Inflation: The cost of everything is increasing and that will include the cost to operate, repair, install new tenant improvements, and build new buildings. This cost will be shared with tenants in higher base rates and triple net expenses.
Basis Value: Many properties have traded hands during the past 5 years of rapid price increases in Austin. Those new owners now have a higher basis value with the new purchase prices, which come with new expectations and investment return targets. Mortgage holders often have loan covenants that prevent them from signing new leases below a certain threshold.
Building Valuation: The value of an office building is based on the income stream that the asset generates for the owner over time. If a landlord were to lock in a discounted rate during a short-term economic dip, it would destroy a portion of the value of that building for years. For example: If a landlord were to discount $5 per SF on a 10,000 SF space for 5 years, that would be giving up $50,000 worth of revenue each year for 5 years or $250,000. That same $50,000 income stream sold at a 6% CAP rate equates to $833,333 worth of building value. Huge implications for every dollar of discount.
Short-term incentives: The landlord has other levers to effectively lower the occupancy cost for office tenants without lowering the base rate. The most common incentives include free rent at the front of the lease, large tenant improvement packages, and moving & furniture allowances. All of these are real savings to the tenant but are front-loaded discounts that preserve the higher base rates for owners.
Austin recovers fast: Historically, Austin is the last to enter a downturn and the first city to come out of it. The dips experienced here are less extreme than in some of our larger Texas cities like Houston and Dallas. Comparatively, we are “small” too. It doesn’t take many big leases to move a large chunk of the market.
Austin is still growing like a weed: New demand is entering our market at a steady clip, which helps absorb some of the vacancies. The 5 county area that makes up Austin is expected to reach a population of 3.3M by 2040, which would make us larger than San Antonio is today.
Slow market reaction time: The real estate market, as a whole moves slowly in reaction to dips in occupancy. The delay can be 12-18 months. By the time the current recession is really felt, we will already be on the other side of it and growing again.
Patient owners: A few common owners of commercial office space are REITs, Insurance companies, and Retirement funds. These owners are not overly concerned about short-term vacancies. They look at their whole portfolio and try to build value for their own time horizon, which can be decades for some. Sitting on extra vacancy and collecting no rent while they wait for the right long-term tenant doesn’t always seem logical, but may be a perfect fit for their long-term strategy.
Not all subleases are competition: Increasing sublease inventory shows weakness in the market from a supply side, but in reality, landlords are still collecting rent on those spaces. If a landlord doesn’t have vacant space of the same size as the available discounted subleases, the extra inventory shouldn’t change the competition for their spaces of a different size. There could be 100 cheap subleases of 30,000 SF and it would not affect the landlord with vacant suites of 10,000 SF and below. These are apples and oranges. Large spaces can’t be easily subdivided into smaller spaces without incredible cost so will never compete for smaller tenants.
