COVER STORY, NOVEMBER 2005

OFFICE UPDATE
A look at the state of the office sector in four major markets.
Daniel Beaird

The Texas office market, as a whole, has performed better this year than in the previous 2 years. Experts predict that most Texas office markets will continue to see steady improvement into next year as well as 2007. Texas Real Estate Business explored office markets in Austin, Dallas, El Paso and San Antonio. Each offer different perspectives on how its market will achieve continued success.

El Paso

El Paso is unlike any other market in Texas, or the country, for that matter. Resting on the U.S.—Mexican border, El Paso's unusual economy relies heavily on its relationship with its neighbor to the south and the Maquila market. A maquiladora is a factory or plant operated across the Mexican border under tariff programs established by U.S. and Mexican governments to encourage development in Mexico. A maquiladora performs assembly, or sub-assembly, operations. Components are imported duty free to Mexico, whereupon a maquiladora performs the assembly necessary to complete the work. Large, international corporations like RCA have been taking advantage of maquiladoras for years, which has allowed El Paso access to skilled labor on the border. From a market standpoint, El Paso is often grouped with sister cities Juarez, Chihuahua, Mexico; and Santa Teresa, New Mexico. The three-city region forms the largest international border community in the world.

El Paso's office market consists of only 5.5 to 6 million square feet of leasable space. “It's an unusual market,” says Will Brown, a principal at Sonny Brown Associates. “There has not been much development in last 20 to 30 years, but that is expected to change.” It will change because El Paso's military base, Fort Bliss, is anticipating the arrival of 4,000 additional military personnel and their families by the end of the year. With the recent Base Relocation and Closure Announcements (BRAC), Fort Bliss could end up with 20,000 more military personnel in the near future. “That could translate into 70,000 or 80,000 more people for El Paso,” Brown says.

Smaller office buildings or build-to-suits have been more popular than larger office buildings in El Paso. Most of that development has been in the suburbs as downtown has only seen the development of government buildings. Major corporations like El Paso Energy, which used to be based in El Paso, have moved their headquarters to larger cities like Houston. Downtown has felt the effects, which has moved development to suburban El Paso. “If not for the suburban areas, the office market would be much tighter,” Brown says.

Call centers have played a significant role in El Paso for the past 10 years. However, only a few of El Paso's call centers are located in build-to-suits, and most are located within industrial buildings. While call centers continue to play a major role, El Paso has seen a recent growth in medical office development as doctors, who are currently located in LEEDS buildings, are opting to build their own facilities. Hospitals, clinics and emergency centers are all on the rise in El Paso.

El Paso's economy has always been strongly tied to its proximity to the border, but its military presence will greatly affect its future economy as well. With the recent BRAC announcements, El Paso's population is expected to rise in the next few years as well as its office demands. “We think El Paso's economy will change drastically to support high-tech military contractors, and suppliers will have to expand their office needs,” Brown says. This will create an office expansion El Paso has been waiting on.

Austin

Austin's office market has been slowly rebounding since June 2004, and its northern and western suburbs are leading the way. “People want to work close to where they live,” says Richard Berns, principal of Berns Commercial. Due to strong residential growth in the area, the northwest suburbs of Austin have seen a steady decline in office vacancy rates for more than 2 years. Meanwhile, Austin's central business district (CBD) has seen a rise in office vacancy rates in that same period of time. “The only reason to be in the CBD is if you are an attorney and need to be near the courthouse, or if your business is related to the state government or the University of Texas,” Berns says.

Austin is the third best place in the country to start a business or career, as ranked by Forbes Magazine, and the second best place for families to relocate. These high marks have helped the Austin office market prosper, and it continues to grow as development projects like San Clemente, The Parke and Barton Creek are all planned to start construction this year. As new developments are built, Austin continues to draw high-tech industries to the area. Freescale, manufacturer of embedded semiconducters for wireless markets, will maintain its world headquarters in Austin for the next 10 years. “High-tech is definitely Austin's strongest industry that is aggressively seeking office space,” Berns says.

Even as Austin's suburbs continue to grow, the city's largest office development in recent years was the Frost Bank Tower, located at 401 Congress Avenue in downtown Austin. Developed by The Cousins Properties of Texas, the 33-story building stands 515 feet tall and contains 525,000 square feet of leasable space, including ground floor retail. “Austin has not seen many large office developments recently, but The Frost Bank Tower was planned before the bubble burst 5 years ago,” Berns says. “It was already on the books, but if something was not on the books, it probably did not get built.”

Austin is slowly recovering, according to Berns, though, as the office market has performed much better this year than in the previous 2 years. “Next year should be even better,” Berns says.

San Antonio

According to the latest U.S. Census Bureau statistics, San Antonio is the fastest growing city in Texas and the third-fastest growing city in the country. Employment growth has contributed to the overall improvement of San Antonio's office market. Almost 10,000 jobs have been added to the city's workforce during the past 12 months.

The San Antonio office market is working its way back to full recovery. Through the third quarter of this year, San Antonio has seen nearly 245,000 square feet of positive net absorption. Vacancy rates have dropped more than two percentage points from this same time last year to 16.3 percent. The average quoted rate reached $17.91 per square foot on a full-service basis, a 1.2 percent increase from last year. San Antonio's office growth remains steady because speculative construction has remained under control. The market has only seen approximately 200,000 square feet of development this year.  

Also, the total amount of sublease space has diminished to 236,000 square feet, down from its peak of 800,000 square feet in 2002. “Landlords have purchased sublease spaces and are marketing the spaces as direct vacancies,” says Brian Harris, senior vice president of REOC Partners. “For example, the CityView Building bought out the space left behind by AT&T and turned around to lease it to ETS.” As call centers continue to grow in San Antonio, single-story and low-rise office flex projects are in high demand. The larger floorplates, higher parking ratios and cost efficiency of office flex projects are attractive to call center operations.

Toyota is building a new $850 million truck manufacturing plant that is set to open in the fall of 2006. Major medical and retail developments have been announced. The University of Texas at San Antonio was granted $138 million for capital improvements, and San Antonio plans to have a Texas A&M campus in 2009. These factors, together, can be very attractive to potential employers who are looking to relocate.

For example, Seattle-based Washington Mutual recently selected San Antonio as the location for its new regional operations center. It's predicted to bring 4,200 new jobs during the next 7 years.

The largest office trend in San Antonio has been tenant expansions. “Led by Tesoro Petroleum, Pape Dawson and Rackspace Managed Housing, tenant expansion has accounted for much of the positive absorption that has occurred in the San Antonio market,” Harris says. “Tenants are motivated to shop for the best lease economics available.”

Dallas

Woodland Hills, Calif.-based Younan Properties recently acquired three Class A office buildings in Dallas totaling 1.1 million square feet.

Tenants have begun to upgrade to Class A office space. Woodland Hills, Calif.-based Younan Properties recently acquired three Class A office buildings in Dallas totaling 1.1 million square feet. “Dallas is one of the top five major office markets in the country, and it has seen its strongest absorption in the past two quarters,” says Zaya Younan, CEO of Younan Properties. “We like the Dallas office market better than any other market in Texas.”  

According to Younan, Dallas has a young, educated workforce that attracts companies, especially high-tech, to the city. Dallas has a lower unemployment rate than the national average. This, along with its low cost of living and its geographically centralized location, makes Dallas a nice fit for corporate America.

Dallas' submarkets are popular with corporate America as well. The Richardson/Plano submarket has accounted for the absorption of 257,419 square feet of office space this year, while 12 speculative developments, totaling more than 1.55 million square feet, are in production in the far North Dallas submarket. Eighteen other projects are under construction in the Dallas/Fort Worth Metroplex.

These positive absorption rates, along with recent construction activity, have caused lower vacancy rates in 10 of Dallas' 17 submarkets for the second consecutive quarter. “There is not much space to be had for the larger tenants anymore,” Ingrum says. For the third quarter, vacancy was 21.18 percent, a modest decline from the second quarter's vacancy rate of 21.41 percent. “Four to 5 years ago, we would receive downsizing notifications from tenants almost every day,” Younan says. “Today, it seems like every single tenant is expanding.”

“Dallas has been overlooked in the past,” Younan says. Developers are not overlooking Dallas anymore. Third quarter construction numbers jumped to 3.28 million square feet, doubling second quarter numbers.    

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