FEATURE ARTICLE, AUGUST 2006

OFFICE LEASING REPORT
Brokers in four of Texas’ hottest regions discuss trends in the office market.

Activity in the office sector across the state of Texas is regaining strength, and many of the specific markets in the region are experiencing healthy conditions and re-energized growth. Four brokers who cover four different major markets share their insights with Texas Real Estate Business on the overall climate of office trends, investment and leasing activity in their respective sectors.

AUSTIN

The Austin office space market has experienced quite the peak and valley during the last 6 years. The current office market trend, which is no secret to landlords or to tenants in the market for new space, is that occupancy is increasing and rents are rising.

These two aspects of the Austin office market are gaining momentum and have been fueled predominantly by four phenomena — strong job growth, which has the effect of increasing occupancy through increased rental activity such as absorption; higher occupancy in specific Class A buildings; higher taxes; and higher construction costs.

Regarding strong job growth, Austin seems poised to be a leader among metropolitan areas throughout the country. A look at absorption numbers for the year-to-date bear out that more space is being leased than vacated. A specific example is that in the first 6 months of this year in the central business district (CBD), about 6 percent of the Class A space has been absorbed. This amounts to about 311,000 square feet of absorption in the first half of this year.

When rental rates were sliding downward between 2001 and 2004, there seemed to be a more or less proportional decrease between occupancy rates and rental rates. A snapshot of specific Class A suburban office buildings shows that rental rates have increased dramatically during the last year. For example, one specific office building in the Northwest submarket has raised rental rates by $6 per square foot during the last 12 months. When focusing on these buildings only, there seems to be little correlation between rental rates and occupancy rates. Many of these same Class A buildings are at lower vacancy levels than their Class B counterparts, and many of these Class A buildings are approaching 100 percent occupancy. In this case, the landlords can basically name their price. As their prices rise, however, other landlords are following suit and rental rates are rising across the board.

Tax assessments are increasing, thereby increasing operating expenses and overall rent. A quick check of the county tax records will bear out that this is the case across the board for all commercial properties in Austin.

Construction costs are also rising significantly on both new construction and tenant improvements. There are several projects either under construction or ready to break ground. The costs of constructing these new buildings are dictating rents to be $18 NNN and up. Also, as landlords compete to provide tenants what they need in the way of space improvements, rents rise in order to compensate for the increased costs of constructing these improvements.

All in all, several factors are at play in the office market, and they all seem to point in one direction — up. These trends appear to have the momentum to continue for the foreseeable future, and once again we are moving towards the peak of another cycle.

— Derek Silva is an office specialist with NAI Commercial Industrial Properties Company in Austin, Texas.

HOUSTON

Tamlyn

The tide is turning from a tenant-in-control to a landlord-in-control market. Every energy, oil service and engineering firm is hiring and taking more space. Many new firms and spin-offs are occurring in the energy field. Houston is the energy capital of the world, and the region is continuing to see consolidation from markets such as New Orleans; Tulsa, Oklahoma; Denver; and Midland, Texas.

The market is performing well with 2 million square feet of net absorption in first 6 months of 2006. Energy-sustained high oil and natural gas prices have finally convinced the industry to hire more professionals. The housing market is booming with 50,000 new housing units in 2006. The associated support industries, such as furniture and appliances, are starting to take note of Houston as well.

Corporate users in Houston’s office market are looking for the new 40,000- to 50,000-square-foot floorplates to meet their parking and large electrical needs. This Class A casual two- to three-story tilt wall office product is available along the Sam Houston Tollway.

Houston continues to have a strong central business district (CBD), but there is more and more demand in the suburbs. Companies are beginning to move out to where employees live.

— Rusty Tamlyn is the managing director, capital markets group, in Trammell Crow Company’s Houston office.

SAN ANTONIO

Garza

Aside from landing Toyota’s newest truck manufacturing plant, which opens later this year, the city has experienced key contributions during the past year from the healthcare industry, financial services and the energy sector. Existing companies such as Valero Energy, Tesoro Petroleum, Citibank and World Savings & Loan have experienced significant expansions. The former Sony Electronics plant is being transformed into a regional hub for the National Security Agency (3,000 jobs). Washington Mutual (5,000 jobs) just opened its new regional operations center, and most recently, Lowe’s Home Improvement Warehouse selected San Antonio to build a $126 million data center to be located in Westover Hills. These are just a few of San Antonio’s recent successes.

San Antonio is now home to an estimated 200 call centers including such giants as QVC, USAA, and Chase Cardmember Services. Call centers, which currently account for an estimated 52,000 employees, continue to discover all that San Antonio has to offer, namely a bilingual work force, central time zone, availability of real estate and low cost of doing business. First quarter activity included a 33,500-square-foot lease by Harris Connect for a 250-person call center. In the second quarter, Afni Inc., which expects to employ 400 people by next year, signed a lease for 32,400 square feet. Office flex and traditional office space with larger floor plates, high parking ratios, reliable power sources and fiber-optic networks are important features to these back-office operations.

Job growth and an expanding economy are fueling the recovery of the local office market, which has experienced nine consecutive quarters of positive net absorption. According to Kim Gatley, Director of Research for REOC Partners, Ltd., the office market experienced nearly 400,000 square feet of positive net absorption through mid-year compared to roughly 250,000 for the first two quarters of 2005. The expansion of existing tenants within the market accounts for the majority of the activity as corporate confidence continues to rise. The citywide direct vacancy stands at 14.4 percent, down from 17.3 percent recorded last year at this time. Activity and new development has tightened the suburban market vacancy rate to 13 percent while the softened downtown vacancy hovers close to 20 percent. Citywide, the Class A market experienced nearly 150,000 square feet of positive net absorption year-to-date resulting in an improved vacancy rate of 11 percent, down from 13 percent recorded last year at this time. As a result, speculative construction is on the rise with projects such as Heritage Oaks (160,000 square feet), La Arcata (103,000 square feet) and Union Square II (127,000 square feet), which was originally proposed in the late 1980s, getting underway.

In many cases, landlords are once again gaining the upper hand in lease negotiations, although some concessions — generally in the form of a short rental abatement period — are still being offered in those buildings with significant vacancy to fill. Conversely, larger tenants with outstanding credit are still highly sought after by most buildings and still sometimes gain the upper hand. While some deal points remain relatively stable, such as the typical 5-year lease term, the size of the typical office lease has grown, now ranging between 3,000 to 3,500 square feet, which is slightly larger than the average through the 1990s. Tenant improvement allowances have also risen slightly in response to the increased cost of construction materials and labor. Improving occupancies have supported rental rate increases throughout the market. The citywide average quoted rental rate climbed to $18.30 at mid-year, up $0.36 over a year ago. The citywide average quoted rental rate for Class A space has topped $21 per square foot on a full-service basis, which is the highest it’s been in this market.

Leasing fundamentals continue to improve steadily. As a result, investment activity is on the rise along with sale prices. On the large end of the investment spectrum, the user purchase of the former MCI campus by Washington Mutual dominated investment news. Meanwhile, buyers and capital are abundant. Maier Siebel Baber recently added another Class A building to its San Antonio portfolio with its purchase of Pacific Plaza (104,000 square feet) and Equastone entered the market in a big way during the last year with the purchase of two Class A buildings – One International Centre (299,000 square feet) and Tetco Tower (256,000 square feet). On the smaller end of the investment spectrum, office condominiums are the hot trend among private investors, physicians, and baby-boomer business owners. Investors, more confident than ever that the best years lay ahead, recognize that San Antonio office properties offer tremendous growth potential — especially compared to other markets around the nation.

— Steve Garza is a partner with Providence Commercial Real Estate Services/CORFAC International in San Antonio.

DALLAS/FORT WORTH

O’Keefe

Tenants are continuing to upgrade from Class C and lower grade B product into more desirable Class A and B space. The potential concern for vacancy in the market is the high volume of speculative projects under construction. This is particularly relevant in Far North Dallas — an area considered by developers to be the next big growth area — where less than 10 percent of the 1.4 million square feet under construction has been pre-leased.

Another area of strong office growth is Dallas’ central business district (CBD) and Uptown submarket. Companies that had moved out to the suburbs years ago are now looking at downtown due to its light rail transportation, construction of hundreds of new apartments, condominiums, hotels, retail space and various public-sector improvements. 

With more than 7.1 million square feet of office space available, it remains clear that Downtown Dallas has some viable options available for both Class A and B buildings. Lincoln Plaza, Thanksgiving Tower, 2100 Ross, Renaissance Tower, Bank One Center, Plaza of the Americas and One Dallas Center all have more than 150,000 square feet of contiguous space. In addition, CityPlace will have approximately 500,000 square feet of office space available after 7-Eleven moves to Billingsley’s One Arts Plaza in The Arts District — an area that is seeing particularly strong growth. With 7-Eleven as its anchor tenant, One Arts Plaza has approximately 266,466 square feet of office space still available.

Hunt Properties and Corgan Associates are also breaking ground in The Arts District on an office complex of around 460,000 square feet combined that will house their various companies. Across the freeway is the trendy Uptown/Turtle Creek area, which has approximately 413,000 square feet of space in construction, more than a third of which is pre-leased.

In the hopes to connect Uptown and Downtown and create even more synergy between the areas, developers are working on an office tower on 2.9 acres overlooking Woodall Rodgers Freeway and McKinney. The 20-story tower will be the biggest office building constructed in Uptown in more than a decade. Plans have progressed to construct a park that would bridge Woodall Rodgers Freeway between Lincoln’s building site and downtown. On the northwest side of downtown is the extensive Victory development that includes office space, hotels, retail shops and a spice of the nightlife, which will likely draw attention to the area.

In addition, we’re seeing strong growth in corporate relocations into the DFW area. A few corporations that have relocated or expanded, or plan to in the near future, include Fluor Corporation, Sanyo Energy, The Home Depot, Countrywide Financial, The First American Corporation and AmerisourceBergen Corporation.

— Pat O’Keefe is senior vice president of CB Richard Ellis in the firm’s Dallas office.

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