| FEATURE ARTICLE, JUNE 2007
OFFICE LEASING
Brokers in Dallas/Fort Worth, Houston and San Antonio discuss office leasing in their respective markets.
Dallas/Fort Worth
The Dallas/Fort Worth office market is boasting improved market indicators thanks to an active local business climate. The first quarter of 2007 marked the 10th consecutive quarter of positive net absorption in the market dating back to year-end 2004. During that time, Metroplex office vacancy has declined by 20 percent to reach one of its lowest levels in the past 5 years.
Tenants in the market have shown a preference commonly referred to as a “flight to quality,” where significant upgrading activity has moved companies from Class B and C space into the Class A environment. Markets such as Dallas/Fort Worth are prime for such activity, as there is often only a minor overhead increase for tenants moving between class types. Accordingly, the Class A sector has been vital, experiencing a majority of the positive net absorption each quarter in recent history.
Across the market, certain owners of Class A buildings are seeking to differentiate their property through the addition of attractive amenities and renovations. The delivery of cutting-edge Class A office space to the market, when coupled with a healthy demand, has contributed to significant rental rate growth among the Class A sector. Owners are keeping an eye on their future in a market that has recently seen high-profile relocations, such as Comerica moving its world headquarters to Dallas from Detroit.
Although there is a wide mix of companies seeking office space in the Metroplex, several industries have been the most active and numerous. A sizeable number of technology/telecom firms are in the market for large blocks of space, particularly in suburban areas. Meanwhile, other tenants commonly shopping for space across Dallas/Fort Worth include those within the banking, insurance and consulting industries.
So far in 2007, the office investment market has been active with nearly $1.5 billion in reported transactions. DFW has garnered consistent interest as a top office investment market, having both prices and cap rates that compare favorably with the nation at large. There has been renewed investment interest near Downtown Dallas, where the blossoming of Uptown and the Arts District provides a very optimistic view of the future. Properties such as Thanksgiving Tower, 2100 Ross and Cityplace Center have been recent high-profile transactions.
Meanwhile, certain office properties appear to be particularly enticing to investors. As Russell Ingrum, executive vice president at CB Richard Ellis notes, “Value added assets are garnering the most attention. Properties that have rollover, vacancy or asset positioning issues that a buyer can come in and fix are at the top of the shopping list for most investors.”
Across the Dallas/Fort Worth area, average asking lease rates continue to rise on a quarterly basis. During the first quarter of 2007, the average rate increased by $0.15 per square foot to reach $18.43 market-wide. After years of declining office rental rates, the trend reversed course and began to grow in early 2006. Since that time, the average asking rate has increased by $1.23 per square foot, and continues to grow at approximately $1 per square foot each year.
Phil Puckett is executive vice president of CB Richard Ellis in Dallas.
Houston
National investors have taken notice of Houston’s healthy office climate, particularly in downtown, as they are hoping to capitalize on rising rents and increasing demand for space, and the Energy Corridor. Medical office properties are beginning to attract development and investment interest.
For the most part, these investors — typically REITs and large institutions — are interested in office properties that have stabilized occupancy and proven cash flow. There is not much speculative investment in office buildings, which is due to the high cost of lease-ups and construction build-out.
The current trends in Houston’s office leasing market are the continuing rise of rental rates. Rental rates had increased by 2.1 percent at year-end 2006, and this trend seems to be continuing into the first quarter of 2007.
The overall net absorption for the Houston office market was a positive 506,156 square feet. Class A product absorbed 491,586 square feet; Class B product absorbed 214,200 square feet; and Class C product had a negative absorption of 199,630 square feet, still creating a very competitive market condition.
Current activity in Houston is being driven by job growth, with more than 75,000 new jobs added to the metropolitan area in 2006 — a 3.1 percent increase over 2005, according to the Texas Workforce Commission. Smaller companies are beginning to expand as well as the larger companies, and Houston continues to have a large base of oil- and gas-related businesses experiencing expansion and rapid growth.
At the present time in most submarkets, the tenant has the upper hand in lease negotiations, with the exception of Class A properties located downtown where this particular submarket is leaning more toward the landlord. This is probably going to be the continuing trend for the near future due to the fact that there is still approximately 30 million square feet of office vacancy on the market; however, that may change by year-end 2007. This year has started off a little slowly by absorbing only 500,000 square feet, but the leasing activity has not declined. It still seems strong and moving in a positive direction.
The largest blocks of office space are being shown to oil and gas, construction and engineering businesses, and technical/vocational schools. The oil and gas companies and engineering firms are looking at only Class A product, while the technical/vocational schools are looking at Class B.
Large blocks of Class A space greater than 50,000 square feet are currently in demand. The area also is seeing a demand for buildings that have large blocks of contiguous open space with the capability of doing short-term leases to accommodate engineering-type firms for specific contract assignments.
The suburban market continues to have lower vacancy than downtown. Tracking new construction, there are 64 buildings currently under construction and only two of them are in the downtown market. The majority of the buildings under construction are in suburban areas.
Peggy Rougeou is the director of commercial leasing for Tarantino Properties in Houston.
San Antonio
San Antonio’s office investment market continues its strong performance with no immediate signs of slowing down. According to Real Capital Analytics, private, public and institutional investors spent nearly $492 million for the 12 months ending April 2007 to acquire office properties in the San Antonio area. High occupancy levels, strong economic conditions and national recognition are driving much of the investment activity. Well-located, high occupancy Class B office properties are garnering the most attention. Some of the top investment buyers in San Antonio within the past 12 months include Brass Real Estate Funds, Intercontinental Real Estate, Maier Siebel Baber, Koll Bren Advisors and Equastone. The next 12 to 18 months will demonstrate a heightened interest by investors as vacancy levels slide downward and asking rents steadily climb.
San Antonio’s office leasing market is continuing where it left off in 2006. Overall vacancy continues to slide downward and asking rents are climbing in response to the increased tenant demand. Well-located Class A space is extremely sparse, leaving many tenants little options for expansion or relocation. Large contiguous space is another challenge for tenants in both Class A and B sectors. New developments, in the 40,000- to 131,000-square-foot range, are being constructed in the North Central and Northwest submarkets. These developments, however, will be hard pressed to keep up with demand as many are coming on line at more than 70 percent pre-leased.
San Antonio’s office leasing market remains strong and all indications point to more positive growth in 2007. During the first quarter of 2007, Class B significantly outpaced the other classes with 67,928 square feet of black ink, while Class A and C closed the quarter with 4,624 and 7,692 square feet, respectively. Class B continues its growth with its eighth consecutive quarter of positive gains. As a result of the market’s steady improvement, San Antonio’s overall office vacancy decreased by 10 basis points to 12.1 percent. As landlords respond to the positive market forces, full-service asking rents for all property classes are reaching, or exceeding, their highest levels in over 5 years.
Strong economic conditions, national recognition, relatively low asking rents compared to other Texas markets, and the low cost of doing business are all major factors in attracting new businesses to San Antonio. San Antonio continues to be on the map for data center and call center businesses as they are attracted by our low energy costs, central time zone, bilingual work force and the fact that we are not in “tornado alley”, hurricane or earthquake zones. For example, Microsoft just announced its purchase of 44 acres in Westover Hills (Northwest San Antonio) for a 470,000-square-foot data center.
There appears to be a much more strategic approach by the tenants as landlords now have the upper hand in negotiations and finding valued priced space is increasingly more difficult. Since many of the existing buildings are more than 90 percent occupied, the availability of large contiguous blocks of space has become scarce. In many cases, tenants requiring over 10,000 square feet of space are needing to turn to new buildings either under construction or on the drawing board to find suitable space that will not only meet current requirements but that also will accommodate expansion needs.
Financial services, oil and gas companies, data centers, call centers and medical offices are all active in San Antonio’s marketplace. Many office tenants are looking for Class B space with larger floor plates and parking ratios in excess of 5 to 1000. Call center and back office tenants are typically looking for parking ratios of at least 6 to 1000 and in many cases are ideally looking for 10 to 1000 parking ratios.
Class A space is also in demand. Our current inventory of Class A space is only 7.9 million square feet and is 88.7 percent occupied. Therefore, it is very difficult to find any blocks of large contiguous Class A space in the most desired submarkets (Far North/North Central and Northwest San Antonio). This demand, together with the ability to achieve higher rental rates, has prompted the construction of two new Class A buildings, Union Square II and La Arcata, both in the North Central submarket. These buildings will come on line in 2007 and both are significantly pre-leased.
Across the board, San Antonio is experiencing a significant increase in office space development, which will bring new options to both expanding local and incoming businesses in 2007. Currently, there is 956,565 square feet of new development underway. The lion’s share of this new construction, approximately 782,799 square feet, is in the Far North/North Central submarket. This new space will challenge tenants to pay premium rents to secure such space. In addition, the amount of new space coming on line may not be enough to keep up with demand levels.
Several key projects are in the Far North/North Central submarket. One is the Legacy Office Development, a huge draw for the submarket as this lifestyle center offers office, retail and residential space. Other well-known projects include Shavano Oaks I and II, Heritage Oaks, 4500 Lockhill Selma, Union Square II and La Arcata.
The suburban office market, particularly the Far North/North Central and Northwest submarkets, is seeing much of the leasing market activity. However, there appears to be the beginning of a resurgence of activity in the central business district (CBD) as suburban rates are now exceeding CBD rates including parking costs. It will be interesting to see how effective this rate differential will be in allowing the CBD to post some much needed positive absorption.
Vicki Cade is a senior vice president with Grubb & Ellis in San Antonio.
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