalitarian, and good for our camaraderie and morale. It was a big leap of faith, but just think of what it does for our clients and the buyers.

McArtor: It was big news in the industry to have five different very successful, commission-based brokers, all come together to provide a one-stop shop. It’s all about delivering the best solutions for the clients, and sharing the revenue as part of a bigger organization. The clients benefit from ease of communication and national information, as well as the access to capital. We share information real-time with all the partners; we know who is the most active capital is on the buy side, who pays the most. We like to call them bridesmaids—the investors from No. 2 to No. 10 on a spreadsheet.

Fraker: These buyers are disappointed to have just missed out. So we take that information and use it to our clients’ benefit to drive pricing on their assets.

RealPoints: How do you keep the two partnerships separate?

McArtor: The 20 cents that Jack mentioned? We give Gary and Russell 10 cents of that, and we get half of their office work. To see such highly successful people put their egos aside and take a “one-for-all, all-for-one” spirit—it would be very difficult to replicate, at least at the volume level we’re talking about.

Fraker: Our industrial partnership sold 65 million square feet last year. Year to date, we have closed about 30 million square feet, we have 50 million square feet on the market, and another 15 million square feet in the title company. Because of the sharing of resources, we can absolutely handle the volume. It’s like a Swiss watch; these deals are perfectly synchronized. The sellers appreciate that level of professionalism, and the buyers have become accustomed to it. … When everyone knows the rules, it’s easier to compete.

RealPoints: How would you compare activity in North Texas compared to other markets?

McArtor: We’re at the top or second to the top. The West Coast has been extremely busy this year, especially during the first half of the year, when we were surprisingly a little slower. … In the second half of this year, volumes will continue to increase. If last year was like 2004, this year could easily be like 2005 or even somewhere between 2005 and 2006 levels.

There was such a high volume that traded 2005 and 2006 and 2007, and these are typically five- to seven-year funds. So there has to be that recycle of capital that’s happening right now. We’ve done a lot of work on the Class A sector, but the Class B sector represents I’d say at least a third of that volume, so you’re going to see an uptick there. I’ve felt and seen the investors get a little frustrated with how pricey the Class A assets have become. They’d like to get a bit more yield for their investment. So I think we could see a continuing shift from Class A into very functional Class B assets during the last six months of this year and into next  year.

Fraker: We’re fortunate to be in Dallas. We’re home to some of the best development companies in the country, and we have masterplanned parks, which they don’t have in many other parts of the country. Wide streets, and convenants, codes and restrictions all of that is more prevalent in Dallas-Fort Worth than other parts of the country. The major developers here set the standards for the rest of the country.