Two quarters into 2016 and we have already seen a turbulent year, with January and February lows replaced by some rebalancing in March and April, only for volatility to return at the end of the second quarter with Brexit. While Q1 2016 was likely the bottom of the oil commodity downturn, we have again in recent weeks seen WTI prices fall. This is likely a short-term result of Brexit and the value of the dollar, but nonetheless presents further concern for local and national economies. Projected U.S. GDP for 2016 has now been revised down from 2.4% to 1.8%, with the latest revision for Q1 at 1.1%. Consumer spending and consumer credit remain strong points, fueling about two-thirds of GDP. Recent changes in national employment further underscore the volatility of the first half of the year, dropping to only 11,000 new jobs in May and then bouncing back to 287,000 new jobs in June. Brexit will likely have minimal effects on the U.S., and the world as a whole, as the United Kingdom only accounts for about 4% of global GDP. Yet, Brexit could actually catalyze U.S. commercial real estate investors to remain in the U.S. rather than Central London, where many have previously sought opportunities. While the economic outlook for Texas as a whole remains uncertain, sitting on the edge of uncertainty, San Antonio has weathered the downturn in energy prices with job growth in recent months at 2.3% annualized and the San Antonio Business-Cycle Index at 5.4% indicating continued acceleration.
In Q2 2016, net absorption was 232,000 sq. ft., a demand for office space that is within the range of historic Q2 performance. However, leasing activity in Q2 was just 368,904 sq. ft., significantly lower than historic Q2 performance. Office supply, as measured by vacancy and availability, remained steady, with availability at 20.7% and vacancy at 15.8%. Deliveries in Q2 2016 were 58,712 sq. ft., decreases of -81% QoQ and -40% YoY, with 391,000 sq. ft. under construction. Declining leasing activity suggests that coming quarters will see lower net absorption, as net absorption lags behind leasing activity.
While the overall economic outlook has again declined for Texas as a whole, San Antonio continues its push forward in economic expansion with another strong quarter. Brexit has increased volatility in financial markets, but could lead to increased CRE spending in U.S. as investors shift from Central London. The oil and gas downturn is now manifesting throughout much of Texas, but San Antonio seems to be remaining stable. Job growth in San Antonio was a strong 2.3% annualized and the San Antonio Business-Cycle Index continues to show expansion at 5.4%.
Economic data in recent weeks and months are sending mixed messages for second quarter performance, leading many to further debate whether the economic expansion will continue or reverse course and slide downward. The Leading Economic Index (LEI) declined by a slight 0.2% in May—its third drop in six months—but overall this looks to be short lived. The U.S. gross domestic product (GDP) is now projected to be 1.8% for 2016, a modest decrease from 2.4% in 2015. GDP was revised up to 1.1% for Q1 2016, and is expected to come in around 2.4% for Q2. Strong consumer spending, which accounts for about two-thirds of GDP, will continue to fuel economic growth. Consumer credit further strengthened in May, and strong consumption in April and May will likely account for growth in Q2 2016. Consumer confidence increased 7.6 points in June, though some concern remains in the job market. International trade will continue to decline and hamper GDP with the strong dollar (up nearly 20%). Greater import growth in May led to a wider trade deficit, which is likely to increase by 4% in 2016, following a 6.2% increase in 2015.
At the center of the mixed messages in economic data are numbers on employment. Job growth in May dropped to only 11,000, but bounced back higher than expected to 287,000 new jobs in June, resulting in a three-month trend of 147,000 new jobs. With the unemployment rate remaining below 5%, the labor market continues to tighten. However, recent growth in jobs has been in industries with high and low wages, leaving middle-class wages to lag.
After a few months of growth and modest stability following lows in January and February, volatility has again returned to the financial and commodity markets, largely as a timely result of Brexit. Since the vote for the U.K. to leave the European Union, global financial markets have settled down. Effects on the U.S. will likely be minimal over the long term, but uncertainty will continue as the UK and EU begin working out negotiations on their future economic relationships. The U.K. will likely dip into a mild recession later in 2016, but this should not have a large effect on world economics, as the U.K. only represents 4% of global GDP. With uncertainty in the U.K., investors in commercial real estate from the U.S. may shift from Central London and simply remain in the U.S. with its strong CRE industry. To wit, the Dodge Momentum Index, a 12-month leading indicator of non-residential construction spending, jumped 11.2 percent in June and overall in Q2.
The ISM non-manufacturing index increased in June to 56.5, indicating that the economy continues to expand at a moderate pace. Moreover, the NFIB Small Business Optimism Index increased in June for the third month in a row. The ISM manufacturing index indicated that in June factories grew at the strongest rate since early 2015, but growth will remain modest in months to come, as shipments, orders and inventories are still declining, though at a slower rate. Given a variety of headwinds, including low May job growth, financial volatility, and reduced manufacturing, the current speculation is for only one remaining interest rate hike by the Federal Reserve Bank, likely after the presidential election.
The housing market is yet another variable producing mixed economic signals. Both the good-time-to-buy and good-time-to-sell indices increased in June, but the Home Purchase Sentiment Index dropped to 83.2. The high value of the dollar has led the National Association of Realtors to point out that home values by international buyers have decreased by 1.3%. This is leading such buyers to seek out lower-priced homes. Sales of new homes decreased by 6% in May.
The outlook for Texas and San Antonio economies are similar, poised for modest growth. Employment in Texas, despite the energy pullback, grew 0.4% in February compared to U.S. at 2.0%, with 4,500 new jobs following 23,700 new jobs in January. Unemployment in Texas was 4.4% in February, still lower than U.S. level of 4.9%. Job growth in San Antonio, while remaining positive, slowed to 1.6% for three months ending February 2016. Job growth was broad across many sectors, excluding mining. The San Antonio Business Cycle Index of the Dallas Federal Reserve measures the San Antonio economy based on movements in local unemployment, nonagricultural employment, inflation-adjusted wages, and inflation-adjusted retail sales. Business growth in San Antonio was 5.3% in January, but dropping to a still positive 4.7% in February, the slowest but again still positive growth since early 2013.
Net absorption in Q2 2016 was a robust 232,000 sq. ft. However, leasing activity, another measure of demand, was only 368,000 sq. ft., which is statistically less than the historic Q2 average of 667,000 sq. ft. Declining leasing activity suggests that coming quarters will see lower net absorption, as net absorption lags behind leasing activity. Office supply, as measured by vacancy and availability, remained steady, with availability at 20.7% and vacancy at 15.8%. Deliveries in Q2 2016 were 58,712 sq. ft., decreases of -81% QoQ and -40 YoY, with 391,000 sq. ft. under construction.
Demand, as measured by net absorption (direct plus sublease space), is the change in occupied stock inventory, including direct and sublet space. Figure 2 shows net absorption since 2006 by year and quarter for combined Class A and B office space. Positive net absorption of 232,827 sq. ft. occurred in Q2 2016, yielding a 7% increase QoQ and a strong increase of 2,321% YoY given Q2 2015 had negative absorption (Table 1). The historic Q2 average (± 95% confidence interval) for net absorption is 127,475 sq. ft. (± 182,743). We are 95% certain that Q2 net absorption typically falls between -55,268 sq. ft. and 310,218 sq. ft. Thus, while a net absorption of 232,000 sq. ft. is solid performance above the average, it is nevertheless not significantly greater than historic Q2 performance.
Leasing activity, another measure of demand, is the total amount of space represented by direct leases, subleases, renewals, and pre-leasing of rentable building area. Figure 3 shows leasing activity since 2006 by year and quarter for combined Class A and B office space. Leasing activity of 368,904 sq. ft. occurred in Q2 2016, which represents decreases of -10% QoQ and -32% YoY (Table 1). The historic Q2 average (± 95% confidence interval) for leasing activity is 666,993 sq. ft. (± 214,767). We are 95% certain that Q2 leasing activity typically falls between 452,226 sq. ft. and 881,761 sq. ft. This indicates that current leasing activity is statistically lower than historic Q2 measures since 2006. With absorption lagging behind leasing, lower leasing activity in Q1 suggests lower absorption in quarters to come.
Vacancy and availability measure the supply of office space. Availability better measures total supply because it includes vacant, occupied, and sublease space. Vacancy better measures empty space on the market, whether or not that space is leased or for rent. For Class A and B buildings combined, availability was 20.7%, representing relatively little change QoQ and YoY (Table 1). Likewise, vacancy was 15.8%, down about 3% QoQ and YoY (Table 1). Overall, office supply remained relatively stable in Q2 2016 (Figure 4).;
Figure 5 plots asking rent for direct and sublease space since 2006 for each of Class A and Class B buildings. In Q2 2016, both Class A and B space showed stable direct asking rents, with Class A asking rent at $24 and Class B at $19. However, asking rents of sublease rents for both Class A buildings continue their downward trend.
Construction of new RBA is an important variable shaping the supply of office space. RBA delivered refers to completed construction, while RBA under construction refers to space under construction that has not yet been completed. As detailed in Figure 6, deliveries in Q2 2016 were 58,712 sq. ft., decreases of -81% QoQ and -40% YoY (Table 1). RBA under construction was 390,946 sq. ft., decreases of -13% QoQ and -56% YoY (Table 1).
Figure 7 depicts changes in the inventory of Class A and Class B buildings since 2006, both in terms of RBA and the number of buildings. RBA inventory for Class A and B office space included 35.7 million sq. ft. for 840 buildings (Table 1, Figure 7). Note, only 93 of these buildings are Class A buildings, and of the Class B buildings, about 50% are <20,000 sq. ft. in size. Stock inventory is up 2.3% YoY.
This office market report includes information and data for multi-tenant Class A and Class B buildings, but does not include Class C buildings.
IInformation and data within this report were obtained from sources deemed to be reliable. No warranty or representation is made to guarantee its accuracy. Sources include: U.S. Bureau of Economic Analysis, CoStar, Council on Foreign Relations, Federal Reserve Bank of Dallas, FiveThirtyEight.com,Moody Analytics, NAI Global, National Association Realtors, Texas A&M Real Estate Center, Well’s Fargo, University of Houston’s Institute of Regional Forecasting, U.S. Bureau of Labor Statistics.