Q3 2022 saw a softer office market as activity slowed tremendously.
- Unemployment rate statewide has dropped back down to pre-pandemic levels.
- Vacancy increased slightly while absorption continued a negative trend primarily due to new deliveries.
- Little additional construction from Q2 to Q3.
- Sublease space in the market has increased by 28% from Q2 to Q3.
The Boots On The Ground
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 industrial market.
Q3 2022 saw a softer office market as activity slowed tremendously. Many companies put their office leasing inquiries on hold and capital markets (sales) have been almost nonexistent due to the ambiguity of interest rate stabilization. Without reasonable debt, it is tough to purchase a building at terms that make sense for most sellers. The few transactions that have occurred have been slow and difficult and, much like with leasing activity, most Sellers are in a holding pattern until Q1 2023. A similar trend reigned true with development as some projects have come to a halt being at the mercy of economic and market conditions though there are some major development projects still underway, like Waterline Tower at 98 Red River.
Moreover, employment levels remain high in Austin, and in combination with still relatively low vacancy rates and performing assets, we have not seen any notable distress that would force Sellers to consider dropping prices to move product. On the leasing side, activity and transactions have considerably stalled. As companies adjust to a hybrid arrangement—resulting in less office traffic—plus economic headwinds provoking hiring freezes and personnel cuts, we have seen an influx of highquality subleases come to market. Vacant sublease space increased by 28% from Q2 to Q3, this being the most sublease vacancies we have seen compared to the past 5 quarters. This hasn’t lowered asking rates, other than a few hard-hit suburban
office markets. For the sake of retention and winning deals, we are starting to see Landlords show flexibility in lease terms and willingness to offer competitive incentive packages. Though slower, transactions are still happening, especially in traditionally high-demand markets including the CBD, Domain, and areas surrounding downtown. We also continue to see a tide of lab/value office users flock to Austin, targeting single-story flex space in North Central and Southeast Austin.
The Market at a Glance
Absorption has gone negative for the first time this year and direct vacancy rates continue to increase. This could be due to new deliveries still getting filled and again, the uncertainty of the economy keeping companies from acquiring space. The East had the most vacant space (direct and sublease) with 29% of the existing East inventory vacant. The Far Northwest had the least number of vacancies coming in with a vacancy rate of 16.4%.
Austin has a reputation as the “last in, first out” market when responding to economic headwinds (inclusive of the “R” word). While we believe Austin will once again have a shallow downturn compared to other markets, we don’t foresee any quick fix on the horizon. With millions of square feet in the pipeline and hundreds of thousands more in ideation, one can’t help but wonder how new space will perform with interest rates and inflation making capital tough to come by, combined with many companies reporting less than stellar financial results. It is safe to assume activity will remain slow for an extended period; vacancy rates will likely continue to increase, absorption is anticipated to continue a negative trend, and subleases will keep coming to market. Rumors are already swirling of a few huge Class A blocks of sublease space potentially coming in Q4 2022. As mentioned before, developers are forced to pause speculative construction, obligating Landlords to compete against aggressively priced subleases (which will certainly increase incentive packages and presumptively create rate drops). Our crystal ball tells us that 2023 is likely to be a great market for companies looking to find high-quality space, with some rough patches for Landlords (i) who are delivering shell space or, (ii) who have large blocks of Class B space that aren’t in core locations. Luckily, even though the market seems to be softening, the potential economic downturn can be considered mild compared to past recessions, and additionally, unemployment rates are back to pre-COVID levels meaning there is still hope for the future.
Austin Capital Markets
Investment sales activity in Austin continued to slow in the third quarter primarily driven by the increase in interest rates and continued tightening by commercial lenders. Multi-family and industrial properties continued to see the highest levels of interest followed by retail, albeit well off the pace of transactions in Q3 2021. Sales of institutional quality office assets in the third quarter were minimal as interest in office products has dropped substantially. We expect Q4 2022 to be similarly slow, though there is hope for increased activity in 2023 as interest rates stabilize and there is some clarity on CAP rates. Austin reflects national trends in all product types−higher CAP rates and a substantial drop in the number of transactions across the board. Investor interest in Austin remains high and capital is readily available for transactions, but there is a significant pricing gap between buyers and sellers.
Direct Lease Rates
The average asking rate across all office classes came out at $47.78, just a slight increase from the $47.29 we saw in Q2. CBD rates saw an even smaller increase going from $65.91 in Q2 to $65.92 in Q3. The class A average rate market-wide in Q3 2022 came out to be $48.25 with a CBD class A average of $68.62.
Notable Q3 2022 Completions