TEXAS SNAPSHOT, MARCH 2008

San Antonio Office Market

Gostylo

Following a prolonged holiday season that seemed to last well into the middle of January, during which time a barrage of dire economic news was reported on a national basis, it was difficult to go into the new year feeling optimistic. However, while one should never assume immunity to a national recession, in South and Central Texas, the prior year’s vibrancy seems to have returned. Thus, there is realistic hope the parade continues for commercial and office real estate in San Antonio.

From the demand side, San Antonio continues to see better than average job growth compared to the rest of the nation (2.1 percent in 2007). Additionally, there are a number of major projects underway that will keep the construction industry humming for the next few years while promising many new permanent jobs in the near future.

First and foremost is an upgrade resulting from the post-BRAC repositioning of Fort Sam Houston, so that together with BAMC facilities, San Antonio will become an even more important hub for military medicine. New construction projects on Fort Sam alone are anticipated to reach $1.6 billion, with a total budget of approximately $2.1 billion when including projects at other area bases. What’s more, it is anticipated that these military projects will bring more than 10,500 new personnel to San Antonio within the next 3 years. At the same time Rackspace Managed Hosting, a locally grown high tech company, is taking over the former Windsor Park Mall on the east side of San Antonio. Dubbed The Castle, this transformed mall will be Rackspace’s new headquarters with the potential to house upwards of 5,000 employees over the next few years, adding 3,000 jobs to the San Antonio economy.

 On the west side of San Antonio, Corporate Office Property Trust (COPT) is busy reconstructing the former Sony plant. This 450,000-square-foot facility will be home to the National Security Agency (NSA) in San Antonio and will likely be bringing upwards of 2,000 highly skilled jobs to the city. Further west, Microsoft has a 450,000-square-foot datacenter under construction. While the center will create only 100 or so permanent jobs, the Microsoft name has already gone a long way to christen San Antonio as a preferred location for datacenters by awakening the industry’s awareness of what San Antonio has to offer. On the far western fringe of new development in San Antonio, the Texas Research Park, which is already home to a number of prominent high tech companies, hopes to land the $500 million DHS/USDA Biological Defense Lab, which is moving from Plum Island, New York.

On the north side of San Antonio, work is now underway for the new Tesoro Petroleum Headquarters building at US Highway 281 and Loop 1604. The initial structure will accommodate approximately 500,000 square feet, but plans by the developer, Dean Patrinely from Houston, will eventually include a major mixed-use project at this 122-acre site. Tesoro is anticipated to occupy the new building sometime in early 2009.

Upon completion of the building, Tesoro will likely be vacating in excess of 300,000 square ffet of space in a number of buildings further south on Highway 281 near Loop 410 and the airport. This will create a fairly large hole to refill in the airport market. It is also rumored that KCI is shopping for a new headquarters building, which would leave a 200,000-square-foot hole at the intersection of Interstate 10 and Loop 410.

Construction also is underway on a new PGA Golf Resort just north of Tesoro. The resort, which is part of Forestar’s (formerly Lumberman’s) Cibolo Canyons development, will include two 18-hole TPC courses and a 1,002-room JW Marriott Resort Hotel.

Finally, on the south side of San Antonio, Toyota’s first production line has been churning out new Tundras since November of 2006. The Toyota plant now employs approximately 2,000 people; in addition, the 21 suppliers that have located on the adjacent Toyota Business Park have created another 1,800 jobs. San Antonio hopes to see the eventual addition of a second Toyota production line, which could bring total employment at the plant itself to almost 5,000 and potentially attract a significant number of new suppliers.

North, South, East, West and Central — every sector of San Antonio is experiencing a surge in economic activity.

Since the last downturn in the office market resulting from the DOT.COM/Telecom bust in 2000, office development in San Antonio has generally been limited to only a few select buildings in prime locations such that the amount of new space coming on the market has averaged just over 250,000 square feet per year. However, in just the last 18 months, there has been a surge in office development as San Antonio’s growing economy continues to generate job growth and office rents increase with renewed demand. In 2007 more than 600,000 square feet of new office space entered the market. So far in 2008, with several new projects just breaking ground in January and February, the market will likely see in excess of 1 million square feet opening by the end of this year.

Simultaneously though, there is a significant amount of office space coming off the market as firms like HPI Development demolish older, but well-located, office product for redevelopment into retail. With the razing of the GPM Life Buildings in 2007 and the planned demolition of 10 buildings in Centerview Crossing, HPI alone will decrease office supply in San Antonio by approximately 500,000 square feet.

Perhaps one of the most striking trends is the very recent resurgence of truly Class A office properties. San Antonio’s office market previously has been dominated by larger, back-office and call center-type users. The result has been mostly development of value driven office buildings — tilt-wall construction, large floor plates and high parking ratios. This trend won’t be changing in the foreseeable future, but a number of projects are either under construction or proposed that offer a higher image with amenities such as structured parking. These newer projects may also require rents in excess of $20 NNN, so it will be interesting to see how well they go over in a traditionally cost-conscious San Antonio market.

The majority of new office building development is taking place along the northern sector of the US Highway 281 corridor near Loop 1604; along Loop 1604 from Highway 281 to just west of Interstate 10; along the northern sector of the Interstate 10 corridor near Loop 1604; and in the Westover Hills area along State Highway 151 from Loop 410 to Loop 1604.

A handful of new developers have entered the San Antonio market during the past couple years, including Signature Associates from Detroit, Myers-Crow from Dallas, Patrinely from Houston and Griffin Partners. However, most of the new projects can be attributed to local firms that have already been active for many years. Also, a number of local firms have just recently emerged as players in the office development arena, such as REOC Partners, Galo Properties, Milam Real Estate Investors and Stream Realty Partners.

Not since AT&T (formerly SBC) gobbled up close to 2 million square feet in the late 1990s has San Antonio seen any one dominant tenant in the office market. At the peak in 2000 to 2001, AT&T likely had 10 percent or more of the San Antonio merchant office market under lease, only to give back much of that space over the following 6 years as leases expired.

The largest leases in 2006 included Nationwide Insurance at 4300 Centerview for 93,000 square feet; Verizon (MCI) at the Forum for 86,395 square feet; Accenture at 7050 Fairgrounds for 86,000 square feet; and Nustar (Valero LP) at Heritage Oaks for 84,000 square feet. In 2007, Accenture leased an additional 61,643 square feet at 6415 Babcock and HEB leased 45,000 square feet at Cypress Tower. In addition, American National Insurance purchased the newly constructed office building at 4500 Lockhill Selma in shell condition. American National will initially occupy approximately 50,000 square feet of the building and has already leased 21,495 square feet of space to Globalscape.

At the end of 2007, city wide vacancy for all classes of office buildings in San Antonio stood at 13.1 percent, down slightly from 2006. Class A vacancy stood at 10.3 percent, which was up slightly from 2006. To put things in perspective, the total merchant office market in San Antonio is approximately 24 million square feet. Net absorption of space in 2006 was just over 800,000 square feet, with absorption in 2007 at almost 600,000 square feet.

Another area of significant growth in San Antonio is healthcare. However, medical facilities and medical office are not included in general office statistics. The new north central Methodist Hospital is currently under construction on Sonterra Boulevard and is scheduled to open in late 2008. It joins the North Central Baptist Hospital in the Stone Oak area, which has already completed a recent major expansion. Surrounding both hospitals over the past few years has been significant development of medical office and ancillary medical operations, making Stone Oak the third major hub of private medical facilities in San Antonio after the South Texas Medical Center and downtown.

Not to be left behind, the Westover Hills area is poised to become the fourth major hub of private medical facilities with all three hospital groups in San Antonio (Methodist, Baptist and Christus Santa Rosa) already taking down significant land positions along State Highway 151. With construction already underway on the Christus Westover Hospital, medical office is also being completed at this moment with numerous projects on the drawing board. In one presentation last year to the local CCIM Chapter, an executive from the Methodist system stated that over the last 10 years the medical industry has created an average of 2,500 new jobs in San Antonio annually and that it will likely continue at this pace or better for the next 10 years.

— Dan Gostylo is a principal/broker with Providence Commercial/CORFAC International in San Antonio.

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