Like other areas across the county, the Texas office markets are struggling to find firm footing. Across the state, demand for office product is slowing, vacancy rates are rising, and landlords are more generous with incentive packages in the form of free rent and tenant improvement dollars. Furthermore, the amount of available sublease space – so called shadow space – continues to drive higher at the same time the final wave of construction activity is wrapping up. Put it all together, the office market becomes a dire situation for property owners.  

It’s true that Texas markets have seen a more aggressive return-to-office policy, but hybrid work is here to stay resetting demand. At the state level, net absorption declined for the fifth consecutive quarter and the overall vacancy rate stood at 23.0% at the end of second-quarter 2023 compared to 17.1% at year-end 2019. Contrary to past slowdowns, asking rents have been surprisingly sticky, but are expected to be under pressure for several years.

By market, pressure is building across the major metros. Overall vacancy remains the highest in Houston closely followed by Dallas-Fort Worth; however, the greatest headwind may just sit in the state’s capital.

Austin

Tech slowdown, elevated construction activity and corporate consolidation has all contributed to the highest vacancy rate on record. The current 22.2% vacancy rate not only marks a new high-water mark, but also represents the first time the local office market has seen overall vacancies exceed 20% since 2003. For additional perspective, this level of vacancy easily exceeds the market’s 10-year average of 12.6% and is occurring at the same time the construction pipeline remains elevated by local standards. Looking at supply, there are 20 buildings underway, representing 5.4 million square feet. Once completed, the existing inventory set will expand by 7.4% with only 45% of the space pre-leased. 5.6 million square feet of available sublease space is creating additional slack in the market. Put it all together and the market fundamentals strongly favor tenants.    

Turning to rental rents, the average asking rental rate for direct office space was $42.49/SF at the end of second-quarter 2023, up 2.7% from a year ago. Rental rates have trended upward as landlords attempted to keep pace with inflation, but we expect that face rents will begin to decline in 2H23, and concession packages will become more generous as landlords favor occupancy over rent growth.

Dallas – Fort Worth

Second-quarter 2023 marked the third consecutive quarter of negative net absorption. As a result, the key theme continues to be rising vacancy and availability of space. Specifically, the overall vacancy rate hit 25.3%, levels not seen since 1988. When factoring in sublease space, the total availability rate hit a staggering 28.9%. With much of the excess supply occurring in the downtown submarket, several office-to-multifamily conversions have been planned, including projects at Energy Plaza, Santander Tower and Bryan Tower. While conversions remain a popular topic, the feasibility of additional projects are limited due to the high costs.

In terms of new supply, activity has been limited with 1.4 million square feet hitting the market over the past year. Furthermore, the construction pipeline remains muted with 2.6 million square feet currently underway representing a 1.0% expansion of the existing inventory upon completion.

Turning to rental rents, the average asking rental rate for direct office space was $30.11/SF at the end of second-quarter 2023, up 2.7% from a year ago. With asking rents trending higher for multiple years, we expect rents they will begin to decline in the remainder of 2023 and 2024 combined with aggressive concession packages until availability of space comes down.

Houston

Despite the improvement in the energy sector, demand for office space remains subdued in Houston. Conversely, the 63 million square feet of space available for lease remains near all-time highs. The overall vacancy rate remains elevated at 25.7%, one of the highest rates nationally amongst major markets. However, the impact is not uniform. Well-located, recently delivered Class A buildings typically have vacancies below 10%. The amount of available sublet space – so called shadow space – is stubbornly high at 6.2 million square feet.  

Turning to supply, the construction pipeline remains largely muted. At the end of second-quarter 2023, there was 1.4 million square feet underway representing 0.6% expansion of existing inventory upon completion. This was the smallest construction pipeline as a percentage of existing inventory of the four major Texas markets. 

Turning to rental rents, the average asking rental rate for direct office space was $30.32/SF at the end of second-quarter 2023, down 1.7% year-over-year. Moving forward, we expect asking rents to decline slightly with landlords to remain tenant friendly by using attractive concession packages, including free rent in an attempt to backfill unused space. 

San Antonio

Since the pandemic began, the normally stable San Antonio office market has been hit hard.  USAA, a longtime occupier of space, underwent a massive consolidation moving 500 employees from the downtown locations into the headquarters campus in Northwest San Antonio which has only exacerbated the problem. In-turn, this has pushed the vacancy rate to 19.3% compared to 11.4% in fourth-quarter 2019. New supply created a double whammy with nearly 1.0 million square feet being delivered over the past year. Moving forward, the construction pipeline is expected to be muted which should allow for vacancies to crest later this year and then tick lower in 2024 and 2025.

Looking at rental rents, the average asking rental rate for direct office space was $24.51/SF at the end of second-quarter 2023, up 0.7% year-over-year. With vacancies elevated, we expect face rents to dip slightly the remainder of the year and again in 2024 before stabilizing in 2025. All things considered, San Antonio is better positioned than many other markets across the state and occupiers should use this period of weakness to their longer-term advantage.

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RubiCrown Commercial Real Estate offers site selection advisory, economic incentives negotiation, tenant representation / brokerage services, and construction project management for users of office and industrial space in North America. RubiCrown’s core mission is to deliver competitive advantages, mitigate risks, and reduce costs related to built and occupied commercial real estate. Robbye Kirkpatrick may be reached by email at robbye@rubicrown.com for an in-depth analysis of your lease or real estate portfolio.