When Dallas real estate investors and developers talk about the "Y2K threat," they aren't referring to the computer bug. Instead, the worry in Dallas' property market is as old as the real estate business: Will there be enough tenants next year to fill all the new buildings?

Several years of booming construction have left Dallas' hot property market teetering on the brink of overbuilding. Office, retail, industrial and apartment vacancy rates are all rising again in Dallas, after almost a decade of decline. And even the most optimistic developers and landlords admit it's too early to tell if 2000 will bring another year of profits or a familiar construction glut.

Savvy Dallas real estate players are hoping for the best, but still hedging their bets. "I'm cautiously optimistic now that, if we maintain absorption and with new construction all but stopped, that without an external force like a downturn in the economy we will be okay," says Jack Eimer, president of Dallas-based Transwestern Commercial Services. "The markets are pretty much in balance and we have an opportunity to keep them that way. Shame on us if we don't."

The cutback in Dallas building starts that began with last fall's credit crunch shows no sign of a rebound. Dozens of Dallas building projects have been delayed or canceled, giving hope to investors that the supply of new space coming on to the market is under control. And with real estate investment trust buyers on the sidelines, there has been a significant decline in investment property sales in the Dallas area this year.

"No question about it - Dallas is redlined and being used as the poster child for overbuilding, which Atlanta was two years ago," says Eimer. "The degree of overbuilding here is probably greater than what they saw in Atlanta, but our economy and demand for real estate is stronger."

Dallas' economy has so far outpaced most analysts' projections. For two years, forecasters have been predicting a drop in job growth in north Texas. But, so far, employment gains in the area have continued to be among the strongest in the nation.

As of mid-year 1999, the Dallas area had created almost 84,000 new jobs during the past twelve months. That's more than the 80,700 new jobs created during the 1998 calendar year. At the end of second-quarter 1999, the Dallas area ranked fourth nationally in job growth behind Chicago, New York and Los Angeles. "Yes, the economy has continued to be much stronger than we thought would be the case ...," says analyst Ron Witten, president of Dallas-based M/PF Research. "But it's clear we are in a more challenging environment now. We are past the easy part of the market cycle."

Other economists are not as surprised that Dallas' employment sector has remained so strong. "One of the reasons Dallas-Fort Worth does so well is momentum begets momentum - we have a lot of stuff in the pipeline," says economist Bernard Weinstein, director of the Center for Economic Development at the University of North Texas. "I would argue that our economy is the strongest in the nation right now.

In the case of Dallas' office market, the slowdown in ground breakings is welcome. Thanks to a fall in office starts this year, the amount of office space being built in the Dallas area has dropped from more than 13 million sq. ft. in 1998 to currently just less than 10 million sq. ft. Even with the decline, Dallas ranked as the country's top office construction market in Washington, D.C.-based Oncor International's mid-year 1999 survey of U.S. real estate market.

Surveys turned up about 2 million sq. ft. of net office leasing in the first half of 1999. That puts Dallas on track to match the 4 million sq. ft. to 5 million sq. ft. of office absorption in 1998. "Net absorption may or may not surpass the 1998 level of 4.96 million square feet, but with all things being equal and no massive market disruptions, the Dallas office market will continue to perform strongly," says Reagan Dixon, senior managing director of New York-based Cushman & Wakefield's Dallas regional office. "Certainly 1999 won't reach the same pinnacle that 1998 saw in terms of construction activity, which is good."

Office market brokers expect that construction totals will continue to decline into next year as most of the buildings in the development pipeline are completed. "I don't think you will see many more people starting buildings - we certainly aren't," says Jeff Swope, managing parter of Dallas-based Champion Partners, which has new office projects in three of Dallas' suburban markets. Champion has almost fully leased its 10-story, 300,000 sq. ft. Addison Circle office tower in the booming Dallas North Tollway corridor in the northern suburbs. Major tenants include Caprock Communications, J.D. Edwards and The Staubach Co.

While Swope has land for a second phase, he's in no rush to start another project. "We need to wait awhile and let leasing catch up with all the new construction," he says. More than 2 million sq. ft. of office space is still under construction along the tollway. About 1 million sq. ft. of office absorption was recorded in the tollway corridor during the first half of 1999.

Developer Clyde Jackson with Dallas-based Wynne/Jackson Inc. is finishing construction on his 14-story, 375,000 sq. ft. Millennium office tower on the tollway, which opens in December. "I think the market is rocking along pretty good right now," says Jackson, who is building the project with Dallas-based Archon Group, an affiliate of New York-based Goldman Sachs. "We have probably 600,000 sq. ft. to 700,000 sq. ft. of lease deals we are looking at. But I think it's healthy for everybody if we don't have a whole bunch more starts."

Along with Wynne/Jackson's Millennium project, a handful of major office towers are opening on the tollway this year. Houston-based Hines Interests is completing construction on two office towers in its Galleria North project. Tenet HealthSystems will occupy the first 16-story, 375,000 sq.ft. office building. A 13-story, 325,000 sq. ft. speculative office high-rise adjoins the Tenet tower.

Earlier this year, Hines sold three existing office towers in the Galleria complex to TrizecHahn. "Yes we are competing against a lot of new space," says TrizecHahn vice president Michael Toon. "But we still have lots of activity and one of the best locations in the city."

Just north of the Galleria, developers have constructed two new towers. Dallas-based developer MJS Resources is completing work on its 15-story, 411,686 sq. ft. concrete-and-glass tower. Advertising and public relations firm Publicis has leased about a quarter of the building. A block away from Centura, Dallas-based Wilcox Development is opening One International Center, a 13-story, 370,000 sq. ft. speculative building. Wilcox Developments President Bill Cawley is bullish about lease up prospects on the tollway. "The leasing activity on every project we have is very good," he says . "As long as we don't build too much more, the market will be fine."

Washington, D.C.-based Carr-America Realty has finished its two-building Tollway Plaza office complex in far north Dallas. Bill Vanderstraaten, who heads Carr's Dallas regional office, says the 360,000 sq. ft. complex is almost fully leased. Major tenants include Stewart Title, PeopleSoft Inc. and AmeriCorp Relocation Management Inc. "We still have land for about 130,000 sq. ft. of additional office space," says Vanderstraaten. "The market looks promising from the long-term prospect, but short term we don't think its time to start anything."

Likewise, Dallas-based Granite Properties has completed two towers in the city's north suburbs but doesn't plan any more for a while. The 10-story, 260,000 sq. ft. Granite Park building sits at the north end of the tollway near the Legacy business park. About 10 miles south on LBJ Freeway is the developer's new 10-story, 250,000 sq. ft. Granite Tower. "We have really been pleased from the leasing activity we are seeing," says Granite president Michael Dardick. "Absorption is still very strong in Dallas, and people are still making good money."

Not everyone has heeded the call for no more construction on the tollway. Wilcox broke ground in August for a 100,000 sq. ft. multi-tenant office building on the tollway. And two other developers have also pushed ahead with additional projects. Dallas-based North American Properties this summer began spec construction on its 5-story, 250,000 sq. ft. Park Center building on the north leg of the tollway. And Dallas-based Hall Financial Group started work on a third-phase, 105,000 sq. ft. office building in its Stonebriar office park. "If it was just one building on the tollway I wouldn't do it," says developer Craig Hall. "But we are trying to build a 3 million sq. ft. office park here. We don't have a mortgage on the building we just started. We are building it with our own funds."

Lenders say they have closed the window on funding for spec buildings in Dallas' suburbs. "We wouldn't sponsor another completely speculative building along the Dallas North Tollway," says Mark Gibson with Dallas-based mortgage banker Holiday Fenoglio Fowler. "The underwriting is tightening a little bit."

After the tollway corridor, Dallas' busiest suburban office market has been the Las Colinas business district near Dallas-Fort Worth International Airport. At the peak last year, almost 3 million sq. ft. of office space was being built in Las Colinas - much of it speculative space. But strong leasing in late-1998 and this year have filled much of the new empty space and developers have quit starting spec buildings. About 2 million sq. ft. of office space has been leased in the Las Colinas area this year. "We've been pleasantly surprised that most of the new space has leased up," says Dary Stone, president of Dallas-based Cousins-Stone, which manages the Las Colinas project. "And there are a bunch of big tenants still out there."

This summer, Microsoft leased more than 220,000 sq. ft. in Dallas-based Champion Partners' Sierra office park in Las Colinas. Microsoft has agreements to take additional expansion space in a new building. And Dallas-based EMC Mortgage, a subsidiary of New York-based Bear Stearns, leased 84,012 sq. ft. in Dallas-based Opus South Corp.'s new six-story MacArthur Ridge II office building. GTE has already occupied the first of the twin office buildings.

CarrAmerica Realty has leased two new buildings in its Commons of Las Colinas office complex to Nokia, the Finnish telecommunications giant. Nokia has its U.S. headquarters in Las Colinas. And CarrAmerica is building a 120,000 sq. ft. building in its Royal Ridge office complex in Las Colinas for Capital One Financial Corp. Capital One will use the new building as a call center. "The signs are more positive now than a year ago," says Carr-America's Bill Vanderstraaten. "We have built almost 1 million sq. ft. in Las Colinas and there is no available space in it at all."

Dallas-based Archon Group has broken ground in Las Colinas for a two-building, 525,000 sq. ft. office complex for NEC America Inc. The big consumer electronics firm is relocating employees from New York to occupy the new Irving office project. And Dallas-based Lincoln Property Co. has completed construction on a 318,000 sq. ft. Las Colinas office building to house the operations of Sterling Commerce.

On the north edge of Las Colinas, Dallas-based developer Means Knaus LLC has finished the first building in its Colinas Crossroads office park and is breaking ground on the second phase. i2 Technologies has leased all of the first six-story, 180,000 sq. ft. building and will occupy two more.

"Our strategy is to acquire the best sites in Dallas," says developer Steve Means, whose company recently formed a partnership with Jacksonville, Fla.-based St. Joe Corp. "We think with these sites and St. Joe as our partner, we can capture a very large market share."

During this wave of development, office construction has been limited in Dallas' center city market. No new office projects are under construction in the downtown area. But several renovations are underway. The largest is Houston-based Spire Realty Corp.'s redevelopment of the 25-year-old, 1 million sq. ft. Bryan Tower. Built by Dallas-based Trammell Crow Co., the gold glass skyscraper is located on Dallas' light rail commuter line and is across the street from the new Adam's Mark convention hotel. Conversion of the mostly vacant office tower into new first-class space has attracted a lot of tenant attention.

"I think downtown can hold its own in the current market," says Trammell Crow Co.'s Joel Pustmueller, who is leasing Bryan Tower. "We've already had a good bit of leasing and several of the companies we've seen are coming from outside downtown." New tenants at Bryan Tower include Chicago Title Co. and First Extended Service Corp., a credit firm moving from the Galleria complex in the north suburbs.

Across the street from Bryan Tower, advertising giant Omnicom Group Inc. has leased about 200,000 sq. ft. from New York investor Witkoff Group in the Harwood Center tower. The advertising company canceled plans to occupy a new building in the suburbs and is coming downtown instead. "It's a reaffirmation of downtown and shows that the central business district still has a big appeal for major tenants," says real estate broker Jerry Fults, president of Dallas-based Fults*ONCOR Inc. "With the coming of DART (light rail) and housing downtown, it makes for a lot better environment and companies can't help but recognize this."

On the north edge of downtown, the Dallas-based Crow Family Trust is also building a new office tower. The 19-story, 356,000 sq. ft. 2100 McKinney Tower is scheduled to open this year. In the same area, Dallas-based developer Harwood International is building the fourth building in its International Center office park. Centex Corp., the big nationwide home builder and construction company, is the major tenant in the 20-story, 240,000 sq. ft. building.

Most of the development in downtown Dallas hasn't been office space but conversion of aging office buildings into loft-style apartments. Almost 2,000 residential units have been added to the area in converted commercial buildings. Developers active in the downtown residential conversion market include Atlanta-based Post Properties, Dallas-based Hall Financial Group and Dallas-based Southwest Properties Group. The historic Magnolia Building in the heart of Dallas' old financial district opened this summer as a 330-room executive hotel. Holtze Corp. of Denver redeveloped the vacant landmark.

Although three major downtown office towers were pending sale in Dallas in September, the number of big deals downtown has declined significantly since 1998.

"Everyone has got deals working but it's taking a lot more time," says Jack Minter with Chicago-based Jones Lang LaSalle's Dallas office. "We will have some great job growth this year and our construction has all but stopped. But many buyers don't like markets with vacancy rates over 10 percent. The buyers - like pension funds, foreign buyers and public funds - are wondering if Dallas will burn them again."

Kevin Brands, who heads the Dallas office of Chicago-based CMD Realty, agrees that investment sales in Dallas this year "have been pretty slim."

"It's going to take some time for investors to get comfortable buying in Dallas," Brands adds. "With the fears of all the new construction and vacancy rates going in the other direction, the amount of investor interest in Dallas is pretty weak now."

At mid-year, Dallas' downtown office vacancy remained stubbornly near 27%. In the suburbs, office vacancy rates have crept up to near 15%. Even so, office rents have stabilized near $20 per sq. ft. annually, with new buildings fetching between $22 per sq. ft. and $24 per sq. ft. on average.

"There is no question that the new buildings are filling up at the expense of the old ones," says Fults. "That's where we are seeing the greater vacancy - in the old buildings." But investors who own many of Dallas' earlier generation office buildings believe they can be very competitive with the new product.

New York-based Insignia/ESG and GE Investments are spending almost $17 million to renovate the two-building Campbell Centre office complex in Dallas' North Central corridor. The 25-year-old, 860,000 sq. ft. complex competes directly with four new buildings in the same market. "We know we don't have a new building here, but we are putting in a position to compete with those guys," says Jake Ragusa Jr., Insignia/ESG's regional director. But even the most well-positioned office landlords concede they will have to work hard to keep tenants from being lured away to new buildings.

"We are not excited about 10 million or 11 million sq. ft. of new development," says Peter Johnson, senior vice president of Equity Office Properties Trust's Southwest Region. "But all the demographics say Dallas is still a great place to be."