The Austin industrial market continued its strength at the beginning of 1Q 2020, but a wave of uncertainty took hold during the latter part of the quarter due to the COVID-19 pandemic. This unprecedented event disrupted the global supply chain and softened demand for commercial real estate space, causing many projects and decisions to be put on hold.
However, despite the global pandemic, several large industrial transactions were completed this quarter in Austin, perhaps indicating that industrial real estate may be more resilient than other product types. The recent social distancing and shelter-in-place orders have caused an uptick in e-commerce, last-mile and cold-storage space requirements. Due to this shift in demand, AQUILA believes Austin’s industrial market is well poised to take on new absorption in the coming months.
Strong Absorption As Result of 2019 Transactions
In 1Q 2020 there was approximately 754,252 square feet (sf) of positive absorption region-wide for industrial and flex space, reflecting an increase of 66,626 sf from 4Q 2019 and 416,583 sf from 3Q 2019. This increase in activity is the strongest growth experienced in Austin over the past eight quarters and mainly a result of transactions that were bottlenecked towards the end of 2019 and finalized this quarter.
A few large transactions that fueled the growth were Amazon’s new lease of a 305,768-sf cross-dock building at Park 35 in Hays County, Mattress Firm’s 99,200-sf renewal at 401B Parker Drive in North Austin and EDC Moving Systems’ 93,313-sf new lease at Innovation Business Park 3 in Hutto, Texas. The North Austin and Hays County submarkets continue to absorb space in new construction and have benefited from their superb access along major arterials such as IH-35, SH-45, and SH-130.
Rates Increase, Vacancy Ticks up Due To Deliveries & New Competition
Rental rates in the industrial sector increased from $8.31 in 4Q 2019 to $9.00 in 1Q 2020, while flex rates increased from $13.55 in 4Q 2019 to $13.66 in 1Q 2020. This is the highest industrial rate we have seen since 3Q 2018 and is 13% higher than in 1Q 2019. The increase in industrial rates is largely a result of new construction and more demand for industrial space.
Flex rates have been on the rise for three straight quarters as vacancy rates in this product type have decreased over the last 12 months. The cause of this increase in rates can be attributed to the high cost of converting industrial space to flex space, the lack of new construction of flex buildings and strong leasing activity from groups looking for high-finish flex spaces in the Austin market.
Vacancy rates in the industrial sector increased slightly from 8.3% in 4Q 2019 to 8.5% in 1Q 2020 but decreased in the flex sector from 5.3% in 4Q 2019 to 5% in 1Q 2020. Despite the Hays County industrial submarket leading the way in positive absorption for the quarter at 366,831 sf, the vacancy rate rose from 10.3% in 4Q 2019 to 15.7% in 1Q 2020. This rise was due to the delivery of Majestic Realty’s speculative two-building 535,113-sf industrial project in Kyle, Texas among other projects. The Southeast industrial submarket performed the best over the quarter, decreasing from 12.8% to 8.1% vacancy since 4Q 2019. The region-wide industrial vacancy rates of 8.5% and flex vacancy rate of 5% indicate the new supply delivering over the next three to four quarters will likely be absorbed.
Unemployment Increases as COVID-19 and Oil Price Impact Is Felt
According to the Bureau of Labor Statistics, the Austin area unemployment rate reached 3.5% in March, up from 2.6% in February and 2.4% at the end of 4Q 2019. This rate continues to be well below the state rate of 4.4% and national unemployment rate of 4.7% for March, but the numbers reflect the initial effect from the COVID-19 pandemic on Austin’s labor force. A more accurate picture of the pandemic’s effect on labor and unemployment will emerge as we move into the second quarter of 2020.
In addition to the fallout from the pandemic, the production disagreements between large oil exporters, Saudi Arabia and Russia, and the resulting drop in oil prices have played a large role in the increased unemployment rate at the state level. While the oil business is not as prevalent in Austin, it’s an integral part of the overall Texas economy and trickle-down effects can already be seen in Austin’s energy sector.
As a result of the increase in the unemployment rate, there will be some companies that will have to sublease or relinquish space due to lower inventories and headcount. That being said, Austin continues to be attractive to employers and employees alike, and our strong tech, education, and state employment sectors have Austin well positioned to withstand the economic effects of COVID-19.
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The Austin industrial and flex market continued its streak of strong leasing, sales and development activity in 1Q 2020. However, the recent global pandemic has created a clouded outlook of things to come. In the near-term, activity will be slower with the expectation that velocity will increase in 3Q and 4Q 2020 going forward. The long-term expectation is that Austin will benefit from increased transactional activity in the cold storage, e-commerce and last-mile spaces, and there is potential for increased absorption attributed to manufacturing requirements as well.