Tenant Demands Changing in Austin Industrial Market
The story of industrial real estate today, at least in terms of national media coverage, centers around compressing cap rates and the steady stream of capital flowing into the sector.
But in Austin — the kid brother of two major industrial markets, Dallas and Houston — the story over the past 12 months has been the large increase in the volume of industrial construction.
Austin delivered 3.1 million square feet of industrial product in 2017, a 55 percent increase over the total space delivered during the previous year. Throughout the past year, the metro also trailed the national average in industrial vacancy, net absorption and percent change in rental rates from 2016 to 2017.
Many developers that broke ground during one of the healthiest periods in Austin’s industrial history are now delivering space at a time when the Austin economy is starting to cool. Employers have found themselves in a more competitive environment, with annual job growth slowing to sub-3 percent levels and the unemployment rate reaching numbers not seen since the dot-com boom.
Austin’s recent industrial performance should not be seen as cause for alarm, but rather as an opportunity to understand the changing mindset of the tenants and developers that are shaping the trends of a secondary market’s industrial landscape.
When discussing year-end numbers with Austin’s industrial brokers, they are quick to identify a story behind those figures: Tenant demand has not slowed. We are still in a landlord’s market, but tenants are looking for more efficiency in their spaces.
In recent years, industrial tenants were not only faced with sticker shock when looking to renew leases, but were also given limited relocation options. Given that the market was experiencing eight straight quarters of sub-6 percent vacancy and a rate of new construction that equated to 1.1 percent of the national industrial inventory, these trends weren’t too surprising.
Industrial rents in Austin averaged $7.01 per square foot from 2000 to 2011, with moderate year-over-year changes in asking rents. In 2012, when the signs of a rebounding real estate market began to emerge, Austin went down a path of intensified rent growth.
On average, between 2012 and 2017, that path would lead to a year-over-year asking rate change of 6.4 percent and a rental rate of $9.14 per square foot. The average asking rent for industrial properties in Austin currently sits at $10.86 per square foot; our primary distribution market neighbors, Dallas and Houston, average $6.16 and $7.12 per square foot, respectively.
One can easily conclude from the data that the plan to combat this explosive rent growth was simple: build more. From the second quarter of 2016 to the fourth quarter of 2017, Austin delivered 4.6 million square feet of industrial space.
To put that number into context, consider the fact that prior to that stretch, it took the metro nine years to deliver 4.9 million square feet of new industrial product. This feverish new pace of building, coupled with rising rental rates, has forced developers to find unique ways to draw in prospective tenants.
Otto Swingler, senior associate at Live Oak, an Austin-based, full-service real estate firm, notes that higher ceiling heights are at the forefront of new industrial features demanded by today’s users.
“We’re seeing deals for 24-foot clear height buildings being lost to those with 28-foot or higher clear heights, like you see in larger industrial markets across Texas,” says Swingler. “Developers delivering buildings that offer 28- to 32-foot clear heights are reaping the benefits of an added tenant amenity.”
“In this development cycle, the cubic volume of space leased, even at a premium for taller clear heights, allows for a fifth or even sixth racking system for high-pile storage,” Swingler adds.
“While tenants in previous cycles may have been more local-services driven, this feature is becoming important to today’s user.”
Heavy construction of late in the Southeast submarket has led to completions of phases of Park 183, Southpark Commerce Center V and Commerce Center South. Each of these properties features buildings with 28-foot clear heights. Nearby Freeport Tech Center South will stand a bit taller with 32-foot clear heights.
Another emerging tenant preference — shrinking footprints in larger bulk warehouses — represents an easy way for industrial users to reduce occupancy costs. However, some tenants are going even further and looking for ways to own and occupy their buildings.
Capitol Wright Distribution recently moved into its 435,000-square-foot, owner-occupied facility in Manor, Texas, consolidating numerous leased locations around the Austin area. In southeast Austin, Travis Association for the Blind has its own 350,000-square-foot, build-to-suit property under construction.
Larger industrial users seeking their own facilities can also take control of their real estate costs by consolidating under one roof.
As this trend unfolds, Austin — a supply-constrained market that often faces geographic challenges, rising construction costs and an unpredictable permitting process — should see a significant reduction in the its volume of new development. This slowdown should coincide with the delivery of nearly 1 million or so square feet of industrial product currently under construction.
Whether it be higher clear heights, shrinking footprints or more build-to-suit opportunities in non-typical locations, changing tenant demands will steer Austin’s industrial future.
— By John Taylor, managing director, HFF, and Dom Espinosa, analyst, HFF. This article first appeared in the February 2018 issue of Texas Real Estate Business.