- Economic uncertainty associated with an unprecedented presidential election cycle will continue after new administration moves in due to ongoing discontent between parties.
- U.S. energy sector has likely bottomed out; real signs of recovery have emerged over the past quarter, such as increases in rig counts.
- Gross domestic product (GDP) is anticipated to be 1.4% for 2016 and 2.0% for 2017, both slower than 2.5% in 2015.
- U.S. employment remains steady, posting 156,000 new jobs in September, after 167,000 in August. Job growth below 200,000 per month suggests tightening labor market.
- The San Antonio metropolitan area’s GDP grew 5.9% from 2014 to 2015, the largest of any major Texas city and among the fastest of U.S. cities.
- San Antonio’s economy remains among the strongest in the state of Texas.
- Net absorption was 109,000 sq. ft., a demand for office space within the historic range of Q3 performance.
- Leasing activity was down 42% QoQ and YoY to 479,000, but within historic levels of Q3 performance.
- Availability declined to 17.7%, a decrease of 11.9% YoY; vacancy declined to 15.1%, a decrease of 5.6% YoY.
- Deliveries were 89,000 sq. ft., a decrease of -78.4% YoY, with 438,677 sq. ft. remaining under construction.
- Reasonable absorption and declining vacancies and availabilities indicate a strengthening market.
The see-through buildings got a boost in the third quarter with the signing of two significant leases in newly constructed buildings: 150,735 square feet in Vista Corporate Center and 129,015 square feet in West Ridge Two at La Cantera. USAA is the tenant in both projects. This should give a bounce to the other new buildings in the Northwest and North Central submarkets, such as Lockhill Crossing and Heritage Oaks III. The window of opportunity may not stay open long, as a handful of other projects are scheduled to deliver in the next two quarters.
The market has seen an increase in the number of subleases, rising 44% to 135,000 sq. ft. Out of this total inventory, Class A subleases nearly doubled to 80,000 sq. ft. from last quarter, while Class B sublease space increased to 46,000 sq. ft. Compared to cities highly dependent on energy, San Antonio has a small percentage of sublease space at about 2%, but this does not reflect the difficulties of back-filling subleases due to their limitations of lease term, space size, and other restrictions of original agreements.
Class A quoted rental rates increased 2% in the third quarter, largely driven by high new construction rates and the existing Class A buildings gaining the benefit of those higher new construction rates. We should reach an equilibrium once the buildings under construction are completed. The next few quarters will prove to be interesting to watch unfold.
NAI Partners | San Antonio
With a truly unprecedented election cycle and associated economic uncertainty coming closer to an end, discontent between parties will still likely hang over policy and decision makers as a new administration takes hold. Gross domestic product (GDP) is anticipated to be 1.4% for 2016 and 2.0% for 2017, both slower than 2.5% in 2015. GDP is being led by consumer spending and job gains, but weak business, government spending, and slow export sales are holding it back. Consumer spending increased strongly by 4.3% in Q2. Revolving consumer credit continued its slow but steady increase, with August showing the largest increase in 2016. Consumer interest rates remained steady. The Consumer Sentiment index moved higher in September, rising 1.4 points to 91.2, most of which came from higher income households.
Employment continues to remain steady. September posted a solid 156,000 new jobs, following 167,000 new jobs in August. Job growth remaining below 200,000 per month is suggestive of a tightening labor market. As more people entered the labor force, unemployment moved up to 5%, which historically has been considered full employment in the labor force. Also, wage growth increased by 2.6% in September, following 2.4% in August. Some analyses still suggest that the recovery is weak and as a result interest rates may stay low. With strong September job growth, and two more job reports to go, the December FOMC meeting following the election will likely result in an interest rate hike by year’s end. Nevertheless, interest rates are expected to remain low and fluctuate within a small range.
International trade continues to see slow export sales. U.S. exports are down 3.7% YoY. Yet, the negative economic impacts of falling import prices is beginning to fade, as import prices inched up 0.1% in September and are only down 1.1% relative to this time last year. The trade deficit widened modestly in August, but realized net exports are likely to make a positive contribution to GDP in Q3. Demand for U.S.-made durable goods abroad will remain weak and flat through the end of the year and increase modestly by 3-4% in 2017. These trends may stifle U.S. business investment.
The Small Business Optimism Index of the National Federation of Independent Businesses (NFIB) continued its decrease over the past 12-18 months, declining 0.3% points in September to 94.1, but remaining unchanged relative to the past six-month average. This indicates businesses are cautious on hiring and inventories. While factory orders of durable and nondurable goods rose in Q3, business investment in capital goods fell, which signaled a softer quarter. In September the ISM manufacturing index bounced firmly back into expansion territory at 51.5.
The U.S. energy sector appears to have bottomed out, and over the past quarter or so has begun to show real signs of recovery, with consistent weekly increases in rig counts being led by the Permian Basin. Nevertheless, modest increases in drilling activity and oil production does not signal the end of the persistent oversupply and large stockpiles. Recently, the Organization of the Petroleum Exporting Countries (OPEC) has agreed to agree to cut production at the next OPEC meeting, but when it still remains unclear when the global rebalance of the oil market will occur.
More people are looking to buy homes, but home availability remains low, driving up prices. Residential housing for August, in terms of sales of both new and existing homes fell, and new housing starts declined as well. Yet, this is in the context of a strong first half of 2016 where home sales and new home construction were very strong through July 2016. The Dodge Momentum Index of non-residential construction declined 4.3 percent in September to 129, but is up 5.1% YoY. Both July and August saw pullbacks in total construction momentum across residential, nonresidential, and public spending.
The San Antonio metropolitan area’s GDP grew 5.9% from 2014 to 2015, the largest of any major Texas city and among the fastest of U.S. cities. Texas continues to have a mixed set of economic numbers in 2016, but all indications are that the bottom has come and we are now moving up. Rig count has increased every week for 15 of the past 16 weeks. While Houston technically did move into an economic recession in November of 2015, San Antonio remains stronger. Employment in Texas grew 2.6% in August and 3.2% in July, with an annualized increase of 0.8% for 2016 thus far. The employment forecast for Texas is 1.2% in 2016. Jobs in San Antonio grew 4% in August and 3.7% in July. Job growth remains slow in the manufacturing and retail sectors, but jobs in construction grew strongly. Unemployment was 4.7% in Texas.
The revenue index of the Texas Service Sector Outlook survey increased from 6.5 to 13.0 in September. Meanwhile the sales index of the Texas Retail Outlook Survey increased from -5.3 to 2.0. Factory activity in Texas did increase substantially in September, according to the Texas Manufacturing Outlook Survey. The index which measures manufacturing conditions rose 12 points to 16.7, again a substantial increase. Nevertheless, consistent with the broader U.S. economy, business conditions in Texas are mixed. The general business activity index continued into negative territory for another month at -3.7, representing almost two years in negative territory. The San Antonio Business Cycle Index decreased to 1.0% annualized in August 2016, from 1.6% in July; these are some of the slowest rates of expansion since the economic recovery began in late 2009.
Demand, as measured by net absorption 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 109,499 sq. ft. occurred in Q3 2016, representing a -53% decrease QoQ but an increase of 17.7% YoY (Table 1). The historic Q3 average (± 95% confidence interval) for net absorption is 229,095 sq. ft. (± 305,130). We are 95% certain that Q3 net absorption typically falls between -76,035 sq. ft. and 534,225 sq. ft. Thus, net absorption of 109,000 sq. ft. is reasonable performance within its historic confidence bounds.
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 479,447 sq. ft. occurred in Q3 2016, which represents decreases of -42% QoQ and YoY (Table 1). The historic Q3 average (± 95% confidence interval) for leasing activity is 691,898 sq. ft. (± 145,958). We are 95% certain that Q3 leasing activity typically falls between 545,940 sq. ft. and 837,856 sq. ft. This indicates that current leasing activity is statistically within the historic expectations of Q3 measures since 2006.
Vacancy and availability measure the supply of office space. Availability is a better measure of 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 17.7%, representing -10.6% decrease QoQ and a -11.9% decrease YoY (Table 1). Likewise, vacancy was 15.1%, a decrease of -0.7% QoQ and -5.6% YoY (Table 1). Overall, office supply tightened a bit in Q3 2016 (Figure 4).
Figure 5 plots both gross and base (NNN) asking rents for direct and sublease space since 2005 for Class A and B buildings. Despite limitations of asking (rather than actual) rent, we can derive information on market conditions by examining the difference between direct and sublease base rents. The greater the positive difference between direct and sublease asking rents, the softer are market conditions. Yet, negative differences between direct and sublease asking rents indicate a strong, tight market in which sublease space is getting equal or greater rents as direct space.
The difference between direct and sublease base asking rents for Class A buildings has decreased from $6.97 to $4.85 over the past four quarters (Figure 5B). Historically, Class A buildings have shown an average difference of $3.14 between direct and sublease base asking rents, with a 95% confidence interval of $2.44 to $3.83. At the current $4.85, Class A rents are outside this expected range. Note, however, this difference between direct and sublease asking rents is decreasing, suggesting a strengthening market. Historically, Class B buildings have shown an average of $0.84 difference between direct and sublease base asking rents, with a 95% confidence interval of $0.23 to $1.45. At the current $-1.23 difference, Class B rents are outside of this range, and negative, indicating a strong Class B market in which subleases are getting higher rents than direct spaces, likely due to limited supply.
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 89,014 sq. ft., an increase of 22.5% QoQ but a decrease of -78.4% YoY (Table 1). RBA under construction was 438,677 sq. ft., decreases of -11.8% QoQ and -25.7% 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 37.6 million sq. ft. for 865 buildings (Table 1, Figure 7). Note, only 94 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 1.6% 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.
Information 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.