Austin office market taking hit during pandemic

Not surprisingly, the most recent occupancy figures for office space in Central Texas show the cornovarius pandemic is taking a toll. Local brokers say leasing activity has slowed significantly during an unprecedented time in the Austin-area office market.

Still, a report by real estate data company CoStar Group says that, despite some weakening over the past year, Austin’s office occupancy rates remain healthy. CoStar says a number of factors working in favor of the Austin region will help maintain the office market’s resiliency and spur additional demand for office space.

The region’s average occupancy rate for the highest quality (Class A) office space fell to 88.7% in the April-to-June quarter, down from 90.4% in the second quarter of last year. That’s according to the latest figures from Cushman & Wakefield Austin, which tracks the Central Texas office market.

The average rent for Class A space ticked up, however, to $44.86 a square foot per year as of June, compared with $43.73 per square foot at mid-year 2019, according to Cushman & Wakefield.

CoStar’s report said that, depending on how long and how deep the coronavirus-induced downturn lasts, “rent growth is likely to flatten out in the near term, if not outright fall... The days of 8% rent growth are likely in the rearview mirror.”

Rick Whiteley, managing director of tenant representation for Cushman & Wakefield, said leasing activity “has slowed tremendously” since last year.

“Most of the activity is related to (lease) renewals and near-term lease expirations that require tenants to consider their current location as well as get out in the market to evaluate alternatives. We likely hit a low in done deals last quarter... Deals with tenants who are new to the market were very rare during the second quarter,” Whiteley said.

Heightened volatility

As the second quarter approached, COVID-19 had forced the shutdown of most economic activity in March, triggering a global recession. Until then, Austin's economy had been one of the nation’s strongest.

In another second-quarter office report, global real estate services firm CBRE said that -- for the first time since 2010 --- the Austin office market saw net leasing activity dip into negative territory.

CBRE said there was a “sharp uptick” in sublease space in the Austin area, with significant spikes both downtown and in Northwest Austin.

In addition, CBRE said, “the effects of the current economic conditions have spread to the development pipeline, as new construction activity appears to have halted. There are currently 33 projects under active construction, totaling approximately 6.5 million square feet. Of these, only two were started in (the second quarter).”

Sublease space is up by about 2 million square feet over the past year -- to about 2.7 million square feet -- and is now higher than during the 2007-2009 recession, CoStar reported. The amount is still shy, however, of the 2002 peak of about 3.5 million square feet available for sublease, according to CoStar.

“Here in Austin, we’re building more office space relative to our market’s size than all major U.S. markets other than Nashville,” said Sam Tenenbaum, director of analytics for CoStar Group. “Depending on how long the coronavirus weighs on tenants leasing decisions, we could be adding a lot of new, unleased space to our market. That would cause vacancy rates to rise, which would give tenants more leverage in negotiations with landlords.”

With buildings empty and coronavirus cases spiking, “Austin's office market looks to be entering a period of heightened volatility,” CoStar’s report said.

“The coronavirus outbreak continues to cause significant economic disruption across the Austin market,,” CoStar said. “What should have been the much celebrated weeks of South by Southwest has quickly morphed into a nightmare for many small business owners across Austin. The trajectory of Austin's economy and its commercial real estate sector will depend on how widely the virus spreads and how long containment policies like social distancing need to be maintained.“

Whiteley said Austin-based Parsley Energy put the largest amount of space on the sublease market during the quarter.

“Austin is fortunate not to have a larger energy related sector because cities like Houston and Denver that do are getting hit with the huge downturn in the sector, plus all of the COVID-19 fallout,” Whiteley said.

However, Austin is a technology hub, and tech companies have been among the largest industries giving up space and/or trying to sublease it, Whiteley said.

“Examples like GoDaddy, ScaleFactor, Netspend and Cognitive Scale all put spaces in excess of 50,000 square feet on the sublease market during the quarter,” Whiteley said. “Examples of companies who took more space are very hard to find and are usually small unless you want to count DLA Piper, which terminated their lease at 405 Colorado and leased about 73,000 square feet at Colorado Tower.”

DLA Piper, a global law firm, was to have been the lead tenant in 405 Colorado, a 25-story office tower under construction at Fourth and Colorado streets downtown.

Although leasing activity is down from where it was before April, deals -- including new leases and lease extensions -- are still being done, said Jason Steinberg, a partner in the Austin office of ECR, a commercial real estate services firm.

However, most of the larger space requirements “are on hold until decision makers can travel to Austin or businesses have a better picture as to what the future of their business may look like,” Steinberg said.

“We are still in a wait-and-see situation and I anticipate it will continue at least through the next few months and possibly until early 2021 when the majority of the larger tech companies plan to bring their employees back to the office,” Steinberg said.

Steinberg said there’s a record of more than 8 million square feet of office space under construction and due to enter the market in the next 12 to 24 months, even as many sizable office spaces (greater than 50,000 square feet) are being marketed for sublease.

Some of that space, including in downtown and East Austin, “could attract new companies looking to expand or relocate to Austin as a result of the pandemic and new tax laws,” Steinberg said. “Texas remains highly considered for corporate relocations and expansions by companies currently in California, Illinois, New York, and other states.”

Whiteley said the impact the pandemic is having on the market “is getting bigger every day as tenants delay making decisions on such things as long- term commitments, expansions in their current locations, and space in a new property.”

Many tenants, Whiteley said, are seeking short-term renewals -- one to two years -- “due to the high level of uncertainty present today.”

Longer term, Whiteley said, “the pandemic and the work-from-home business model that was forced on most of us will have likely have an impact on the amount of space tenants require in the future as they consider incorporating the work-from-home model into their standard business practices.”

Optimistic on future

Dennis Tarro, executive managing director of real estate and development firm Patrinely Group, said he remains optimistic about Austin.

“Austin continues to be a top market in the U.S.,” Tarro said. “There’s a tremendous amount of buzz in the Austin marketplace and interest coming from out-of-state companies, especially tech companies, remains strong... We expect the Austin market to pop much quicker than most cities in the U.S., specifically in the tech sector.

“Not only is Austin attractive from a business standpoint, but it’s also booming in population growth because of the lifestyle it provides. Austin has that cool factor, a great quality of life, and a lower cost of living than markets on the West Coast. This may have slowed down in the current environment, but it’s definitely not going away.”

CoStar is also bullish on the Austin-area market.

“Longer term, Austin's office market has been resilient across cycles,” CoStar said. “The economy continues to outperform the broader U.S., and no other market in the country has seen its population growth outstrip Austin... Looking forward, while much uncertainty remains, the metro's strong creative environment and robust talent pool should keep companies expanding in Austin long-term.”