Sublease space on the rise as Austin maneuvers through the COVID-19 pandemic
Boots On The Ground
Commentary by Ally Dorris | Associate | Austin
Our “Boots on the Ground” viewpoint is the voice of our experts, who have broken down the market data and compared it to what they are seeing for themselves. This is their take on what the numbers actually mean for the Austin office market.
A tidal wave of sublease space has crashed down on Austin. Some of the biggest players in town, such as Parsley Energy and GoDaddy, have listed large blocks of space on the sublease market, over 100,000 SF each. Sublease inventory has increased by more than 40% since the start of the 2nd quarter. The number of subleases has more than doubled compared to Q2 2019. A drastic spike in sublease space is an evident product an economic recession, which was officially announced by the National Bureau of Economic Research in early June. With office space typically being a company’s second greatest expense behind compensation, and with so many employees currently working from home, subleasing unused office space has become the first line of defense in efforts to reduce overhead during these unprecedented times.
However, even during a global pandemic, Austin continues to move forward and show signs of prospering. Downtown skyscrapers continue to be proposed while the skies remain flooded with active cranes. Other than temporary shutdowns due to COVID-19, construction continues on large developments like Google and Indeed’s new downtown towers. Austin also continues to be a safe haven for companies seeking refuge from state income taxes and higher costs of living in states like California and New York, now also fueled by differences in the handling of COVID-19. Telsa, recently dubbed the most valuable carmaker, is the newest tech giant to set its sights on Central Texas. During Q2, Tesla was in incentive negotiations with the State of Texas after identifying a 2,100-acre site in Southeast Austin for their newest gigafactory.
The first half of 2020 is unlike anything we’ve seen before, but to watch companies, big and small, adapt to the changing world around them has been fascinating. With Austin still ranked as the #1 Best Place to Live (U.S. News & World Report), we look onward in hopes that Austin is as quick to rebound as many believe.
While increasing supply, coupled with a decrease in demand for office space, is a recipe for a long overdue softening in the market, Austin’s poised to recover. Though we have lost a few iconic restaurants and music venues that attributed to the culture which makes Austin a one-of-a-kind city, the quality of life Austin provides remains unmistakable.
The question on everyone’s mind: How do we move forward in the midst of a global pandemic? One thing we know for certain is that tenants will not be returning to the same type of office environment that they left in Q1. Architects have flooded the marketplace with plenty of information regarding new office configurations and designs, as well as an emphasis on healthy working environments. In efforts to decrease the costs of office space, many employers are moving to flexible schedules for their employees by implementing rotating schedules in the office or the freedom for employees to work from home 1 – 2 days per week, and are reconfiguring their workspace, allowing them to reduce their office footprint.
Austin Office Overview
In the second quarter of 2020, Austin’s office market reported 276,569 SF of negative net absorption. A large amount of the negative absorption occurred in Class A buildings with a total of 165,602 SF of negative net absorption. Class B buildings in Austin posted 98,524 SF of negative net absorption and Class C properties recorded 12,443 SF of negative net absorption.
There is 7,045,063 SF of office space under construction and 2,014,130 SF of that is pre-leased. Looking forward, in the third quarter of 2020 we expect to record 1,157,726 SF of deliveries with 485,109 SF of that being pre-leased, but COVID-19 may change those projections. One of the buildings set to deliver in the third quarter of 2020 is Highland 3 at 523 East Highland Boulevard; the entire 250,000 SF building is 100% pre-leased to City of Austin Planning and Development.
5th + Tillery at 618 Tillery Street was the largest building to deliver in the second quarter. This 182,716 SF building delivered in June and is vacant, but ready for tenant improvements. The third quarter of 2020 is expected to see thirteen new buildings come online, but many of those deliveries will likely be pushed back. The citywide average rental rate increased over the quarter from $36.36 per SF in Q1 2020 to $36.41 per SF in Q2 2020. Class A rental rates in Austin’s CBD decreased by 0.8% over the quarter from $53.43 per SF to $52.99 per SF in Q2 2020. The overall suburban Class A rental rate increased from $38.13 per SF to $38.43 per SF, over the quarter.
Due to COVID-19, most offices are still working from home and major companies in Austin, like Facebook and Google, have declared that their employees with be working from home until 2021. A lot of these larger companies realize that having hundreds of employees coming up the elevator 2-6 people at a time is inefficient and would rather offer support to their staff to create a better at-home experience.
On July 22nd, Tesla announced that it has chosen Austin as the new site for their gigafactory. Telsa plans to build a multi-million square foot manufacturing facility near the airport. This new factory will inevitably raise housing prices in the area, but will also employ around 5,000 people.
Vacancy & Availability
Austin’s citywide vacancy rate increased from 13.1% in the first quarter of 2020 to 13.6% in the second quarter. The Northeast submarket’s Class A vacancy rate had the largest jump in vacancy moving from 25.7% in Q1 2020 to 30.4% in Q2. This was caused mostly by 33,934 SF being vacated at Parmer 3.2 (13011 McCallen Pass Drive).
The largest decline in vacancy was recorded in the Class A Southeast submarket, where the rate decreased from 25.7% to 20.2%.
Absorption & Demand
Austin’s office market posted 276,569 SF of negative net absorption in Q2 2020. Despite this, eight submarkets experienced positive absorption over the quarter, including Cedar Park, Central, Far Northwest, Northeast, Northwest, Round Rock, Southeast and Southwest.
A large amount of Q2 negative net absorption occurred in the Class A CBD submarket, totaling 330,500 SF of negative net absorption. Over 200,000 SF of the CBD Class A’s negative absorption is from sublease space being added to the market. One of the notable subleases now on the market is at Indeed Tower (200 W 6th Street), which is still under construction and isn’t set to deliver until 2021. Teacher Retirement System of Texas signed a lease at Indeed Tower, which is still under construction, for the 100,992 SF of space in March and then put the space on the sublease market in June.
The Far Northwest submarket recorded the highest positive absorption number with 67,146 SF of positive net absorption. The majority of the absorption in the Far Northwest submarket happened in Class A space and can be partially attributed to an unknown tenant moving into a 20,578 SF sublease space at Amber Oaks Building A (13640 Briarwick Drive).
The Austin market recorded sixteen leases over 10,000 SF each in the second quarter with Tata Consulting leading the way with its 58,873 SF lease at Parmer 4.2. In the CBD, Husch Blackwell signed a renewal for their 46,000 SF space at 111 Congress Avenue.
According to CoStar, our data provider, Austin’s citywide average rental rate increased 0.13% over the quarter from $36.36 per SF to $36.41 per SF.
The highest rental rates across the Austin office market in the second quarter were in CBD Class A buildings where net rental rates average $52.99 per SF. Rental rates were also high in the East submarket where Class A rental rates reached $47.21 per SF.
Citywide Class B rental rates decreased marginally in Q2 2020 to $33.02 per SF down from $32.87 per SF in Q1 2020. CBD Class B rental rates decreased 3.4% over the quarter from $51.43 per SF to $49.66 per SF in Q2 2020.
Austin’s office market recorded 386,684 SF of leasing activity in Q2 2020. Only sixteen leases for 10,000 SF or more were signed in Q2 2020 while 37 were signed in Q1 2020. Major transactions this quarter included two leases for a total of 100,873 SF at Parmer 4.2. The two tenants, Tata Consulting and WiPro, signed in May and are set to move into their spaces in October 2020. This puts Parmer 4.2 at 78.2% leased with just the first floor remaining vacant.
Commentary by Doug Rauls | Executive Vice President | Austin
The COVID outbreak has caused a virtual shutdown in investment sales activity. In Q2 2020, The American Founders Building (6937 N I-35), a Class B, 70,229 SF office building, was the only office building sale over 50,000 SF. It sold in April to Integral Care who plans to use it for their headquarters. The property was vacant at the time of sale.
There were numerous commercial property sales, of all sizes and property types, that were called off in Q2 due to COVID. In many cases, the buyers in these transactions forfeited significant earnest money. The lack of financing (both debt and equity) was a main reason many of the transactions failed to close. While still tight, debt and equity markets have loosened up recently, which will allow for additional transactions in Q3 and Q4. However, we expect overall volume of commercial office, industrial and retail sales to be much lower in 2020 compared to 2019. A number of sellers are taking a “wait and see” approach toward the COVID outbreak, delaying potential property sales until later in 2020 or early 2021.
Office Development Pipeline
7,045,063 SF of office space was under construction during at the close of the 2nd quarter. Just three buildings delivered in Q2 with the largest being 5th + Tillery (618 Tillery Street). This 182,716 SF building delivered in June and is vacant. 29% of all space under construction is already pre-leased and over 1,000,000 SF is set to deliver in Q3 2020. It is very likely that most of these dates will get pushed back due to delays caused by COVID-19.