Austin is maturing as a commercial real estate market. Over the past few years, the city has witnessed an increase in institutional and foreign capital attracted to Class A office assets in the metro area.
Most of the new investors in Austin are capitalizing on continued rental rate growth in the office sector, but is this growth sustainable? Austin’s overall office occupancy rate and rental rates have traditionally been a series of steep peaks and valleys, but will future growth be dictated by these historical trends?
Tech Bubble Bursts
Leading up to the burst of “tech bubble” in 2001, office leasing in Austin was in full swing, with an occupancy rate of 93 percent. Dun & Bradstreet ranked Austin as the top city for high-tech startups in 1999, and Angelou Economic Advisors estimates that more than 200 new companies were added to Austin’s roster of technology firms in that year. Austin companies secured an estimated $740 million in venture financing in the first three quarters of 1999, more than triple the funding placed in all of 1998.
The absorption witnessed leading up to this bubble was phenomenal, but the growth was inflated by the source of the rental payments. These payments were, in many cases, not coming from the web-based start-ups’ operating incomes, but instead by their venture capital partners. Those same startups which were absorbing so much of Austin’s prime office space were not prepared for investors to sour on their offerings so quickly. Numerous Austin groups, including Pets.com, eToys.com, Living.com and DrKoop.com closed their doors and either defaulted on their leases or attempted to sublet their space.
Due to the inflated absorption and climbing rental rates seen in 2000, many commercial real estate developers began plans for new office developments in Austin, and nearly 3.5 million square feet of office developments broke ground that year. But by the end of 2001, the amount of sublease space available in Austin had increased by 645 percent, with more than 2.2 million square feet of sublease space added to the market from year-end 2000.
Unsurprisingly, the combination of the 3.5 million square feet of newly developed office space and 2.2 million square feet of available sublease space placed significant downward pressure on rental rates.
The Recession’s Effects
From the trough in 2003 to the peak of the next cycle at year-end 2007, tenants absorbed 4.9 million square feet of Class A office product in Austin, and occupancy increased from 79 percent to 85 percent.
Unlike the quick spike in rates seen from 1998 to 2000, rental rates experienced steady growth, averaging an increase of about 4.8 percent every six months from mid-year 2004 through year-end 2007.
The subsequent decline in 2008, attributed to the nationwide financial crisis, saw Class A occupancy rates decline to 77.2 percent by 2010, the lowest level since 1990. However, rental rates were not as significantly affected as they had been during previous crises and only saw a nominal annual decline of 2 percent from the peak of $30.38 at mid-year 2008 to $28.06 at mid-year 2011.
This rate of decline was not as severe as the decline from 2001 to 2003, when rates were falling at an average annual rate of 14 percent.
It is important to note that during each of Austin’s periods of rental rate decline, the decline never dipped as low as the previous trough. For example, in 2003, Class A rental rates declined to $20.49; in 2011, Class A rental rates bottomed out at $28.06.
However, the reverse is not true for the rental rate peaks; until recently, we had not witnessed a level of Class A rental rates as that seen in 2000.
We do anticipate that Austin will continue on its current path of rental rate growth due to a number of strong fundamentals. It’s not just our firm that believes that, either: In October 2013, Austin topped The Business Journals’ list of 102 metro areas ranked by economic viability.
The news website also determined that Austin has added 67,800 private-sector jobs since 2008, an increase of 11 percent, while no other market studied grew faster than 8 percent.
Austin also has been a magnet for corporate expansions and relocations from other states, and this in-migration of companies and a talented workforce will continue to foster new business development.
Based on the continued strengthening of Austin’s economy by diversification, Austin’s Class A rental rates could easily continue to grow steadily at rates of 4, 6 or 8 percent annually.
— By Leah Gallagher, Managing Director, Transwestern Austin. This article first appeared in the June issue of Texas Real Estate Business magazine.