Many people ask me if the increase in the Austin area office vacancies will trigger a price decrease in both rent and property values making them more affordable. The answer to that question lies in several factors which I’ve explained below.
First, it’s important to know where vacancy rates are trending. Currently, they are on the rise in downtown where vacancies are 18.7%, up from a vacancy rate of only 11% a year ago. The northwest Austin sector has the highest vacancy of 21.7%, up 2.8% from a year ago. The south Austin sector has the highest uptick with a vacancy sitting at 19.5%, an 8.2% increase from the 11.3% it was a year and a half ago.
The most stable sector is southwest Austin with a vacancy of 15.4%, only increasing 1.6% from a year and a half ago. Overall, this was expected as businesses memorialize their “work from home” protocol. Surprisingly rental rates have not come down much, if any (other than expected market stabilization). I do believe this will change if these increased vacancy rates continue for a while longer. At some point, landlords will have to lower rental rates to attract tenants.
Another factor that affects property values is interest rates. Currently, they are still at a 15-year high of around 7-8% for a commercial real estate loan. Interest rate levels have clearly affected the market in a negative way since the higher they are, the more expense money is to borrow. Because of the increase in interest rates, property owners with expiring loans will be taking a financial hit as their low interest loans are replaced with higher rates, significantly increasing their payments.
As nearly 20% of U.S. Class B office properties loans mature over the next few years, we can expect that some owners will be unable to cover their debt service, especially if they are experiencing high vacancy. Unless lenders can work out a payment schedule under which the property owner can operate, that property owner may have to liquidate — creating an opportunity for eager investors seeking a deal.1
A second important factor affecting commercial property values is sales volume. Currently we are seeing a significant slowdown in sales volume nationwide by as much as 70%. This applies to at all levels of investment, from over $100M all the way down to under $1M. 2 What I expect will come from this slowdown in sales volume will be that sellers may have to lower asking prices to attract buyers or provide other incentives.
1 – Commercial Edge, Evelyn Jozsa, September 7, 2023, “Loans on nearly 1 in 5 Class B Offices to mature soon. What are the hotspots?”
2 – Costar, Chad Littell, September 19, 2023, “Sales of Large Office Properties Plunge to Lowest Levels in more than a Decade”