FEATURE ARTICLE, JANUARY 2006

LOOKING BACK, MOVING FORWARD: PART II
Commercial Texas continues its glimpse into the evolution of Austin's office market from 1980 to now.
Michael Kennedy

This is the second article in a three-part series by Commercial Texas that chronicles the history of Austin's office market. Part 1 can be found on page 23 of the December 2005 issue of Texas Real Estate Business or at http://www.texasrebusiness.com/articles/DEC05/feature1.html. Part 3 will be published in the February 2006 issue.

Though 1989 was a banner year in terms of absorption, the depressed economy that was present led few to realize that the turn upward had been made as Austin entered the 1990s. The Resolution Trust Department was created by the federal government to deal with the massive bank and savings and loans failures, resulting in a huge volume of foreclosed and abandoned commercial real estate assets. Austin was littered with unkept office buildings, shopping centers, housing subdivisions and apartments, some of which should never have been built, others of which were never able to be leased or occupied.

These assets began to be purchased by risk-taking investors at prices as low as 15 percent to 20 percent of what their value might have been a short 4 to 5 years earlier, and well below what replacement cost would be.

Additionally, the Save Our Springs ordinance was passed, which provided for 15 percent impervious cover restrictions in the Barton Creek watershed. When coupled with the further U.S. Fish and Wildlife endangered species protections for migratory song birds and cave dwelling creatures in even larger areas of the southwest and northwest markets, the environmental restrictions effectively removed thousands of acres from development.

One classic case is the approximately 450 acres on the west side of North Loop 360 near Spicewood Springs Road. Originally intended as a large mixed-use development that sold for $17 million in the 1980s, it was acquired by an environmental group for just $3 million and set aside as a preserve. It remains so today. The lack of economic need or value in much of the raw land or existing properties gave the environmental community significant strength in creating restrictions for any future development.

In the meantime, the Sematech Consortium, formed by U.S. chip manufacturers to combat the Japanese domination in the arena in 1988, brought many companies to Austin from California. These companies, including Applied Materials, a company that manufactures the machines that manufacture the chips, would not have entered the region otherwise. Applied Materials' location, subsequent growth, and the peripheral suppliers and vendors relocating to Austin became a catalyst for recovery in the industrial and office markets.

Motorola, AMD and IBM all expanded their manufacturing facilities in Austin in the early- to mid-1990s. Dell, in particular, came into its own in the early 1990s and began its march to be the Number 1 private employer in Austin by the end of the 1990s at approximately 20,000 employees. In fact, Austin was the only major city in Texas to have more manufacturing jobs at the end of the 1990s than when the decade began.

Manufacturing-related jobs tend to bring more jobs and business to an area. This increase fed directly into building the office and industrial marketplace. In December 1993 Capitol Market Research stated that, for the first time since 1990, positive office absorption occurred in every submarket in the city.

Investor purchases in 1993 exceeded owner-occupant purchases, reflecting recovery. Even new construction was being initiated, albeit in selective locations and by developers building out of their pocket as neither pre-leasing, equity or available financing were easy to come by. By 1995, occupancy was close to 90 percent, job growth was rising and new construction was underway.

However, all the real estate activity was suburban. With considerable absorption and very little Class A suburban space available, rents escalated more than 20 percent in the northwest submarket during the prior 24 months.

By 1996, rates had jumped another 15 percent to more than $22.50, and the new construction at Bridgepoint Square, The Terrace and Barton Oaks V was all leasing quickly.

Office building REITS CarrAmerica and Crescent entered, following Equity Office's lead, to acquire both suburban and central business district (CBD) properties. Class A rents citywide had increased by more than 30 percent in 30 months, and new construction accelerated while the Class A, B and C vacancy shrank to less than 9 percent citywide. The tech boom was full on, and all suburban space was at a premium.

With start-ups securing financing at lightning speed, and no suburban space available, the only place to go was downtown. These young companies with young people found the older historical buildings “cool.” This absorption of functionally obsolete space, in conjunction with the leadership of the Downtown Alliance and the Mayor's office, would lead to a growing renaissance in Austin's CBD.

Lured by the economics of a long-term ground lease on city-owned land fronting Town Lake, and encouraged by the environmental community to be off Barton Creek, CSC Corporation built two five-story office buildings downtown. The acceptance of the CBD by tech firms lured Intel and encouraged other smaller tech firms to see the CBD as the place to be.

By year-end 1997, absorption totaled approximately 1 million square feet. Rental rates were up an additional 10 percent, and vacancy was just over 6 percent in Class A and B space. Bridgepoint Square, a 350,000-square-foot project, sold at a then record $177 per square foot to HPRT REIT. The market was superheated with 1 million square feet under construction and another 1 million planned to begin in 1999. Job growth was robust and each day it seemed the papers screamed out the name of another NASDAQ IPO with its stock soaring.

The year 1998 offered more of the same. There was another 8 percent increase in rent with 2.5 million square feet under construction or planned. Job growth soared and overall Class A vacancy was at 3.5 percent, which marked unbelievable growth and prosperity.

For the first time in the decade, supply in the pipeline exceeded demand, but with so little space actually available to be occupied, this anomaly was short lived. Once again more than 1 million square feet was absorbed and Austin's tech party seemed destined to go on forever.

The following year, 1999, was the big one. Approximately 2 million square feet was absorbed, twice Austin's historical high point of 1989. Overall vacancy stood at 6.3 percent citywide with the total space square footage at approximately 29 million square feet, an increase of nearly 8 million square feet of inventory in 6 years.

More than 3 million square feet was under construction, and another 3 million plus was planned. With typical market absorption of 1 million square feet per year in a good year, Austin was looking at potential trouble ahead. Believing a new paradigm for business had arrived, the old principals were ignored.

A new decade and century would change all that. The 1990s were a time of rebirth for Austin. By the middle of the decade, private sector jobs outnumbered public sector jobs for the first time in Austin's history. Manufacturing jobs begat many service jobs. Technology in Austin came into its own and took over the economy, raising salaries and the cost of living. Venture-backed firms and seemingly overnight riches spawned a whole class of moneyed people inhabiting the city. Real estate went from the outhouse to the penthouse, and those brave souls who bought in the early 1990s when all was dark reaped their reward as the decade closed.

Economic growth and dilution of the old guard on both the pro-business and environmental sides led to compromises that created the Balcones Canyonland Preserve and development restrictions on open space property that enhanced quality of life while increasing values throughout the area. The influx of people and success led to another major issue: traffic. Its annoyances would be carried into the new century.

Michael Kennedy is president of Austin, Texas-based Commercial Texas.

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