COVID-19 pandemic continues to affect the market, but Austin could bounce back quickly
Boots On The Ground
Commentary by Will Nelson | Associate Vice President | Austin
Our “Boots on the Ground” viewpoint is the voice of our experts, who have broken down the market data and compared it to what they are seeing for themselves. This is their take on what the numbers actually mean for the Austin office market.
As the late, great Jim Morrison once sang, “the future’s uncertain and the end is always near”. As we look over the horizon to the end of 2020, surrounded with unprecedented uncertainty on both a macro and micro level, Jim’s enigmatic lyric rings more prophetic than ever. The future remains most definitely uncertain, but only time will tell how near we are to the end of this recession. With the pandemic continuing to march on, and a national election just around the corner, it seems as if we are all looking forward with one eye open to see how this uncertainty continues to play out economically for the Austin market.
Looking at the numbers, the Austin market is still very much caught in the market softening inertia of the second quarter. With the market-wide vacancy rate increasing by 2.2%, and YTD net absorption spiraling downward, the 3rd quarter finds itself continuing much of the same trajectory from the previous quarter.
Construction still abounds across the market, with approximately 6.8 million square feet underway. Average rental rates continue to hold despite the decrease in demand and increase in sublease space that continues to pervade the market. Landlords are preferring to increase concession packages in the form of free rent and improvement allowances, rather than dropping quoted rental rates. We can tell you that “behind closed doors” Landlords are striking deals for shorter terms, and at rates lower than advertised. The pool of investors looking to acquire in Austin remains robust. With interest rates remaining at all-time lows, more buyers will continue to flood the Austin market looking for value and attractive risk-adjusted returns.
The ongoing pandemic and resulting economy are changing the landscape in Austin by the day. There is no denying the fact that Q4 2020 in Austin will look much different than the Q1 2020, both economically and culturally. The city will continue to scramble, as it always has, to continue to hold on to its identity in an everchanging, pandemic world.
With an increasing supply of new development and sublease space, and a decrease in user demand, the market will proceed to soften well through the end of the year and into the beginning of 2021. We’re forecasting a decrease in rates until at least the first quarter of 2021, when we expect demand to begin its recovery.
There is light at the end of the tunnel, however. The quality of life and friendly business environment continues to make Austin a premier destination for families and companies. We’re already seeing a flood of inquiries from companies interested in relocating from both coasts. This demand for Austin as a destination will be one of many contributing factors that make Austin one of the first markets to climb out of the pandemic recession.
Austin Office Overview
In the third quarter of 2020, Austin’s office market reported 860,228 SF of negative net absorption. A large amount of the negative absorption occurred in Class B buildings with a total of 573,608 SF of negative net absorption. Class A buildings in Austin posted 262,248 SF of negative net absorption and Class C properties recorded 24,372 SF of negative net absorption.
There is 6,815,882 SF of office space under construction and 2,759,758 SF of that is pre-leased. Looking forward, in the fourth quarter of 2020 we expect to record 1,612,710 SF of deliveries with 639,999 SF of that being pre-leased, but the delays in construction due to COVID-19 may change those projections. One of the buildings set to deliver in the fourth quarter of 2020 is Seven Oaks West at 8701 FM 2244; the entire 130,152 SF building is 100% preleased to Abbott Laboratories.
The Grove - Block 1 at 4301 Bull Creek Road was the largest building to deliver in the third quarter. This 134,114 SF building delivered in September and is currently 79.7% leased. The fourth quarter of 2020 is expected to see seventeen new buildings come online, with many of those deliveries being pushed back from their original third quarter delivery dates.
The citywide average rental rate increased over the quarter from $36.41 per SF in Q2 2020 to $36.45 per SF in Q3 2020. Class A rental rates in Austin’s CBD increased by 1.0% over the quarter from $52.99 per SF to $53.54 per SF in Q3 2020. The overall suburban Class A rental rate decreased from $38.43 per SF to $37.94 per SF, over the quarter.
On July 22nd, Tesla announced that it has chosen Austin as the new site for their gigafactory. Tesla plans to build a multi-million square foot manufacturing facility near the airport. This new factory will inevitably raise housing prices in the area, but will also employ around 5,000 people.
This new factory will sit on about 2,100 acres of land and will be between 4 and 5 million square feet. Tesla will be using it’s fourth U.S. factory to build the new Cybertruck along with Model Ys and Model 3s. It will be open to the public and Elon Musk has described it’s future as “an ecological paradise”.
Vacancy & Availability
Austin’s citywide vacancy rate increased from 13.6% in the second quarter of 2020 to 15.2% in the third quarter. The West Central submarket’s Class A vacancy rate had the largest jump in vacancy moving from 5.0% in Q2 2020 to 23.1% in Q3. Since the West Central submarket is so small, a 9,382 SF being vacated at JLL Plaza (1703 West 5th Street) was a factor in the jump in vacancy.
The largest decline in vacancy was recorded in the Class A Cedar Park submarket, where the rate decreased from 26.9% to 15.4%.
Absorption & Demand
Austin’s office market posted 860,228 SF of negative net absorption in Q3 2020. Despite this, four submarkets experienced positive absorption over the quarter, including Cedar Park, Northeast, Round Rock and Southeast a.
A large amount of Q2 negative net absorption occurred in the Class B buildings, totaling 573,608 SF of negative net absorption. Just in the CBD submarket, there was 140,073 SF of negative absorption, which makes up 16% of the entire market’s net absorption. Some notable subleases now on the market are at Austin Centre (701 Brazos Street), and consists of three full floor opportunities for a total of 136,558 SF. GoDaddy signed a lease at East6 (2010 E 6th Street) in 2017 for 114,417 SF and has now put all of that space onto the sublease market. This is a majority of the East submarket’s available sublease space, which is a total of 173,412 SF.
The Cedar Park submarket recorded the highest positive absorption number with 83,940 SF of positive net absorption. The majority of the absorption in the Ceadar Park submarket happened in Class A space and can be partially attributed to two tenants moving into a total of 52,651 SF of space at Paloma Ridge Building C (13620 Ranch Road 620 North).
The Austin office market recorded eleven leases over 10,000 SF each in the third quarter with Auctane leading the way with its 104,153 SF lease at The Grove. In the CBD, Hippo Analytics Inc. signed a lease for 31,641 SF space at 1701 East 5th Street.
According to CoStar, our data provider, Austin’s citywide average rental rate increased marginally over the quarter from $36.41 per SF to $36.45 per SF.
The highest rental rates across the Austin office market in the third quarter were in CBD Class A buildings where net rental rates average $53.54 per SF. Rental rates were also high in the East submarket where Class A rental rates reached $47.21 per SF.
Citywide Class B rental rates decreased marginally in Q3 2020 to $32.97 per SF down from $33.02 per SF in Q2 2020. CBD Class B rental rates decreased 1.3% over the quarter from $49.66 per SF to $49.00 per SF in Q3 2020.
Austin’s office market recorded 358,967 SF of leasing activity in Q3 2020. Only eleven leases for 10,000 SF or more were signed in Q3 2020 while 38 were signed in Q3 2019. The largest lease signed during Q3 was Auctane’s lease at The Grove (4301 Bull Creek Road). This lease for 104,153 SF, signed in August, put the bulding at 79.7% leased just before the building finished construction in September.
Commentary by Doug Rauls | Executive Vice President | Austin
Investment sales activity in Austin picked up in the third quarter, compared to an extremely small number of closed transactions in Q2. Major transactions in Q3 included the sale of the BAE Systems campus to Karlin Real Estate, in which Colliers represented BAE in the sale of the property. The BAE campus is comprised of 527,697 SF in multiple buildings on a 146 acre campus in East Austin.
General interest in commercial property listings has picked up in Q3 with more properties under contract in Q3 than in Q2 along with talk of some larger properties coming to market. We are also seeing some purchases of distressed debt and distressed real estate, but it is a very small portion of the overall activity. While the volume of investor interest in Austin has declined substantially from Q4 2019 to Q1 2020, there are still plenty of investors that want to enter the Austin market or grow their portfolios here, but not enough supply of available properties to purchase. Debt markets have largely stabilized after the disruption of the second quarter and reasonable debt is available, albeit with slightly stricter underwriting. We expect investment sales activity (closings and properties under contract) to continue to improve through Q1 2021.
Office Development Pipeline
6,815,882 SF of office space was under construction at the close of the third quarter. Just five buildings delivered in Q3 with the largest being The Grove - Block 1 (4301 Bull Creek Road). This 134,114 SF building delivered in September and is 79.7% leased. 40% of all space under construction is already pre-leased and over 1,500,000 SF is set to deliver in Q4 2020. It is likely that most of these dates will get pushed into 2021 due to delays caused by COVID-19.