COVER STORY, DECEMBER 2007

BROKER OUTLOOK 2008
Experts wrap-up the year and look toward the future.
Lindsey Walker

Texas Real Estate Business spoke with a number of brokers from across the state to find out how the Texas markets performed in 2007 and what to expect in 2008. While not all cities and property types are expected to post the same impressive numbers as they did this year, by all accounts, Texas’ industrial, office, retail and multifamily sectors are on track for an active, healthy 2008.

Dallas/Fort Worth

Dallas/Fort Worth has had a successful year in the commercial real estate arena. “Leasing activity has often exceeded benchmarks from 2006 and has been driven by consistent demand from the local business community,” says Mark Fewin, senior managing director for CB Richard Ellis in Dallas. “Correspondingly, the Dallas/Fort Worth Metroplex has seen growth among area rental rates, particularly in the office sector.”

The overall vacancy in the office arena remained flat at 20.7 percent in the third quarter of 2007, with approximately 575,902 square feet in positive absorption, according to Kevin Santaularia, president/CEO of Bradford/CORFAC International in Dallas. “Leasing activity remains steady; however, there is some pressure from the related housing sector users in the form of sublease space that is beginning to generate untimely vacancies.”

The Class AA office sector is in high demand, particularly among the newest developments with luxurious amenities, Fewin says. “Despite high asking lease rates, tenants value such space for its business advantages.”

Tenants also value office space that offers amenities such as nearby (or on-site) retail, restaurant, residential and hospitality uses. “A new trend has already begun to emerge in the development industry for the full integration of new office and retail product within mixed-use developments,” Fewin says. “Projects such as Victory Park, Legacy Town Center, Frisco Square and the upcoming Park Lane Place all demonstrate a new placement strategy for commercial product that offers greater convenience and lifestyle benefits to its tenants. The great success and appeal of these developments is likely to inspire similar concepts in 2008.”

In 2008, the Central Expressway, Uptown and Far North Dallas submarkets are each poised to grow as a result of innovative and exciting development projects, Fewin says. “The Park Lane Place development, in particular, could create greater momentum and activity in the Central Expressway submarket,” he notes. “Uptown continues to be one of the fastest growing and sought-after submarkets.”

Retail leasing, which began a strong positive trend in late 2006, has continued through 2007 with more than 4.7 million square feet absorbed this year, according to Fewin. “That represents a remarkable increase from this time last year, when year-to-date absorption had been negative,” he adds.

In terms of multifamily, the long-term economic and demographic outlook — employers are on pace to add 87,700 jobs in the Metroplex by year-end — and above-average yields are expected to tighten investment activity, according to Tim Speck, regional manager of Marcus & Millichap’s Dallas office. “Vacancy rates are expected to tighten by year-end, placing upward pressure on asking rents, and effective rents are expected to finish 2007 at $759 per month and $696 per month, gains of 3.4 percent and 4.3 percent, respectively, since the end of 2006.”

The industrial sector, which encompasses approximately 620 million square feet, saw its vacancy rate slip below 10 percent for the first time since 2000, according to Santaularia. “There are 15 million square feet of active spec developments in the pipeline, and with absorption through the third quarter in the 11 million-square-foot range, the market is in equilibrium as long as absorption remains at current levels,” he says. “The industrial sector seems to be the favored son in the Dallas/Fort Worth market, with continued inflow of users from both the East and West coasts, serving the Southwest and Midwest with cheaper distribution logistics.”

In 2008, “continued job growth will lead the Dallas/Fort Worth area to an improved office market, with industrial leading the charge,” Santaularia says.

HOUSTON

The energy sector has continued to support Houston’s growth in 2007, and Houston’s employers are on track to add 72,100 jobs in the metropolitan area by year-end, boosting employment by 2.9 percent, according to Michael Hoffman, regional manager of Marcus & Millichap’s Houston office.

Leasing activity remains extremely consistent in Houston’s industrial market, which boasts vacancy around 7 percent. “We are seeing 50,000-square-foot plus in distribution requirements, says Brian Corriston, senior commercial services provider for Caldwell Companies in Houston. “This is due to the Houston economy, which seems insulated from the national economy and is driven by the energy sector. Freestanding manufacturing buildings, specifically crane-served, seem to be in short supply. Second- and third-generation space less than 20,000 square feet also is scarce.”

The North Corridor of Houston has seen plenty of industrial activity in 2007 with companies like Atlas Freight (68,000 square feet), EMCD (150,000 square feet), CED (80,000 square feet), and LoneStar Fasteners (45,000 square feet) taking space. “The new developments in the North Corridor are leasing up nicely, mainly due to favorable lease rates, amenities such as lay down yard, and great access to major freeways,” Corriston says.

As long as the economy and job market stay strong, 2008 will be another good year for industrial in Houston. “Developers will continue to acquire land sites to keep up with demand,” Corriston says.

On the multifamily side, the apartment investment market will continue to be buoyed in the coming months by the metro’s attractive average cap rates, which currently are in the high-7 percent to low-8 percent range, as well as its solid long-term economic and demographic outlook, says Hoffman. “Due to the increase in spreads and tighter lending standards, apartment investors are expected to seek assets in the growing metro in 2008,” he says. Local buyers will focus on lower-tier properties in emerging submarkets around the Outer Loop, Hoffman notes.

“Larger investors with longer holding periods are expected to buy Class A assets in emerging submarkets next year, such as Katy/Bearcreek, Sugar Land/Fort Bend County and Montgomery County,” Hoffman says. “In the coming months, in-migration patterns in these areas, coupled with rising housing costs, will support revenue growth above the metro average.”

With the collapse of the subprime mortgage industry, Houston’s apartment occupancy levels will rise in the coming months, Hoffman says. “Vacancy is forecast to finish the year at 10.1 percent, a 120 basis point improvement from the rate posted at the end of 2006,” he says. “In 2008, vacancy is expected to slip below the 10 percent threshold.”

The retail market also has a positive investment outlook for 2008, according to Hoffman, as the long-term economic and demographic forecasts for the metro support future fundamental improvement. Single-tenant properties have initial yields in the high-6 percent range that are still above the national average; however, Hoffman warns, velocity may ease in the coming months as 1031 capital dissipates. “Multi-tenant cap rates also are above the national average, currently hovering around mid-7 percent,” he adds.

Local investors are expected to take advantage of redevelopment opportunities in the close-in submarkets, while institutions, REITs and other large investors are targeting new shopping centers in emerging communities along the outlying areas, according to Hoffman.

AUSTIN

With a favorable long-term economic outlook, the state’s capital appears to be on track for a bright year in 2008. While employment growth and absorption numbers aren’t expected to be quite as strong as in 2007, Austin’s economy is outpacing national trends and should remain healthy across the board in the coming year.

“Austin’s economy currently is outpacing the national economy, and is expected to do well in 2008,” says Kevin Roberts, president of the Central Texas Region for Transwestern. “Austin has seen a construction boom in the last 18 months affecting all commercial real estate sectors — office, industrial, retail and multifamily. However, even with new deliveries coming to market each quarter, the absorption for all sectors has remained positive.”

The multifamily sector, in particular, is performing well — though there is concern that the subprime fallout will slow the growth of the condo market. “Since the rise in interest rates and the recent collapse of the subprime mortgage industry, the housing market has become less affordable for many of the area’s residents,” says Bradley Bailey, regional manager of Marcus & Millichap Real Estate Investment Services’ Austin and San Antonio offices.

The central business district (CBD) is the prime growth area for multifamily, with more than 3,500 condo and apartment units planned or under construction as of November 1, according to Roberts. For buyers, the submarkets adjacent to the Central submarket — such as the Near South Central and East Austin areas — are hot. 

The city’s employment growth is contributing to the active multifamily market, which currently boasts occupancy at 97 percent. In 2007, Austin area employers were expected to expand their payrolls at one of the fastest rates in the country by adding 23,500 positions, a 3.2 percent annual increase, Bailey says. 

According to Bailey, rentals rates are set to increase for apartment properties in 2008. Asking rents are forecast to reach $822 per month this year, while effective rents will finish 2007 at $738 per month — both gains of 3.9 percent from year-end 2006, he says.

Next to the multifamily market, the industrial sector is the second most robust property type with several large leases and expansions having been executed in 2007, says Roberts. “Industrial absorption will likely be between 1 million and 1.5 million square feet by the end of the year, which is above last year’s 1.1 million,” he says.

The Austin industrial market is on pace to enjoy its fifth consecutive year of positive absorption, adds David Barber, industrial specialist/investment sales with NAI Commercial Industrial Properties Company in Austin. “New construction has remained steady and responsible to meet demand and the market is witnessing pre-leasing success of these projects ahead of projections,” he says.

The North and South submarkets are the places to be for industrial space, with the North being the largest in terms of square footage and the South due to the relocation of Austin’s major airport. The Southeast submarket, in particular, is booming with approximately 3 million square feet under construction and an additional 1 million square feet planned, according to Roberts.

Flex and office/warehouse properties are experiencing steady activity, according to Barber. “As the population growth continues and more service and distribution companies expand and locate to Austin, office/warehouse will remain leased,” he says. “Rates for Class A space are at a historical high. These rates are applying pressure to the Class B office market, which causes many users to opt for flex space as an alternative to traditional office space.”

With these office users moving to flex space, Austin’s office leasing activity is slightly lower than last year, says Ford Alexander, office tenant representative for Oxford Commercial in Austin. “R&D flex space is less expensive than office space, and it allows tenants to have their industrial needs filled in-house,” adds Ryan Kasten, also an office tenant representative for Oxford Commercial.

The most notable vacated office space in Austin will come from AMD leaving its current home and heading to its new campus on Southwest Parkway, according to Josie Marshman and Lise Luchsinger Wineland, office specialists with NAI Commercial Industrial Properties. 

“Leasing activity for 2007 has been healthy, yet slower than the year prior,” Marshman says. “At the mid-year, the city of Austin has low absorption due to the fact that a large number of properties were delivered but not yet leased.” This occurred predominately in the Northwest and Southwest sectors with a combined negative absorption of 500,000 square feet; however, both sectors experienced only 10 percent vacancy. “The CBD, on the other hand, enjoyed a healthy positive absorption of more than 260,000 square feet,” notes Wineland.

With more than 3 million square feet of new office construction, the story in 2008 will be whether Austin will absorb the new space, Marshman and Wineland say. “Overall, the office market in Austin remains strong with rising rental rates and steady, relatively low vacancy,” they say.

In the retail sector, there has been relatively flat occupancy in 2007, indicating that there isn’t very much space being vacated, says Travis Waldrop, retail specialist with NAI Commercial Industrial Properties. “The one exception has been the continued closing of Albertson’s locations in the market and the subsequent vacancy of these large spaces,” he says.

Absorption has been very strong; in the first 6 months of 2007, the market absorbed more than 1 million square feet of retail space, according to Waldrop. “The fact that 8 major projects have been delivered this year and our overall vacancy rate is relatively flat from 2006 is evidence of the strength of the market,” he says.

These major projects — Southpark Meadows, The Domain, Shops at Arbor Walk, Shops at Arbor Trail, Sunset Valley Homestead, 1890 Ranch, Mueller Phase I and Hill Country Galleria — are attracting some exciting new tenants to Austin. Nieman Marcus, the most notable anchor tenant to enter the market, has signed on at The Domain, which also has attracted upscale retailers such as Oakville Grocery, Barney’s Co-Op, Tiffany & Co., Louis Vuitton, Martin + Osa and Sur La Table.

According to Bailey, Austin’s favorable long-term economic outlook will remain a draw for retail investors. “Cap rates — currently in the low-7 percent range for single-tenant assets and mid-8 percent range for multi-tenant space — remain as much as 150 basis points higher than markets on the West Coast,” he says. “With above-average initial yields, out-of-state buyers are expected to stay active. Exchange buyers will look to trade up to larger, newer strip centers that offer fewer maintenance issues, while local investors will seek out single-tenant properties under long-term leases.”

SAN ANTONIO

In San Antonio, the end of 2007 is bringing a full line-up of leasing activity, investment sales and new development to the office market, according to Brian D. Harris, senior vice president and partner with NAI REOC Partners in San Antonio. “The completion of two new office projects added a total of 131,715 square feet to the citywide inventory in the third quarter,” he says. “Third quarter completions raised the city’s year-to-date new office development total to 606,488 square feet — nearly double the average of 305,000 square feet added each year since 2000. Demand for space, evident by the stream of leasing activity occurring within the market, is driving new construction.”

Office absorption, while behind 2006, is keeping pace with these new deliveries, says Kevin Roberts, president of Transwestern’s Central Texas Region. “While it will be difficult to eclipse the 812,000 square feet of office absorption in 2006, a strong fourth quarter should pace year-end absorption in the 700,000- to 750,000-square-foot range,” he says.

On the industrial side, absorption through the third quarter has been 1 million square feet, slightly outpacing the 970,000 square feet of deliveries of new space in 2007, Roberts says.

“The past 3 years have been good years for the San Antonio industrial market,” Harris says. “Leasing activity has been strong and demand for space has led to new development.”

Roberts adds, “San Antonio’s industrial market will continue to grow and gain traction as an inland port with the new intermodal activity and resulting secondary demand.”

Retail is still on the grow in San Antonio, despite rising gas prices and slowing residential construction, Harris says. “This is thanks, in a large part, to healthy population and employment growth,” he notes. “New development delivered more than 818,000 square feet in the third quarter. On the horizon, more than 6 million square feet of retail space is under construction.” Three major projects account for nearly half that total: Alamo Ranch Marketplace, Park North and Gateway Plaza.

“Pre-leasing is very strong, so it is a good bet that strong absorption will continue,” Roberts says.

Multifamily occupancies are slightly lower than in 2006 due to new supply coming on line. “To lure renters, move-in specials and other concessions are being offered in 82 percent of Class A apartment communities,” Harris says.

Eleven new apartment projects have been started in the first quarter of this year, accounting for 2,473 units, says Harris. “Combined with projects already under construction, 8,919 units are currently being developed,” he says. “By year-end, an estimated 4,000 of these units will reach completion.”

Looking forward, continued job growth and a healthy national economy are critical to 2008 and beyond, Roberts says. “We have pent-up job growth from firms such as Washington Mutual that continue to add staff, which will fuel office absorption and retail growth.”

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