Office Landlord Market Update

The Austin office market, at mid-year 2009, appears to be stabilizing. In January of 2009, the market was virtually at a standstill after absorbing all of the financial meltdown of Q4 2008. Almost every company looking for office space in early 2009 put that decision on hold to see if the economy or their specific business was going to go over the cliff.

At mid-year, many Austin businesses again appeared confident and moved forward with renewed optimism. While many companies are not growing in 2009, very few are shrinking or going out of business. When the Austin office market is compared to other areas, it looks fairly decent. However, this is more of a statement about how badly other markets are fairing in this economic downturn.

 The Austin market stood at 82% occupied, as of July 1, 2009. Twelve months earlier it was at 86% occupied. The major factor in the occupancy decrease was the completion of 1.5 million square feet of new office buildings in the last six months of 2008. With vacancy rising, effective rents are falling 10-15% and tenant improvement and moving allowances have increased 20%. New construction is now at a minimum, only 300,000 square feet under construction with 140,000 square feet of it is pre-leased. It does not appear that the occupancy rate in Austin will fall any further and that it will begin to rise in 2010. Rent increases are not likely to occur until 2011.

 The CBD submarket is the shining star of the Austin market rents – the rents have been rising for the last two years. Gross rental rates, not including parking costs, in Class A space are in the $38-$42 range. The occupancy rate is at 88%. The major challenge for the CBD in a soft economy will be whether firms elect to move out to the suburbs where rates are $10-$12 per square foot cheaper.

 The SW submarket is roughly 82% occupied. Occupancy has fallen from 88% in mid-year 2008 and 91% mid-year 2007. The decrease in occupancy is directly attributable to the completion of 1.2 million square feet of new construction over the last 2 years. Rentals decreased by 10% in the last 6 months.

 The NW submarket, which is Austin’s largest market at 14 million square feet, has the lowest occupancy rate at 76% at mid-year compared to 84% in 2008. Again, as in the SW submarket, the major factor for the decline was the completion of 2 million square feet over the last 2 years. Rental rates have fallen by 15-20% over the last 12 months.

 Along with the slowing leasing market, the investment sales market in Austin has come to an abrupt halt. There was not a single sale of an institutional quality building in the first half of 2009. If leasing continues to be slow, distress sales will become the norm in Austin. Many of the recently completed new office projects will see their loans mature and many are 100% vacant. With zero rental income, foreclosure by lenders is the most likely outcome with banks then looking to sell buildings at distress levels.

 The stress that the Austin market is under currently could easily be overcome if the market returns to its historical 3% growth rate. Based on what the economy has been through the 12-18 months, 1.5-2.0% seems more likely which would mean 500,000 square feet of growth.