Austin’s Increase in Sublease Availability Signals Strength Rather than Weakness in its Office Market
February 2017 I Vol. 3, ISSUE 2 I Download PDF
For office markets, the national spotlight has been on Houston with its glut of sublease availability arising from oil companies purging their space due in large part to the downturn in the energy sector. Specifically, 27% of Houston’s Class A office market is sublease space (vs. 73% direct), with vacancy increasing upwards of 17%. Similarly, 20% of Austin’s Class A office market is currently sublease space (vs. 80% direct), representing a 28.8% increase year-over-year, but with vacancy decreasing toward record lows of 9%. As a percent of total availability, current sublease availability in Austin is 13.7% for Class A and B buildings and 20.0% for Class A buildings, both of which have surpassed their prior peaks of 11.3% and 15.9% following the Great Recession.
Although sublease availability can rise with a softening office market, it is not a good predictor of the office market cycle or its asking rents. This is because sublease availability can increase under both weakening and strengthening markets. For example, sublease availability in Austin increased as tenants contracted their businesses from 2008-2009 during the Great Recession. In contrast, sublease availability also increased between 2013 and 2017 as Austin tenants expanded their businesses. To this end, asking rents for direct and sublease space are stable in Austin, whereas in Houston asking rents have been declining for two years. While Austin may well be in a peaking market, caution is warranted in interpreting increases in sublease availability as solely resulting from a falling market cycle.
Austin’s commercial real estate industry (CRE) is asking important questions about how variation in the supply and demand of office space is changing and whether or not a shift in its office market cycle is looming. Austin’s economy remains strong, along with its office market, but both have seen some modest weakening in the strength of its numbers. For example, while the economy continued to expand with job growth at the end of 2016, the Austin Business-Cycle Index remained positive but decelerated. Likewise, the office market posted still-strong but slightly lower numbers for net absorption and leasing activity in 2016 relative to other recent years. Likewise, Austin’s office market has seen a 28.8% increase in its sublease availability, with over 1.4 million sq. ft. of rentable space as sublease rather than direct landlord lease.
Shifts in Austin’s office market are anticipated to manifest through subleasing, with office spaces being vacated by business contractions. However, increases in sublease space may also arise with business expansions, so sublease availability may not be best indicator of a shifting office market. Here, we address the extent to which sublease availability can indicate the strength of the office market. We first present an alternative metric to describe sublease availability, that is sublease space as a percent of total availability, in contrast with the traditional CRE metric of percent of total rentable building area (RBA). We then describe market shifts in sublease availability over the past decade, with an emphasis on recent dynamics. Finally, we ask whether changes in asking rents occur as a result of shifts in sublease availability.
Availability represents the amount of space that is being marketed as for rent by prospective tenants, independent of whether it is vacant, sublet space, or soon to be available. Sublease availability is space being put back on the market that is already leased by a tenant, whereas direct availability is space being offered by the building’s landlord. Direct availability plus sublease availability equals total availability, each measured as square feet (sq. ft.) of RBA. Total RBA of Austin is about 77.5 million sq. ft., with direct and sublease available space about 8.9 million sq. ft. and 1.4 million sq. ft., respectively, as shown in Figure 1 for Class A and B buildings.
Sublease availability appears relatively invariant, with little change over time, compared to direct availability (Figure 1). This is not the case, however, but rather an artifact of scale; depicting both on the same scale masks important variation in sublease availability. Figure 2 shows sublease availability on a smaller scale of RBA for Class A and B buildings combined, Class A buildings, and Class B buildings. Changes in sublease availability can be quite pronounced, but what metric is best to express such changes relative to direct availability given differences in their magnitudes (8.9 vs. 1.4 million sq. ft.)?
Traditional CRE metrics express sublease availability as a percent of total RBA of a given market or metropolitan area. This can produce incorrect conclusions about changes in direct and sublease availability. Currently, direct and sublease availability are 11.1% and 1.8%, respectively, of Austin’s total RBA for Class A and B buildings. Expressing direct and sublease availability as a percent of total RBA is misleading, as the denominator of total RBA can change independently (e.g., due to deliveries) and/or concurrently with direct and sublease availability. This is like expressing free throw percentages of a basketball player as a percent of all players on a team, rather than as a percent of the individual player’s total throws.
A metric that more clearly depicts market shifts between direct and sublease space is to express sublease availability as a percent of total availability. Percent sublease availability is sublease RBA divided by total available RBA. In this way, sublease availability is a fraction of total availability so that percent direct availability and percent sublease availability sum to 100. For example, percent sublease availability is about 13.7% for Class A and B buildings for QTD 2017, that is 1,411,000/10,287,000. Because the denominator is total availability, rather than total RBA, direct availability is readily deduced as 86.3% (i.e., 100 - 13.7). Also, the denominator of total availability changes in accord with changes in direct and sublease space. Ultimately, it is important to know the relative availability of sublease to direct space (e.g., 13.7% vs. 86.3%), as this is what can underlie shifts in market dynamics, asking rents, and concessions.
As detailed in Table 1, sublease space as of early Q1 2017 accounts for 13.7% of Class A and B buildings, representing an increase of 19.2% YoY. Even more pronounced is the 20% sublease availability of Class A buildings, up 28.8% YoY. Class B buildings have lower sublease availability at 7.6%, only up 3.7% YoY. Overall, sublease availability manifests most strongly in Class A over Class B buildings.
Figure 2 shows sublease availability in units of RBA and Figure 3 shows sublease availability as a percent of total availability. Based on RBA, sublease availability in Austin is reaching prior peak levels of 1.5 million sq. ft. for Class A and B buildings (1.1 million sq. ft. for Class A) arising from the Great Recession (Figure 2). However, as percent of a total availability, current sublease availability is 13.7% for Class A and B buildings and 20.0% for Class A buildings, both of which have surpassed their prior peaks of 11.3% and 15.9% following the Great Recession.
These historical patterns indicate that sublease availability can increase under both weakening and strengthening office markets. During 2008-2009 of the Great Recession, sublease availability increased from 7.2% to 15.8% for Class A buildings, followed by two to three years of steady declines in sublease availability to just 5.5% of total availability. In this case, the increase and spike in subleasing was likely attributable to tenants contracting their businesses with the economic recession. Then, from 2012-2016, available sublease space again increased for Class A buildings, this time from 5.5% to 20.0% of total availability. In this case, sublease availability increased as tenants expanded and relocated their businesses as a response to economic growth. Thus, we see that sublease availability can increase under both falling and rising phases of the office market cycle.
Figure 4 plots direct and sublease asking rents with percent sublease availability for Class A (Figure 4A) and Class B (Figure 4B) buildings from 2006-2017. There is not a tight, close relationship between sublease availability and market strength for Class A or Class B buildings. When sublease availability increases with business expansion and overall market and economic health, we see that sublease asking rents tend to remain flat or in some cases increase alongside direct asking rents. For example, from 2013-2016 sublease availability has steadily increased from less than 6% to 20%, yet direct asking rents have increased and sublease rents have remained relatively flat. However, we do not see a corresponding decrease in sublease asking rents as businesses contract. To suggest that greater sublease availability leads to increased rents may not be accurate, particularly given that some increases in sublease space arise from a softening office market with tenant contractions in business.
Data were obtained from CoStar in late January 2017. The statistical analyses and data visualization were performed using the R software and programming language:
R Core Team (2014). R: A language and environment for statistical computing. R Foundation for Statistical Computing, Vienna, Austria. URL http://www.R-project.org/.
Dr. J. Nathaniel Holland is a research scientist with 20 years of experience in using the scientific method to extract information from complex multi-dimensional data. He joined NAI Partners in 2014 as Chief Research and Data Scientist. At NAI Partners, Nat leverages his sharp intellectual curiosity with his skills in statistical modeling to guide data-driven business decisions in commercial real estate. Like many data scientists in the private sector, Nat joined NAI Partners following a career in academia. Prior to taking up data analytics at NAI Partners, he held professorial and research positions at Rice University, University of Houston, and the University of Arizona between the years of 2001 and 2014. Nat is the author of more than 50 scientific publications, and he has been an invited expert speaker for more than 60 presentations. Trained as a quantitative ecologist, he holds a Ph.D. from the University of Miami, a M.S. from the University of Georgia, and a B.S. from Ferrum College.