Job Growth Trumps Office Market Fears


The ceiling for Class A office development remains high in Austin. RiverSouth, a 350,611-square-foot project by Stream Realty Partners, is a recent example.

Despite the rise of the gig economy, the explosion of coworking concepts and the move toward greater density among office-using companies, America’s office market is maintaining steady growth and balance, thanks to the exceptional job growth of this cycle.

According to Costar Group, the national office vacancy rate currently stands at a 9.8 percent. Developers delivered approximately 59.3 million square feet of new product over the last 12 months. National net absorption of 56.6 million square feet during that period suggests that the market is quite close to equilibrium.

According to the most current available data from the Bureau of Labor Statistics (BLS) at the time of this writing, between December 2018 and January 2019, American nonfarm payrolls added about 525,000 new jobs. The BLS reported substantially lower job growth in February, with just 20,000 new positions added. However, most economists expect that figure to be revised upward as the effects of Mother Nature and the government shutdown wear off.

While office properties only capture a portion of that activity, job growth expectations are still the main criteria by which office market health is evaluated. By that logic, the office markets of Texas’ four largest cities should all post strong fundamentals in 2019, despite being buoyed by different industries and marked by different potential red flags.

Dallas-Fort Worth

According to CoStar, the office vacancy rate of Dallas-Fort Worth (DFW) has held steady between 14 and 15 percent over the last five years. Prior to that, supply additions were tame as developers tested the post-recession waters.

But a building boom began in 2015, around the time blue-chip companies began eyeing the metroplex for relocations, expansions and regional consolidations. The pace of rent growth dropped from 5.7 percent to 4 percent between 2014 and 2015 as more inventory hit the market. But again, the magnitude and consistency of the job growth provided the confidence that lenders and developers needed to fund and build new projects.

DFW also saw a selloff of office assets in 2014 and 2015. Sellers, motivated by expectations of new product hitting the market, were able to unload their properties at low cap rates as buyers tried to secure their positions ahead of the massive influx of jobs headed toward the metroplex.

Several years later, the jobs are still coming in, new buildings are dotting the skyline and leasing velocity is holding strong. At least from an investment standpoint, the only problem is a lack of inventory for sale.

“Because job growth and leasing activity are still strong, office investors, particularly out-of-state buyers, still feel that the yields they can get in DFW are better than in most major markets,” says Cody Payne, senior associate in Marcus & Millichap’s Fort Worth office. “But now there’s a shortage of marketable supply. Pricing of what is listed reflects what could have been achieved several years ago, but not today.”

Cody Payne, Marcus & Millichap

Payne adds that investors are increasingly targeting value-add office deals, especially for older product in suburban submarkets. Because in a market that spans 36 miles and is home to nearly 7 million people, strong demand for Class B and C office space will always be present. CoStar cites the current vacancy rate of non-Class A product in DFW as 13.4 percent, compared to 18 percent for Class A space.

The conundrum for investors is that the metroplex is becoming younger, hipper and more experience-oriented, thus the need for Class A product in highly amenitized environments is growing exponentially. For proof of this trend, one need look no further than Uptown Dallas, a vibrant submarket that landed the biggest office lease of 2018 when San Francisco-based Salesforce signed a six-figure tenancy at The Union.

“Companies today are more inclined to go where prospective employees are instead of having those employees come to them,” says Mike Ebert, managing partner at RED Development, the firm leading the office portion of The Union. ”Every company is trying to find that perfect live-work balance and to make employees’ workdays more interesting.”


These days, the nagging question behind Houston’s office market is rooted in time: When will absorption from energy users be significant enough to put a dent in the metro’s vacancy rate.

CoStar reports that Houston’s office market closed 2018 at 16.6 percent vacancy, which represents an increase of 200 basis points over 2017, despite the market posting positive quarterly absorption during the second half of 2018 for the first time in several years. The perhaps-temporary spike in absorption stemmed from the prevailing view that the price of oil, which traded at or above $70 per barrel for several months last year, would hover around that threshold. Instead, prices dropped to about $50 per barrel to close the year.

“Energy firms are fatigued with the quickness and harshness of this cycle, so they’re being more cautious with their leasing,” says Lucian Bukowski, executive vice president at CBRE. “These firms felt like they’d seen these cycles before and that the market would stay strong for a while based on historical trends. But the market cycled downward faster than it normally does.”


Downtown Houston could fare better in 2019 than traditional powerhouse submarkets like The Galleria and Greenway Plaza. Hines, which owns 717 Texas in the downtown area, recently executed two new leases totaling 154,000 square feet at the property

Bukowski, who recently represented energy firm Calpine in its 126,000-square-foot lease renewal at 717 Texas in downtown Houston, points to the volume of expiring sublease space as an equally important reason behind the market’s struggles to regain lost occupancy. Due in part to this factor, he expects overall office absorption to remain flat in 2019.

Two of Houston’s more renowned submarkets for office users could see some negative absorption from just a few departures. Marathon Oil is leaving The Galleria, where it currently occupies about 640,000 square feet, and Occidental Petroleum is subleasing all of its 800,000-square-foot space at Greenway Plaza as it relocates to the Energy Corridor.

“There’s going to be some clear winners and losers this year in terms of rents,” says Bukowski. “New Class A product is commanding rents about 20 percent higher than 1980s construction, but many newer buildings are approaching full occupancy. The real positive news for the market is that deals completed in 2018 will be reflected in the statistics for 2019 and 2020.”

Lucian Bukowski, CBRE

Indeed, some of the office sales in Houston reflect optimism for absorption this year, not only from Houston’s expanding finance sector, but also from oil and gas users. Several buyers snapped up distressed properties in the Energy Corridor toward the end of 2018, presumably in hopes of capturing Class A-level rents as oil prices slowly rise and demand for natural gas remains healthy.

Examples of such deals include Next Investments LLC purchasing 11777 Katy Freeway, a 120,520-square-foot asset that was 60 percent occupied at the time of sale; and Plano-based Granite Properties acquiring Eldridge Place, an 824,632-square-foot complex that was damaged by Hurricane Harvey.


Despite adding 3.5 million square feet of new space in 2018, supply of office product in Austin is still playing catch-up to demand, as it has been for most of this cycle. Another 4.3 million square feet of office space is under construction throughout the metro area, more than half of which is preleased and contributing to a 2018 vacancy rate of about 8 percent, per CoStar.

Unsurprisingly, the supply constraints have fostered exceptional rent growth in the post-recession era. According to CoStar, asking rents rose from $21.28 per square foot in 2010 to $32.90 per square foot in 2018, a staggering increase of 54 percent. However, the pace of rent growth began to moderate over the last 18 months as supply additions have come to comprise a greater percentage of total inventory.

“Austin is in a very extended growth cycle and many developers are working hard to get projects approved or started to take advantage of market conditions,” says Matt Frizzell, partner at Peloton Commercial Real Estate’s Austin office. “But we’ve seen in past cycles that even when macroeconomic conditions worsen, Austin doesn’t regress much in terms of occupancy or investment.”

Matt Frizzell, Peloton Commercial Real Estate

Austin’s office market only spans about 52 million square feet of product — 20 percent of which was delivered over the past decade. But few markets of that size have experienced the large leases from marquee companies like Austin has. Based on recent activity, that trend certainly seems to have staying power.

Last year, in a significant expansion move, Apple committed to a $1 billion campus in the Parmer area. Both Facebook and Google signed six-figure leases at downtown Austin properties in 2018, with both tech giants expecting to assume occupancy some time in the next three years. In addition, job site is expanding its footprint in Austin by more than 600,000 square feet, which could translate to several thousand new jobs in the coming years.

“The biggest tech users have grown so quickly, but they now understand they’re in a supply-constrained market,” says Ben Tolson, principal at Austin-based AQUILA Commercial. “Their real estate strategies have shifted to reflect getting ahead and mapping out plans for growth in parts of the city that give them an edge in talent recruitment and retention.”

In this sense, Tolson adds, landlords are notching even bigger wins. Not only has demand outstripped supply in this cycle, but the presence of tenants with exceptional credit that want to occupy 50 percent or more of newly constructed buildings, has allowed landlord to avoid concessions on rent and negotiate lease terms that favor them.

“The advent of larger tenants has made developers’ lives easier,” says Frizzell. “They start construction, talk to a few potential tenants, then one user comes in and takes 75 percent of the space. When large blocks at prime properties become available, the space is marketed a year or two before the lease expires. So the negotiating times for quality space are shorter, and tenants have to act even faster.”

San Antonio 

In June 2018, the U.S. Census Bureau labeled San Antonio the nation’s fastest-growing city based on annual population growth, an obvious bellwether for office market expansion. In addition, Frost Tower, the 460,000-square-foot building that represents downtown’s first Class A office project in three decades, is nearing completion with more than half its space preleased.

Between the trend and the tower, San Antonio appears to be laying the groundwork for more office development. While Frost Tower does account for roughly 25 percent of the 1.8 million square feet of office product under construction, several other properties are expected to come online in the next 18 months.

These include Pearl Office Tower, a 221,000-square-foot project by Silver Ventures that is slated for a September 2020 completion; The Soto, a 192,000-square-foot building by Hixon Properties; and Farinon Business Park III, an 84,890-square-foot asset by Worth & Associates.

“The biggest point of optimism for San Antonio’s office market is that new product is being delivered and absorbed as tenants continue their flights to quality,” says Marshall Davidson, principal and managing director at Avison Young. “However, San Antonio was already late to the office development party in this cycle, so the market could be underbuilt when the next economic downturn begins.”

Davidson notes that this sequence of events also occurred in San Antonio in the late 1980s, resulting in little to no new Class A office development for three decades. And although new space is coming on line, there are still more buyers than sellers in the investment game, which will drive up pricing, Davidson says.

Indeed, San Antonio’s appeal to office investors in this cycle has been tied to its modest supply of Class A inventory, says David Wheeler, chief investment officer at Hartman Income REIT, which is slowly growing its volume of investment holdings in the city.

David Wheeler, Hartman Income REIT

“Frost Bank made a statement by committing to San Antonio with their namesake tower, but we don’t expect to see significantly more Class A product come to market,” says Wheeler. “This is still a market where military and healthcare — two traditionally ‘sticky’ tenants — provide a lot of demand, which should help keep the vacancy rate strong and in check.”

Since 2014, rents have grown by 3 to 4 percent per year, a trend Wheeler expects to continue in 2019. In addition, he says, San Antonio is ripe for value-add office projects. Construction pricing and a sub-10 percent vacancy rate, as well as a pace of job growth that is strong but still constrained by the overall size of the market, are the primary reasons that value-add deals make since in San Antonio.

—  By Taylor Williams. This article first appeared in the April 2019 issue of Texas Real Estate Business magazine. 

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