| COVER STORY, FEBRUARY 2008
INVESTORS REMAIN FOCUSED ON TEXAS
The Lone Star State economy continues to thrive, attracting local and out-of-state buyers.
Tim Speck
Texas’ healthy economy and long-term economic outlook will keep investment activity elevated this year. A mix of out-of-state and local buyers will compete for assets. The number of out-of-state buyers dropped by as much as 20 percent in the fourth quarter, creating more balance between local capital and imported capital. Both in-state and out-of-state investors are attracted to the state’s long-term economic outlook. Texas developers will continue to deliver Class A properties across the state, placing upward pressure on vacancy in 2008. Investor interest in assets will remain mixed this year as some buyers wait out the current building boom.
Apartment Investment Trends
Austin’s growing economy and expanding student population will drive renter demand for apartments this year, though fundamentals will remain mixed as new supply slightly outpaces absorption. The Central submarket, home to the University of Texas, the state capitol and several major employers, has been a hotbed of condo construction and conversion projects that have depleted rental stock in recent years. As a result of the increased presence of for-sale units in the Central submarket, renters are beginning to spill over into neighboring areas. The Near North Central and Near South Central submarkets are expected to benefit from this trend in 2008 as local residents flock to more affordable properties, supporting revenue growth above the metro average. In the suburbs northwest and southwest of the city center, a healthy local economy will produce some migration-generated demand. The renter pool is expected to be further enhanced by tighter mortgage standards, which may convince potential homebuyers to remain in Class A units longer than anticipated.
After arriving late to the most recent economic recovery, the Dallas/Fort Worth Metroplex will sustain relatively strong growth this year, supporting local apartment demand. Specifically, the rate of job growth will remain significantly above the national average, including a more than 3 percent expansion in the traditionally lower-paying leisure and hospitality sector. Expansion will be widespread, but urban development into Denton and Collin counties in particular will bolster renter demand for local apartments this year. Builders are responding to the metro’s healthy growth prospects by accelerating the rate of deliveries, which will keep vacancy in the mid-8 percent range. With plenty of available land, especially in suburban markets, builders are delivering almost exclusively large complexes. The planning pipeline has slowed by more than 20 percent recently, indicating the construction of new units could taper off in the years to come.
Houston’s apartment market is expected to stay on solid ground this year, as job growth continues to fall above the national average. Vacancy in close-in submarkets such as Montrose/River Oaks and Downtown will remain the lowest in the metro, as renter demand is generated by young professionals choosing to live near work and entertainment options. As vacancy tightens, renter demand will likely spill over into adjacent areas, particularly the Galleria and Energy Corridor submarkets, facilitating robust rent growth and some of the highest revenue gains in the metro. To the south, Class A assets in the Sugarland/Fort Bend submarket will fare well this year, capitalizing on migration-generated demand from the area’s high-paying job market. Southeast of the city center, the Baytown and Clear Lake submarkets are expected to be supported by thousands of new jobs associated with the new cargo terminal, enabling owners to realize occupancy gains. Meanwhile, demand in Montgomery County will continue to be buttressed by the area’s proximity to major employers, including George Bush International Airport.
A favorable supply-demand balance in San Antonio’s apartment market will support a solid year for local properties. Job growth, especially in the traditionally lower-paying leisure and hospitality sector, is expected to push vacancy to its lowest level in 2 years. Congestion on the 281 freeway is causing renters to seek Class A alternatives along the Interstate 10 corridor in the Far Northwest and Far North Central submarkets. Local high-end units in proximity to major employers such as Valero Energy, and new shopping and entertainment options, including the Shops at La Cantera, are becoming increasingly popular with renters. This year, the Southeast submarket is expected to record some of the metro’s strongest revenue growth, as vacancy tightens due to the area’s increasing number of new jobs. In addition, healthy spillover renter demand into the Far Northeast submarket will provide owners with sufficient leverage to reduce concessions, and the area is expected to post some of the metro’s highest effective rent growth this year.
Office Investment Trends
After experiencing an extended rebound from the technology bust earlier in the decade, vacancy in the Austin office market will increase this year for the first time since 2002. Robust rent and occupancy gains over the past 2 years have eased concerns about elevated construction costs and developers are increasing their construction of speculative office space. Expanding local employers and companies moving some or all of their operations from high-rent coastal markets will absorb much of the metro’s new space, but vacancy is expected to rise in the metro’s older and smaller properties. Many companies that are leasing new space are contemplating future growth, which may lead to an active sublet market if the economy cools more than anticipated. The number of businesses choosing to build their own offices also is increasing, a trend that could create further competition for office owners. International RAM Associates, for example, plans to occupy only 50,000 square feet of its new 250,000-square-foot facility in the Southwest submarket. Despite the new development, tenant demand in the area remains healthy and the submarket’s vacancy should edge lower in 2008.
Following 4 consecutive years of improving occupancy levels, the Dallas/Fort Worth office market experience an increase in vacancy this year as builders accelerate the delivery of speculative office space. Office inventory in the Metroplex is forecast to swell by 2.4 percent in 2008, pushing vacancy toward the 20 percent threshold. Rising construction costs may alleviate some of the rapid construction activity; however, developers are taking advantage of current land holdings to expand business parks in order to manage construction costs. For example, the next three planned phases of Granite Park in Plano could add as much as 500,000 square feet of space to the Plano/Allen submarket over the next few years. The delivery of large, speculative Class A projects will give the Metroplex an edge over other comparable cities as cost-conscious companies seeking to relocate can find ample leasing opportunities in the area.
Builders are expected to ease the tight conditions in the Houston office market this year with the delivery of over 3 million square feet of office space. Most of the new construction is speculative and concentrated in traditionally strong office-using districts, such as the Energy Corridor, Galleria and Westchase. Additionally, much of the space is in large high-rises, enabling companies to consolidate operations that are currently scattered around the market into contiguous blocks of space. As such, several smaller spaces will come available, pushing the metrowide vacancy rate up to 13 percent by year end. Despite higher vacancy, pent-up demand for large office spaces in the metro persists, fueling rent growth and some concession burn off. Most of this demand will be exhausted during the first two quarters of the year, resulting in slower rent growth and higher vacancy rates as 2008 progresses.
San Antonio is transitioning from an often-overlooked secondary office market to a diversified metro with an increasing number of traditional back-office positions and major corporate operations. Historically, major office users have targeted the metro’s lower-tier space to house nonlocation-essential functions such as customer service call centers due to the metro’s central location and the availability of a bilingual labor force. Over the past few years, however, the addition of true Class A properties, combined with considerable rent increases in coastal markets and nearby Austin, has made the market significantly more attractive to bottom-line-conscious companies. San Antonio’s low business costs will support further major corporation relocations to the area, followed by support companies. Strategic Staffing Solutions, an IT staffing company, for example, recently moved to the area to assist a major client. As such, occupancy levels will climb for the fourth consecutive year, allowing for impressive rent growth.
Retail Investment Trends
Austin’s bright economic outlook continues to attract retailers, a trend that will drive development in 2008. Much of the metro’s construction is centered in master-planned communities to the north and south of the city center, where builders are taking advantage of newly available sites stemming from infrastructure improvements. Additionally, major retail projects are planned or under construction at both ends of state Highway 130, which bypasses the metro to the east. Robust retail development caused vacancy to rise last year, though the increase is expected to be short-lived, due in part to the region’s long-term demographic and economic trends. Population and job growth are forecast to boost retail sales by nearly 5 percent this year, one of the largest advances in the country. Going forward, household incomes for Austin’s highly educated work force will continue to outpace the national median, which, coupled with the area’s relatively affordable housing market, will result in further increases in disposable incomes.
Dallas/Fort Worth will boast one of the strongest economies in the country again this year, though heightened construction activity will result in a supply-demand imbalance. Builders are positioning themselves in the path of growth in an attempt to meet demand from national retailers. As such, several strip centers are expected to come online with a significant amount of vacant space, especially in suburban submarkets like Far North Fort Worth and Southwest Collin County, where much of the new construction is concentrated. Occupancy challenges in new projects should be relatively short-lived, however, as smaller retailers will migrate into the new developments this year, creating long-term occupancy challenges for some older centers in first-ring suburbs. The Arlington submarket will be an exception to this trend as retailers quickly expand into new space in the burgeoning area, hoping to capture demand from both sides of the Metroplex while leaving occupancy in older centers intact. Indeed, Arlington is forecast to rank near the top of the Metroplex’s submarkets for revenue improvement and concession reductions. The Far North Dallas submarket will exhibit the highest revenue gains, however, as vacancy in the area sheds more than 150 basis points.
While demand drivers in Houston will continue to show strength, new supply will put upward pressure on retail vacancy in 2008. Fueled by population and job growth, retail sales will expand by more than 4 percent this year, once again among the highest rates in the country. Much of the population growth is in master-planned communities in outlying suburbs, such as Montgomery County, which is expanding at twice the metro rate. A wave of condos and Class A apartments catering to professionals within the Inner Loop and west of downtown are also increasing population density. As a result, developers are razing and constructing new retail properties, particularly strip centers, in the area. The Pavilion at Post Oak, for example, is being redeveloped with 286,000 square feet of new retail space, despite its proximity to the Houston Galleria, one of the largest malls in the country. On the supply side, construction is putting pressure on older strip centers outside the Inner Loop, which may lose tenants to new construction in the growing suburbs or the revitalized city core.
Demand for San Antonio retail assets will be driven by expansion in the local economy this year. Bucking the national trend, local employers will accelerate hiring efforts, as exemplified by a projected 4 percent uptick in the traditionally higher-paying professional and business services sector. Additional demand will stem from the healthy local tourism industry, supported by attractions such as Six Flags Fiesta Texas and Sea World. As a result, retail sales are expected to climb by nearly 4 percent in 2008, significantly above the national average. On the supply side, expansion of existing power centers in the North/North Central and Northwest submarkets will account for much of the additions to inventory over the next few years. Development is slowing throughout the metro; completions will come in well below recent levels, and the planning pipeline consists of only 6 million square feet, 20 percent less than one year ago. The only major new project slated for completion in 2008 is the 960,000-square-foot Alamo Ranch in the Northwest submarket.
Although the Texas economy remains one of the strongest in the United States, out-of-state and local investors will feel the lingering effects of the late 2007 capital markets crisis. The repricing of commercial investment real estate will require savvy brokerage and real estate services companies to return to the basics when valuating properties. In 2008, investors will acquire assets based on their current or achievable pro forma income. By all accounts, that will be a positive trend that we embrace in the New Year.
Tim Speck is the first vice president and regional manager in the Dallas office of Marcus & Millichap Real Estate Investment Services. Speck wrote this article in conjunction with Michael Hoffman and Brad Bailey.
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