10 Key Insights into Austin's Office Market Challenges and Opportunities

1. Office Demand Decline: Office demand in Austin is waning as tenants adapt to flexible workplace arrangements, leading to smaller office requirements.
2. Impact on High-End Properties: The tech sector’s demand changes challenge landlords of high-end properties, with many tenants returning space through the sublet market.
3. Speculative Construction: Speculative construction continues to add uncommitted space to the market.
4. Leasing Activity Uptick: New leasing activity increased to 1.4 million SF, up from 1 million, but still 40% lower than the 10-year average.
5. IBM’s Consolidation: IBM is consolidating its operations in Austin from 480,000 SF to 320,000 SF, reflecting the trend of reduced lease sizes.
6. Negative Net Absorption: Austin experienced a net absorption of -700,000 SF, with another -1 million SF of net move-outs expected.
7. Construction Pipeline: With 7.2 million SF in construction, a 45% prelease rate, and consolidating footprints, vacancy rates will rise.
8. Rising Vacancy Rates: The vacancy rate has increased to 16.4%, with new properties having a 37% availability rate, 17 percentage points higher than the overall market.
9. Rent Decline: Rents will decline to 2019 levels by next year, with an average rent of $40.40/SF forecasted for Q2 2024, an 8.2% drop from the previous year.
10. Capital Market Cooling: Capital markets are cooling, with volume down 70% from Q2 2022 and the five-year quarterly average. The sale of Met Center Buildings A and B was notable, but details remain undisclosed.

Office Demand Decline

Office demand in Austin is waning as tenants adapt to flexible workplace arrangements. These changes lead to smaller office requirements. The tech sector, a primary driver in Austin, has been notably absent. This trend poses a significant challenge to landlords of high-end properties.

Speculative Construction and Sublet Market

Speculative construction continues to add uncommitted space to the market. Many tenants are returning space through the sublet market, resulting in a surplus of available space. Meta is the latest company to list sizeable sublet space, adding 103,000 SF at 300 West Sixth.

Uptick in Leasing Activity

New leasing activity increased to 1.4 million SF, up from 1 million SF. However, it remains 40% lower than the 10-year average. IBM’s consolidation, the largest deal in 18 months, drives this uptick.

IBM’s Consolidation

IBM is consolidating its operations in Austin from 480,000 SF to 320,000 SF. This highlights the trend of reduced lease sizes. Despite this positive sign, overall leasing activity remains subdued. The volume of leases signed in Austin continues to slow.

Negative Net Absorption

Austin experienced a net absorption of -700,000 SF; another -1 million SF of net move-outs will occur. This trend reflects ongoing market challenges, further exacerbated by the tech sector’s reduction in office space.

Rising Vacancy Rates

With 7.2 million SF in construction and a release rate of 45%, vacancy rates are rising. The current vacancy rate has increased to 16.4%, one of the sharpest increases in the country. The availability rate for new high-end properties is even higher, at 37%.

Declining Rents

Rents will decline to 2019 levels by next year. The forecasted average rent is $40.40/SF, an 8.2% decline from the previous year. Despite this, Austin remains one of the most expensive office markets in the U.S.

Capital Market Cooling

Capital markets are cooling, with volume down 70% from Q2 2022. The five-year quarterly average also shows a significant decline. The sale of Met Center Buildings A and B was notable, but details remain undisclosed. Limited transaction activity and Texas’ non-disclosure laws contribute to this trend.

Impact on High-End Properties

High-end properties like 816 Congress and 501 Congress have seen leasing activity. However, overall demand remains weak. Co-working firms like Industrious are expanding, yet the scale of new leases is modest. These properties are not immune to the broader market challenges.

Leasing Activity by Submarket

Leasing activity has concentrated in the North/Domain, Northwest, and CBD submarkets, which account for over half of all new leasing volume. Companies like IBM plan to upgrade to build-to-suit office buildings in the Domain. Despite these activities, the overall market faces headwinds due to shifting tenant preferences and economic conditions.

Office Rents Poised for Reduction

Austin’s office rents will decline to levels seen during the Great Financial Crisis. Annual rent growth of 0.5% is expected to fall to -2% by year-end, making Austin one of the weakest performers among the top 50 U.S. office markets. The market surplus grows as tenants consolidate space and developers add uncommitted space.

Rising Vacancy Rates

The current vacancy rate of 16.4% is among the highest in the U.S. It is projected to reach 18.5%. This is due to tenants consolidating or letting leases expire. Developers are also adding more uncommitted space to the market.

Suburban Property Rent Trends

Base rents for Austin’s 3-star suburban properties range from $24/SF to $31/SF NNN. For example, Westlake Place quotes directly asking rents of $28.50/SF NNN. Lesser quality properties have seen better rent gains due to constrained supply growth. However, the flight to quality will affect tenant demand and landlord pricing power.

Impact on Higher-Quality Assets

Asking rents for higher-quality assets varies depending on location. In suburban areas, 4-star rents for low and midrise buildings range from $24/SF to $33/SF NNN. The Rialto Center Building 1 quotes $28/SF NNN while offering high-end finishes and amenities. These competitive rates are comparable to 3-star rents in the same areas.

Urban High-End Property Trends

In urban locations like the CBD and North/Domain, 4 & 5 Star rents are the highest, ranging from $38/SF to $45/SF NNN. Some rents go as high as $50/SF. However, landlords of these properties will face a competitive landscape as developers introduce more high-end developments.

High-Quality Asset Inventory

High-quality assets represent two-thirds of the market’s inventory and 90% of the development pipeline. This could lead to a contraction in rent growth from -0.1% to -2.4% by year-end. The influx of high-end properties will pressure rent prices downward.

Competitive Sublet Market

With sublet space remaining elevated, sublet asking rents offer notable discounts. For example, the 4-Star property at 823 Congress offers direct space at $38/SF NNN, 25% higher than sublet asking rates of $30/SF NNN. High-quality sublet space in Austin’s urban core typically ranges from $28/SF to $40/SF NNN.

Sublet Inventory Challenges

Sublet inventories are at all-time highs, keeping pricing competitive. Sublessors are keen to offload these financial commitments, and this competition will continue to impact rent prices and market dynamics.

Tenant Space Consolidation

Tenants are increasingly consolidating space or allowing leases to expire. This trend contributes to the growing office surplus. Developers adding more uncommitted space exacerbates the issue. The market is adjusting to these new dynamics.

Developer Contributions to Surplus

Developers continue to bring uncommitted space to the market, adding to the growing office surplus. Vacancy rates are rising, and rents are declining as a result. The market must adjust to this increased supply and shifting tenant demands.

Austin’s Active Construction Pipeline

Austin has the most active construction pipeline among the top 50 office markets. The total under construction is 7.2 million SF or 5.5% of inventory. Developers were optimistic about speculative construction due to past robust demand. However, the market slowdown has led to a supply surplus.

Concentration in Urban Core

Development primarily occurs in Austin’s urban core, with the CBD and East accounting for two-thirds of the pipeline. These submarkets command high rents and attract large institutions. Their central location and amenities offer office workers a desirable live/work/play environment.

Notable Projects Scheduled for Delivery

This year, several major projects will be delivered, including the 66-story Sixth and Guadalupe tower. Initially preleased by Meta, it is now on the sublet market. The T3 ATX will add another 93,000 SF to the East Submarket. Asking rents for properties in these areas range from $45/SF to $53/SF NNN.

High-Quality Asset Introductions

Builders are introducing high-quality assets as tenants move to newer, amenity-rich spaces. 90% of ongoing construction is 4 & 5 Star rated. Properties over 300,000 SF make up 60% of the construction pipeline. Prominent developers like Lincoln Property Company and Brandywine Realty Trust drive this growth.

Tightened Credit for New Developments

With market oversupply and rising availabilities, creditors have tightened financing for new projects. Capital for building new office space is nearly nonexistent. Construction starts to decline by 60% quarter over quarter. Speculative projects will remain paused until market fundamentals stabilize.

Market Slowdown Effects

The market slowdown has significantly impacted new developments. Developers are holding back on speculative projects due to the high vacancy rates. The focus has shifted to stabilizing the current market conditions. Sublease availabilities must decrease before new projects can commence.

Developer Strategies Amid Oversupply

Developers are adjusting their strategies amid the oversupply. They focus on completing high-quality projects already underway and postpone new projects to prevent exacerbating the surplus. This approach aims to balance supply with current demand.

Institutional Developers’ Role

Institutional developers are crucial in managing the construction pipeline. They are responsible for the bulk of the high-quality developments. Their experience and resources help navigate the market challenges. These developers await a more favorable market environment before starting new projects.

Submarket Dynamics

The dynamics of different submarkets influence development activities. Urban core areas like the CBD and East remain attractive despite the slowdown. Suburban areas see less development activity. The focus remains on high-demand, high-rent areas.

Future Outlook for Austin’s Office Market

The future of Austin’s office market depends on stabilizing current market conditions. Reducing sublease availabilities is crucial. Developers and creditors are cautiously optimistic about long-term prospects. The market needs to adapt to changing demand patterns and economic conditions.

Decline in Property Transactions

Fewer properties are transacting in the Austin metropolitan area. Restricted capital access and higher interest rates are barriers. Owners holding assets longer also contribute to the slowdown. Austin’s turnover rate ranked 40th out of 50 major U.S. metros.

Lower Sales Volume

Austin’s sales volume was 0.8% of inventory, well below Tampa’s 2.9%, the top performer. About 1 million SF were sold in the first half of the year, the lowest semiannual total since 2009.

Focus on Smaller Buildings

Sales this year have centered around small office buildings under 60,000 SF. These account for two-thirds of the total volume. Most of these buildings are 2 and 3-star properties. They span the Austin metro, including Northeast, Round Rock, and Cedar Park.

Few High-Quality Sales

No prices have emerged for 4- and 5-star properties. The exception is Cherry Peak Office Park, a 3,200-SF medical office building that sold for $490/SF in the Southeast Submarket. This indicates notable gains over the past 18 months.

Trade Range for 3 Star Properties

3 Star properties under 40,000 SF are trading around $370/SF. For example, a 12,600-SF medical office condo in Round Rock sold for $375/SF. Few cap rates have surfaced this year. Several 3-star properties traded at rates ranging from 5.7% to 6.8%.

High-Profile Submarkets’ Activity

High-profile submarkets like the CBD, North, and East have seen little inventory. These areas posted strong sales volumes in 2022. This year, the West Central and Northeast submarkets are leading in sales. This shift reflects changing market dynamics.

Notable Sales in West Central

The largest sale this year was Hartland Plaza in West Central. The building’s tenant, AQUILA Commercial, acquired it for an undisclosed price. This transaction highlights West Central’s activity.

Significant Purchase in Northeast

In the Northeast, Central Health purchased The Cameron Center complex. This acquisition is part of their plan to extend hospital services to unhoused individuals. Central Health continues its health equity plan by expanding healthcare throughout Travis County.

Market Adjustments

The market is adjusting to the current economic conditions. Higher interest rates and restricted capital are slowing transactions. Owners are holding assets longer, contributing to lower sales volumes. This trend will likely continue throughout the year.

Future Outlook

The future of Austin’s office market will depend on economic adjustments. Developers and investors are cautious. Market fundamentals need to stabilize for a rebound in transactions. The focus remains on navigating current challenges and preparing for future opportunities.

Closing Thoughts

Austin’s office market faces slowed transactions, rising vacancies, and restricted capital. Developers and investors are adapting to these changes. Stability in market fundamentals is crucial for future growth. Contact Lumicre for your investment needs.