Dallas Office Market Report – Second Quarter 2022

OFFICE MARKET ASSESSMENT

The DFW office market recovery is well underway as return-to-office momentum continues to build, now with its fourth straight quarter of positive absorption largely driven by leasing activity accelerating over the past year as the region continues to be the epicenter of corporate expansions and relocations.

The DFW office sector registered 433k SF of direct net absorption in Q2, marking the fourth consecutive quarter of absorption growth totaling 2.3 MSF, which has caused the direct vacancy rate to subside by 20 bps to 22.2% since hitting its peak in Q3 2021.

The Class A sector registered 309k SF of direct net absorption in Q2, improving the YTD total to 926k SF of occupancy gains. The flight to quality trend remains prevalent as newer buildings have captured a large share of the leasing demand. Class B properties have also exhibited signs of stabilization with 185k SF of absorption gains in Q2, bringing the YTD total to 107k SF.

Leasing activity has rebounded to 16.2 MSF over the trailing 12 months, up 34.4% Y-O-Y. Leasing volume totaled 4.2 MSF in Q2, up 26.1% compared to a year ago, but remains 18.6% below the pre-pandemic quarterly average. Tour activity has picked up as occupiers are evaluating their future space needs and more willing to execute on long-term leasing decisions previously placed on hold due to the pandemic.

Sublease availability rose by 493k SF to reach an all-time high of 10.4 MSF in Q2. Sublet space additions have risen by 1.6 MSF over the prior 12 months as many companies have rightsized their footprints to adjust to a post-pandemic environment.

The construction pipeline remains robust with 5.2 MSF underway (23% pre-leased) as numerous spec projects totaling 3.5 MSF have broken ground over the prior 12 months. Developers delivered 936k SF in Q2, with an additional 1.8 MSF of new product scheduled to deliver by year-end 2022.

Higher construction costs and a tight supply of new office buildings in some high-demand areas have pushed rents higher. Rising operating expenses and inflation have also exerted upward pressure on rental rates, while many landlords are offering competitive concession packages which include tenant improvement allowances and free rent in order to preserve face rates.

As the office market recovery accelerates in the year ahead, the flight to quality trend should continue as newer, highly amenitized Class A buildings in prime locations are expected to capture a larger share of the demand activity and lead to a faster recovery at the expense of lower quality assets.

The DFW employment recovery has been especially robust when compared to other markets across the US. While just over half of major metros that employ at least 1 million people have reached pre-pandemic levels of employment, the Metroplex now boasts 259K more jobs than prior to the pandemic onset. However, higher inflation expectations continue to undermine consumer confidence. The Federal Reserve has begun a sharp tightening of monetary policy. Higher interest rates will cool private investment and reduce consumer purchasing power. Even still, the long-term outlook for DFW remains positive as the region is expected to outperform other major markets as pent-up activity and inbound corporate relocations positively impact the market.

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Houston Office Market Report – Second Quarter 2022

OFFICE MARKET ASSESSMENT

Houston’s office market fundamentals continue to show modest signs of improvement. The office sector registered positive absorption for the third straight quarter with 159k SF of direct space absorbed in Q2, improving the trailing 12-months total to 948k SF of occupancy gains.

The Class A sector accounted for the bulk of the gains with 156k SF of direct space absorbed in Q2, marking the third consecutive quarter of absorption growth totaling 1.4M SF, which has helped reduce the direct vacancy rate by 70 bps to 24.9% since hitting its cyclical peak in 4Q 2021. Noteworthy move-ins contributing to the absorption gains included UT Physicians (139k SF at Bellaire Station), Weaver Tidwell (61k SF at Five Post Oak Park), Entergy (54k SF at Lake Front North), Linde PLC (41k SF at Sierra Pines I), and DLA Piper LLP (32k SF at Texas Tower).

Leasing volume totaled 2.6M SF in Q2 but remains 41.1% below the pre-pandemic quarterly average from 2017-2019 due to the combination of many firms trending towards smaller footprints and the lack of large new deal and expansion activity.

The flight-to-quality trend remains prevalent as tenants continue to prioritize highly amenitized buildings containing fitness complexes, dining options serving up chef-inspired food, rooftop gardens, and finishes in interior and exterior commons areas that are noticeably distinguishable from lower-end or older Class A buildings.

Landlords continue to hold firm on face rates but the gap between asking and effective rates remains significant as highly competitive concession packages with rental abatement and tenant improvement allowances, aimed at attracting and retaining tenancy.

New supply continues to capture a large share of the demand, as 25.7% of the YTD leasing activity has occurred in buildings delivered since 2015 and contributed to all the absorption gains. The largest deal inked in Q2 involved Cheniere Energy’s 151k SF new lease at Texas Tower, which brings the newly built trophy tower up to 62.4% leased.

Sublease availability remains elevated at 7.9M SF but has slightly declined since hitting its peak at mid-year 2021. Even though many companies have already rightsized their footprint to adjust to a post-pandemic environment, some occupiers are still exploring ways to optimize and reconfigure their workspace to meet new challenges and work patterns.

Developers delivered 122k SF of new product in Q2, bringing the YTD total to 802k SF. New construction remains active with 2.0M SF underway currently 20% pre-leased with 567k SF of this new product slated to deliver by year-end 2022. As the office market recovery gathers steam in the coming quarters, newer and amenity-rich Class A office product in prime locations will continue to outperform the broader market in demand, occupancy, and rents at the expense of older buildings.

Employment indicators and consumer spending have remained strong through the first half of 2022 however, higher inflation expectations continue to undermine consumer confidence. The Federal Reserve is now engaging in a sharp tightening of monetary policy. Higher interest rates will cool private investment and reduce consumer purchasing power. Even still, there remains pent up demand which should help improve leasing fundamentals and generate more occupancy as occupiers get more certainty on their longer-term space needs.

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