Q4 2016 Austin Office Market Report

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Executive Summary   

Economy

  • The 115th Congress is expected to see new policies and possible changes in the repeal/replace of Affordable Care Act, corporate and individual tax cuts and reforms, increased infrastructure spending, and trade policy and regulations.
  • With increases in oil prices and rig counts, the energy sector has likely passed its bottom, and national, regional and local signs indicate a positive but bumpy improvement ahead.
  • Gross domestic product (GDP) is anticipated to be 1.6% for 2016 and 2.1% for 2017, both slower than the 2.6% measure seen in 2015.
  • U.S. employment remains steady in posting 156,000 new jobs in December, for a total of 2.2 million new jobs in 2016 (an average of 180,000 new jobs per month); though still strong, 2017 is anticipated to see a slightly lower 160,000 new jobs per month.
  • While Austin’s economy continues to expand, the rate of that expansion slowed last year.

Office Market 

  • Q4 2016 saw 187,309 sq. ft. of positive net absorption, for a total of 1.0 million sq. ft. in 2016, a decrease in demand for office space following the large 4.1 million sq. ft. recorded in 2015.
  • Leasing activity in Q4 2016 was 1.6 million sq. ft., for a total of 6.3 million sq. ft. in 2016, the lowest year since 2009.
  • Both vacancy at 9.2% and availability at 13.4% remained relatively unchanged, signaling balanced supply and demand of office space.
  • Construction and deliveries continue to add rentable building space to the market, with more than 3.1 million sq. ft. in the pipeline.

 

Figure 1

Table 1


Broker's Perspective

    In Q2 2016, we reported on larger blocks of space coming available in specific corridors of submarkets. What we saw at that point were the larger blocks staying on the market longer than what had been observed in 2014 and 2015. Starting in the third quarter of this past year, leasing activity began to slow and this trend continued through the end of 2016. In January 2017, we are seeing a flurry of activity but expect things to go back to the previous levels found in Q4 2016. Another cooldown can be noted in building sales. Austin has been one of the hottest U.S. sales markets (also hottest CRE market) over the past 24 months, with prices continuing to climb. This may be starting to change, as we see prices leveling off.

    During the first week of January, the Dallas Federal Reserve predicted a slowdown in the Austin economy. Given the past few years of activity, it is about time that things begin to level off versus a continued meteoric rise. I for one welcome a steady, sustained growth in Austin, especially since demand has continued to outpace supply.

David Dawkins
Managing Vice President
NAI Partners | Austin


Economic Overview

National Economy

    As the 115th Congress began alongside a new president-elect, some new policies and policy changes that may unfold include repealing/replacing the Affordable Care Act, corporate/individual tax cuts and reforms, increased infrastructure spending, and among others trade policy and regulations. Despite a very vibrant political cycle with some clear consequences, Trump’s election is not anticipated to influence gross domestic product (GDP) in 2017, which is expected to be about 2.1%. GDP may roll in for 2016 around 1.6%, lagging behind 2.6% in 2015. Proposed tax cuts tend to mostly lead consumers to reduce their debt, rather than increase consumer spending, which accounts for about two-thirds of GDP. Consumer spending did grow by 2.8% in the third quarter of 2016.

    Job growth continues to be a strength of the U.S. economy. Employment in December increased by 156,000 new jobs, with particular strengths in health care, hospitality, government and manufacturing. In 2016, there was an average of about 180,000 new jobs added per month, for a total of 2.2 million new jobs and an unemployment rate of 4.7%. Job growth in 2017 is anticipated to slow but remain strong at around 160,000 new jobs per month. Increases in job openings and turnover further suggest a tightening labor market. Nevertheless, with more people entering the labor force, unemployment is expected to drop to 4.5% in 2017. Strong employment and job growth are big contributors to the likely two-to-three interest rate hikes anticipated to occur by the Federal Reserve in 2017. Personal income also rose in every state in Q3 2016.

    Core inflation, excluding food and energy, is projected to be about 2.3% in 2017, a modest increase from 2.2% in 2016. However, energy prices are likely to increase modestly in 2017, for an overall 2.5% inflation in 2017, up from 2% in 2016. The question remains as to whether OPEC’s cuts will really manifest and if so, how much they will lead to the stabilization and increase in oil prices and the energy sector. Either way the oversupply of production and stored oil still persists and needs to be burnt off for WTI prices to see substantial shifts upward. The oil markets are likely to remain volatile in 2017, possibly stabilizing some during the latter half of the year.

    Business spending was largely flat in 2016, but a modest increase of 3-4% may occur in 2017. Demand for factory-produced goods continues to strengthen after a lengthy lull. The Small Business Optimism Index of the National Federation of Independent Businesses (NFIB) increased substantially by 7.9 points in December and 10.9 points in November, following decreases over the past 12-18 months. Such positive swings indicate an expected stronger economy associated with possible easing of regulations. The ISM manufacturing index rose to 54.7, a two-year high on the heels of increases in production and new orders in December. In December, the ISM non-manufacturing index was unchanged at 57.2.

    Indicators such as residential construction suggest that the housing market will strengthen in 2017, despite substantial drops in housing starts in November 2016. Inventory remains low, with more people looking to buy homes than are readily available. With political headwinds in 2016 in both the U.S. and U.K. leading to uncertainty, growth in private nonresidential construction spending is anticipated to be about 7.5% in 2016. The Dodge Momentum Index of non-residential construction increased 2.9% in December after downward revisions for November.

    Export prices are expected to increase with the strong value of the dollar, which in turn will produce an anticipated increase in U.S. trade deficit by 4% in 2017. Meanwhile, import prices rose 1.8% in 2016. Though all data are not yet in, it appears that international trade in 2016 will fare better than initially anticipated with the shortfall on par with that of 2015. Retail sales were weaker overall than hoped for in December, marking an increase of 0.6% in December following 0.2% in November (compared to expectations of 0.5%). 

Austin and Texas Economy

    The Austin metropolitan area’s GDP grew 5.0% from 2014 to 2015, making it the second fastest growing city in Texas just behind San Antonio. 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, Austin 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 Austin grew at a 3% annualized rate for the three months ending in August. Job growth was broad based, with the exception of manufacturing and health and private education services. 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 Austin Business Cycle Index decreased a bit to 3.0% annualized in August 2016, down from 5.5% in early 2016 and 10.2% in 2014.


Market Overview

Net Absorption

    Demand, as measured by net absorption (direct plus sublease space), is the change in occupied stock inventory. Figure 2 shows net absorption since 2004 by year and quarter for combined Class A and B office space. The fourth quarter of 2016 posted 187,309 sq. ft. of positive net absorption, representing decreases of -60.4% QoQ and -76.4% YoY (Table 1). The historic Q4 average (± 95% confidence interval) for net absorption is 400,159 sq. ft. (± 263,569). We are 95% certain that Q4 net absorption typically falls between 136,589 sq. ft. and 663,728 sq. ft. Thus, despite the substantial QoQ and YoY decline, net absorption was still within its historic Q4 performance. However, total net absorption for 2016 was 1.0 million sq. ft., the third-lowest year since 2004.

Leasing Activity

    Leasing activity is another measure for the demand of office space, representing the total amount of space for direct leases, subleases, renewals, and pre-leasing. Figure 3 shows leasing activity since 2004 by year and quarter for combined Class A and B office space. Leasing activity of 1.6 million sq. ft. occurred in Q4 2016, marking an increase of 5.8% QoQ but a decrease of -19.2% YoY (Table 1). The historic Q4 average (± 95% confidence interval) for leasing activity is 1,427,085 sq. ft. (± 397,694). We are 95% certain that Q4 leasing activity typically falls between 1,029,391 sq. ft. and 1,824,780 sq. ft. This indicates that leasing activity is within historic Q4 performance. Total leasing activity for 2016 was more than 6.3 million sq. ft., the lowest since the Great Recession.

Availability and Vacancy

    Vacancy and availability measure the supply of office space, and as such are key indicators of shifts in the phase of the office market cycle. Availability better measures total supply because it includes vacant, occupied, and sublease space. Vacancy better measures empty space in the market, whether or not that space is leased or for rent. For Class A and B buildings combined, availability was 13.4%, an increase of 0.8% QoQ and YoY (Table 1). Vacancy was 9.2%, an increase of 1.1% QoQ and YoY (Table 1). Over the longer term, availability has been hovering between 13% to 14% since late 2012. Meanwhile, vacancy has steadily declined from 12% to 9% (Figure 4).

Figure 2

Asking Rent

   Figure 5 plots both gross and base (NNN) asking rents for direct and sublease space since 2004 for Class A and B buildings. Despite limitations of asking (vs. actual) rent, we can derive information on market conditions by examining the difference between direct and sublease base rents. Negative differences between direct and sublease asking rents indicate a strong, tight market in which sublease space is getting equal to or greater rents than direct space. Positive differences between direct and sublease asking rents can indicate a softening market if the slope of the QoQ sublet rent is negative. In such cases, market conditions are softer the greater the difference. However, if the slope is positive or flat alongside increasing direct rents, then business expansion and a strong market are occurring.

   The difference between direct and sublease base asking rents for Class A buildings has increased from $0.67 to $5.37 since 2013 (Figure 5B). Historically, Class A buildings have shown an average difference of $1.21 between direct and sublease base asking rents, with a 95% confidence interval of $0.71 to $1.71. At the current $5.37, Class A rents are outside this expected range, but the slope of sublet rents QoQ is flat to positive since 2013, indicating business expansion and a strong office market.

   Historically, Class B buildings have shown an average of $-0.37 difference between direct and sublease base asking rents, with a 95% confidence interval of $-0.79 to $0.05. At the current $-0.37 difference, Class B rents are within 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.

Figure 3

2016-Q3-Hou-office-Fig4

Figure 5

Construction and Deliveries

   Construction of new stock inventory shapes 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. Deliveries in Q4 2016 were 291,827 sq. ft. of Class A and B buildings, a decrease of -10.5% QoQ and -66.3% YoY (Table 1). RBA under construction was 3.1 million sq. ft. in Q4 2016, an increase of 30.4% QoQ and 48.0% YoY (Table 1). Figure 6 breaks down deliveries and construction on an annual basis by Class A and Class B products.

Figure 6

Inventory

   Figure 7 depicts changes in the inventory of Class A and Class B buildings since 2004, both in terms of RBA and the number of buildings. Stock inventory for Class A and B office space included 77.5 million sq. ft. for 2,064 buildings, an increase of 1.7% YoY (Table 1).

Figure 7

Methodology

   The quarterly report for the office market includes information and data for Class A and Class B buildings, but excludes Class C buildings. Buildings are not excluded on the basis of single vs. multi-tenancy, owner occupancy, or building size.

 

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, Greater Houston Partnership, FiveThirtyEight.com, Houston Association of Realtors, 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.

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