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First Takes: Texas Office Markets React To COVID-19

Combined with deliveries of speculative projects like 701 Rio (pictured), the disruption caused by COVID-19 could finally curb massive rent growth in Austin’s office market.

It’s still too early to pinpoint how long and how severe the disruption caused by the outbreak of COVID-19, the disease caused by the novel coronavirus, will be to the major office markets of Texas. But brokers in Dallas, Houston and Austin are already seeing their markets display short-term adjustments with regard to deal velocity and structure.

As commercial brokers know all too well, every deal is different. Companies are making decisions on whether to delay or pursue office lease consolidations, renewals or expansions based on their unique cash-flow situations, sales outlooks and current positions in their business cycles.

In addition, because many office-using jobs don’t qualify as essential services, the uncertainty about how long employees will have to continue to shelter in place and work from home is leading many companies to reassess their short-term needs in terms of size, location and density.

Lastly, there are the office users whose businesses have already been walloped by reduced consumer spending. For these companies, decisions about future leasing activity may very well be taking a backseat to a more pressing short-term need to escape an existing lease with minimal bloodshed.

Office brokers have their hands full addressing the unexpected and unforeseen needs of their clients, many of which are relying on their brokers’ expertise to guide their leasing decisions. Questions relating to rent — a key component of most firms’ overhead costs — are squarely under the microscope.

In mid-March, it became apparent that COVID-19 would precipitate widespread business closures, layoffs, furloughs and other forms of economic disruption. At that point, Texas Real Estate Business pivoted from its annual office markets update piece to gauge the thoughts of brokers in Dallas, Houston and Austin on how the healthcare crisis is impacting their day-to-day work.

What follows are the edited responses of Jim Cooksey and Garrison Efird, vice chairman/president of tenant representation and associate director, respectively, at Newmark Knight Frank’s Dallas office; Anthony Squillante, principal at Avison Young’s Houston office; and Ryan Bohls, director at NAI Partners’ Austin office.

Texas Real Estate Business: As a broker, what concerns are you fielding from your office-using clients regarding COVID-19, and how are you counseling them on those issues?

Jim Cooksey, NKF

Jim Cooksey/Garrison Efird: Each case is unique and ultimately predicated on the language set forth in individual leases. Outside of the current force majeure conversation, which deals with unforeseeable circumstances that prevent a party from fulfilling its end of a contract, business income, business interruption and civil authority coverage are other potential areas to exercise.

The landscape is changing by the day and hour in response to this situation, as state legislatures, as well as some landlord entities, make decisions pertaining to coverage and business interruption clauses and rent abatements.

Anthony Squillante: Both the drop in oil prices and COVID-19 provide reasons for Houston office users to be anxious. The reduction in oil prices has already triggered energy firms like Haliburton and others to announce major furloughs of Houston employees. If the oil price remains low for an extended period of time, there will be additional, similar announcements as well as bankruptcies, acquisitions, mergers and consolidations.

Anthony Squillante, Avison Young

Similarly, the mandates received from the local, state and federal governments concerning “social distancing” and “sheltering in place” have caused employers to allow their people to work from home to the extent that the slowing of commerce as a result of this virus has not caused layoffs or businesses to close.

The longer COVID-19 causes America’s economic engine to remain idle, the more challenging it will be for businesses to rebound from this situation. Each of these separate events will undoubtedly change the landscape of Houston’s office market.

Ryan Bohls: Many of Austin’s tech tenants that are dependent on pledged funds from Silicon Valley investors are worried about razor-thin margins and the pre-profit nature of their business cycle. However, some occupiers see this virus as here to stay for the long term and are contemplating de-densification of their workplaces.

Ryan Bohls, NAI Partners

As rents have increased, technologists have responded with dense packing spaces with above-standard allocations of space per employee to gain economies on their occupancy spend. As these companies plan back-to-work strategies, some are evaluating a work-from-home approach combined with a changing workplace plan that centers on
spacing employees to mitigate risk of virus contraction.

TREB: Do you expect any significant short-term dips in occupancy and, consequently, rent growth as a result of COVID-19? In either case, what might be some potential silver linings for the market down the road?

Cooksey/Efird: Subleasing and immediate concessions as a result of early lease restructures are both realistic short-term impacts. Additionally, this situation provides the potential for a market correction in terms of shifting negotiating power to tenants instead of landlords.

Garrison Efird, NKF

Squillante: Unfortunately, the virus has forced commerce to slow to a near halt. The true impact on Houston’s office market will be determined by the duration of restricted population movement and unconventional working environments that Houstonians and the world will have to endure.

That said, tenants that currently have lease requirements could be poised to achieve great financial terms that allow them to flexibly grow their businesses from quality buildings.

Bohls: The space market in Austin is in need of a bit of a reset as rents are at unprecedented high levels. Occupancy costs in the central business district lag behind only Manhattan and the areas surrounding Silicon Valley. Put simply, however sour this medicine may taste at the moment, there could be some benefits to Austin occupiers searching for an interruption of the rising costs of real estate.

Although Houston’s office users have demonstrated a flight to quality assets like MetroNational’s 190,000-square-foot project in Memorial City, low energy prices and shelter-in-place directives are likely to slow leasing activity until later in the year.

TREB: To what extent do you expect the coronavirus to upend or delay the closing of larger office leases/move-ins/relocations that have been announced in your market?

Cooksey/Efird: We are seeing two different positions from tenants: They either want to place a transaction on hold to evaluate where the market will be in the next 90 to 120 days, or expedite the transaction process to execute a lease as soon as possible. We have had conversations lately that have included both approaches; decisions about how tenants want to move forward are largely being driven by their industry.

Squillante: Given these unprecedented circumstances, it’s likely that many transactions will get postponed or withdrawn altogether. Prior to the COVID-19 pandemic, Houston’s office market was offering substantial concession packages including lengthy, free gross rental periods, strong reductions in base rental rates, large tenant improvement packages and extensive parking abatements.

These are the most advantageous concession packages that I’ve ever seen in my 15-year career in commercial real estate. I expect that a prolonged social distancing/work from home program resulting from governmental mandates could cause landlords to be even more aggressive in order to get deals done assuming tenants are willing to transact.

The willingness of a tenant to complete a lease in this environment will be unique to each tenant’s individual circumstances (i.e. industry, financial wherewithal, view of economy after people return to work, etc.).

Bohls: We’re seeing most national tech outlets table their site procurements or expansion processes until there’s more predictability. With significant first-quarter velocity, many transactions have stalled and executives have put their pens down.

By Taylor Williams. This article first appeared in the April 2020 issue of Texas Real Estate Business magazine.

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