FEATURE ARTICLE, OCTOBER 2008

SAN ANTONIO’S OFFICE MARKET
The economy has taken some recent hits, but the outlook still remains strong.
Dan Gostylo

With most of the country still mired in recessionary economics, San Antonio continues to grow in all directions.  However, we all hope to see the national economy begin to turn around soon, because even though we remain very optimistic, we have started to experience some chinks in the armor.

Last month AT&T announced that their world headquarters would move from downtown San Antonio to Dallas.  Although the headquarters represents only 700 of the approximate 6,000 AT&T jobs in San Antonio, the positions moving to Dallas represent the top echelon.  Therefore, we do anticipate further fallout from the move, particularly in our high-end housing market.

Following the AT&T announcement, Toyota announced that its San Antonio plant would need to stop production for up to 90 days to reduce inventory of its full-sized Tundra pick-up trucks, due to slower sales caused by high gas prices.  The bad news was blunted by Toyota’s assurances that full-time employees would not face lay-offs, and by a later announcement that all Tundra production would be shifted from Toyota’s Princeton, Indiana, plant to San Antonio as early as November of this year.  This will be a permanent shift as the Princeton plant will be retrofitted for production of the Highlander SUV.  When pick-up truck sales rebound, this could be good news for the San Antonio facility in the long run.

To put things in perspective, home sales in San Antonio in 2007 were down less than 10 percent from record numbers in 2006, while home prices were pretty much up across the board by 5 to 10 percent.  New subdivision development did come to a screeching halt in the latter part of the year, and housing starts are down significantly, but they are down from record levels in 2006.  So it is anticipated that inventories will come to balance much sooner, since San Antonio’s housing market did not get nearly as overheated as other markets across the country.  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, we have a number of major projects underway, which will keep the construction industry humming for the next few years, while promising many new permanent jobs in the future.

Let’s start on the east side of San Antonio.  First and foremost is a major upgrade of the area’s military bases resulting from the post-BRAC repositioning of Fort Sam Houston so that, together with our 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 these defense projects will bring upwards of 12,400 new military and civilian personnel to San Antonio within the next three 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’s Texas Cryptologic Center and upwards of 2,000 highly skilled jobs.  Farther west, Microsoft has a 450,000-square-foot data center 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 data centers. In August alone, we have had three new data center announcements.  The first was a dedicated $50 million project for Frost Bank. This was soon followed by announcements from both Stream Realty (Dallas) and Power Loft (McLean, Virginia) for the development of two speculative projects which could reach upwards of 350,000 square feet.  If we go to 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, is on the short list 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 well 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 of  Houston, eventually call for a major mixed-use project at this 122-acre site.  Tesoro is anticipated to occupy the new building sometime in early 2009.  At the same time, construction is also well 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.

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; but 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.  On the south side, plans are underway to begin construction on the new Texas A&M – San Antonio branch, a campus which may someday rival the University of Texas – San Antonio campus on the north side and downtown.  Currently at almost 26,000 students, UTSA is growing faster than any other campus in the UT system.

Finally, the central business district of San Antonio has not been left out; it continues to thrive as a tourism destination and convention center, as well as a central hub for all branches of government from local to federal. The most recent addition to the downtown skyline, the 1,003-room Grand Hyatt Hotel, opened for business in March of this year just in time to do a stellar job as headquarters for the NCAA Men’s Final Four Basketball Tournament.  Although not yet finalized, ambitious plans are also underway, and appear imminent, to move the Federal Courthouse from its current location on Durango Street near Hemisphere Park to the west side of downtown.  Since the courthouse will effectively replace the old police headquarters, plans also include redevelopment of other sections of the west side of downtown, resulting in a new, consolidated center of government activity for south Texas. Upon the courthouse’s relocation to a new facility on the west side, the old Federal Courthouse location in Hemisphere Park will likely be transformed into a number of venues to further enhance the burgeoning tourism and convention industry near the park.

Earlier we mentioned the growth of only military medicine at Fort Sam Houston; however, private healthcare is also experiencing significant growth in a number of sectors of San Antonio.  The new North Central Methodist Hospital is currently under construction on the far north central sector of the city and is scheduled to open in late 2008.  It joins the North Central Baptist Hospital, which has already completed a major expansion in the Stone Oak area.  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 development is also underway, with numerous other projects on the drawing board.  According to one executive from the Methodist Hospital System, over the last 10 years the medical industry has created an average of 2,500 new jobs in San Antonio annually – and that growth will likely continue at a similar pace or better for the next 10 years.

North, south, east, west and central city --- every sector of San Antonio is experiencing a surge in economic activity.  And it is evident by the confidence San Antonians exhibited over this past weekend by continuing to reinvest in the city itself.  By overwhelming margins, Bexar County voters on Saturday committed $415 million in tax revenue for enhancements to the scenic San Antonio River Walk ($125 million); for new soccer, baseball and other athletic venues ($80 million); for enhancements to the AT&T Center and Freeman Coliseum ($100 million); and for a performing arts center and other cultural facilities ($110 million).  Job growth in San Antonio is anticipated to continue to outpace the rest of the nation, making the city a preferred location for people to work, live and play.

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, we have seen 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, over 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, we will likely see in excess of 1,000,000 square feet opening by the end of this year.

Simultaneously, we are seeing a significant amount of office space come 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 would decrease office supply in San Antonio by approximately 500,000 square feet. Unfortunately, with a nationwide slowdown in retail, the Centerview Crossing project is temporarily on hold,  pending an anchor tenant.

Perhaps one of the most striking trends is the very recent resurgence of truly Class “A” office properties.  San Antonio’s office market has been dominated over the last decade 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.  We don’t see this trend changing in the foreseeable future, but we are seeing a number of projects either under construction or proposed that offer a higher image and 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.

As mentioned in the preface to this report, the new Tesoro Petroleum Headquarters building is currently under construction just north and east of the intersection of U.S. Highway 281 and Loop 1604.  Upon completion of the building in 2009, Tesoro will likely be vacating in excess of 300,000 square feet of space in a number of buildings farther south on Highway 281 near Loop 410 and the airport.  This will create a fairly large hole to refill in the Airport submarket. 

The majority of new office building development is taking place along the northern sector of the U.S. Highway 281 Corridor near Loop 1604, along Loop 1604 from Highway 281 to just west of IH-10, along the northern sector of the IH-10 corridor near Loop 1604 and in the Westover Hills area along SH 151 from Loop 410 to Loop 1604.  Since San Antonio has two Loop systems (410 being the inner Loop and 1604 being the outer Loop), perhaps an easier way to describe these areas would be the northwest / north central sectors of San Antonio from nine o’clock to twelve o’clock and between Loop 410 and Loop 1604.

We have seen a handful of new developers enter the San Antonio market during the past couple years including Signature Associates from Detroit, Myers-Crow from Dallas, Patrinely from Houston, Power Loft from McLean, Virginia, and Griffin Partners; but most of the new projects can be attributed to local firms that have already been active for many years, and also to a number of local firms that 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 2,000,000 square feet in the late 1990’s have we seen any one dominant tenant in the San Antonio office market.  At the peak in 2000-2001, 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 six years as leases expired. Now, with AT&T’s recent announcement to move its headquarters operation to Dallas, we see the possibility of another 250,000 square feet going vacant in downtown San Antonio.

The largest leases in 2006 included Nationwide Insurance at 4300 Centerview for 93,000 square feet; Verizon (MCI) at the Forum for 86,395 Ssquare 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.  Unfortunately, in 2008, whether it can be attributed to the slowdown in the national economy or that it is an election year, we have not seen any particularly large deals inked yet. We hope to see a pickup in activity soon, particularly as many of the new projects started earlier this year will soon be coming on line.

Since the value-added, large floor-plate office building is such an important part of the market in San Antonio, I would prefer to quote rental rates for different segments of the market.

• New Class A office / flex:

Base rent $14.50 to $16.50 NNN; operating expenses $5 to $7 per square foot (PSF); tenant improvements (TI) allowance (from dark shell) $30 to $35 PSF; and parking (surface) 5.5 to 7.5 per 1,000 square feet.

• New Class A mid-rise office

Base rent $19 to $21 NNN; operating expenses $9.50 to $10.50 PSF; TI allowance $25 to $30 PSF; and parking (including structured) 4 to 5 per 1,000 square feet.

• Existing Class A mid/high-rise office

Full-service rent $24 to $26 per rentable square foot; overall, Class A average rental rates have increased by 6.0 percent since mid-year 2007.

At the end of the second quarter 2008, citywide vacancy for all classes of office buildings in San Antonio stood at 13.7 percent — down one full percentage point from the same time last year.  Class A vacancy stood at 10.1 percent — also down slightly.  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. Although still in positive territory, net absorption for the first half of 2008 stands at just a fraction under 200,000 square feet.

It is very difficult to pinpoint any one particular submarket or corridor that is growing more than others, because San Antonio is experiencing significant economic growth in almost every direction.

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 reminded us that over the last 10 years the medical industry has created an average of 2,500 new jobs in San Antonio annually – an that it will likely continue at this pace or better for the next 10 years.

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

550 Bailey: Transforming the Former Bombay Company Headquarters into Modern, Class A Space Goff Capital is implementing $8 million in renovations to the former Bombay Company headquarters in Fort Worth, Texas. The building, 550 Bailey, will feature 122,834 square feet of Class A office space upon completion. Goff Capital acquired Bombay Company’s headquarters building last year during the Bombay Company bankruptcy, and is now implementing $8 million in renovations to turn the office into Class A space. Located in Fort Worth at 550 Bailey Avenue — just north of the intersection of Bailey Avenue, Seventh Street, Camp Bowie Boulevard and University Drive — the seven-story building spans 122,834 square feet in the city’s dynamic Cultural District, which currently is undergoing a dramatic transformation. “We believe 550 Bailey’s strategic location in the Cultural District will benefit greatly from the significant investment well under way in this area,” says John Goff, founder of Goff Capital. “The area’s renaissance will give our tenants exceptional amenities within walking distance, including restaurants, hotels, shopping, and, of course, world-class museums, including The Modern and the Kimball.” Renovation plans for 550 Bailey include remodeling the lobby and common areas, enhancing the exterior landscaping, and constructing a covered walkway from the parking garage to the building. Dallas-based architecture firm Hellmuth, Obata + Kassabaum, Inc. (HOK) designed the renovations. “The vast new lobby area will feature a clear glass wall [that is] three stories high at the front entrance, sleek bamboo paneling, and slate- and quartz-patterned flooring,” Goff says. “Natural finishes, energy-efficient lighting, natural products and green cleaning technologies are being used in the renovations.” Goff believes that these renovations, coupled with a great location and ample parking, will make 550 Bailey a very attractive choice for tenants in the Fort Worth market. CB Richard Ellis (CBRE), which is handling leasing for the building, is making sure potential tenants see these advantages. “We have developed an interactive e-mail campaign targeting brokers and prospective tenants in Fort Worth, and we have created a web site packed with information about the building and location,” says Bob Scully, managing director at CBRE for the 550 Bailey project. CBRE is targeting a variety of different industries, from oil and gas companies to financial institutions and professional practices. “Our marketing efforts have focused on generating awareness that 550 Bailey is being transformed into a beautiful, modern Class A office building, ideally situated near museums, shopping and restaurants in the thriving Cultural District of Fort Worth,” Scully says. “We want tenants and brokers to know about the exciting, multi-million dollar renovations that are taking place in this building.” — Lindsey Walker

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