TEXAS SNAPSHOT, JUNE 2012

AUSTIN OFFICE MARKET

More than a handful of times I have invoked the “If you build it, they will come…” line in discussions with office developers discussing the Southwest submarket of Austin, with the assurance that they can rely on statistics, trends and history. In fact, Austin is in a position to justify the delivery of new Class A office space in the Southwest submarket and there are some rock-solid reasons why.

Located in the most geographically and environmentally challenging part of Austin, the Southwest submarket has grown from a mere 1.8 million square feet to more than 6.3 million square feet in the past 15 years. During that time, weathering two downturns, it has shown a resiliency for absorption, occupancy and rental rate strength that leaves the rest of the suburban market in the dust.

Here are the factors that drive that resiliency:

• Proximity to executive housing: Decision makers consistently find reasons to locate businesses close to their and other executives’ homes. The most attractive areas for executive homes is in the Southwest part of Austin’s MSA. This will be even more significant as traffic issues continue to cause longer commute times.

• Adjacency to downtown: In particular, the south Mopac part of the submarket offers easy access to downtown without paying downtown rates. In 12 years of leasing the Terrace, we attracted numerous tenants from downtown, the largest being Vinson & Elkins, a traditional downtown law firm. They would not have considered another submarket, but moving to the Southwest lowered their rent substantially while maintaining excellent access to downtown. Historically, the Class A cost savings have been between $5 to $7 per square foot. As downtown increases at a greater rate than Southwest, that difference is now more than $10 per square foot. As popular as downtown is, many firms will elect the savings, further providing demand for the Southwest submarket.

• High-growth tenants: During the past few years, numerous employers including ARM, Intel, Bazaarvoice and St. Jude’s have taken significant chunks of expansion space, and with an improving economy, there is no reason that should not continue.

• Limitation of developable sites: Ironically, the lack of possible development sites is one the prime reasons that the area is ripe for new speculative development. Oxford Commercial’s research shows that there are only six significant Southwest office projects that we believe have sufficient entitlements to deliver more than 100,000 square feet of space within 24 months. While the market certainly could not absorb all this space at once, the overall difficulty of Southwest submarket development safeguards against a slew of buildings that would mean a risk of glut and price depression.

With these factors in play, and with rents, absorption and occupancy at healthy levels, the obvious question is why not? Why hasn’t a developer pulled the trigger on a new speculative development in the submarket?

There are three reasons why: nerve, debt and term.

Nerve: The reality is that the Southwest submarket represents the best Austin has to offer, and other office submarkets are simply not as robust, even with continued employment growth and absorption. On a broader scale, the nation is noticing that Austin is an oasis of health among office markets that continue a difficult recovery from the recession. With this outlook, it still takes nerve to step out without a tenant and build a building in the face of other realities that could always be viewed as a threat.

Debt: Office development is a capital-intensive business, and a willing construction lender is almost always part of the equation for development. Most lenders today require a minimum pre-lease commitment(s) of 50 percent for any new project. The sting is still there from the last cycle, and until that memory subsides, it will be difficult to get a purely speculative project financed.

Term: Historically, whether in the pre-leasing phase or in the initial lease-up, developers look for an anchor tenant who will lock up a significant part of the project for at least 7 years, and preferably longer than 10. However, today’s trend is for tenants to keep lease terms shorter and flexible, which by definition makes it difficult to justify development.

So when will these market pressures result in a new Southwest office building? By the end of the third quarter at least one developer will announce the commitment to build. In Field of Dreams, Ray Kinsella built his baseball field on pure faith — obeying a voice coming to him out of thin air. In Southwest Austin, a developer will have the added benefit of great market dynamics. But make no mistake, at least one developer will build this year, and the tenants will come.

— Spencer Hayes, co-founder/managing partner of Oxford Commercial, a Cushman & Wakefield Alliance member

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