With most of downtown Austin’s existing Class A office space already accounted for, many tenants have had to start leasing space in new developments, either by preleasing while the building is still under construction or signing a lease soon after the building is complete.
Seeing this trend, we began to wonder what additional benefits tenants might receive by leasing space in a brand-new building other than the obvious, like up-to-date common areas and amenities, ample tenant improvement allowances and modern technologies. By looking at AQUILA’s historical market data, we have uncovered an interesting operating expense (opex) trend that could be beneficial to tenants looking to lease space in downtown Austin.
Opex Trends for Developments
For this analysis, we looked at opex in Class A office buildings downtown that delivered after 2001. To simplify the analysis we limited this group to only those buildings included in our CBD competitive set. We compared opex during construction, at delivery and post delivery.
In the chart below, you can see our findings for the buildings in our data set. Two years after delivery, these buildings saw an average opex increase of 45%. To put this in perspective, the average two-year increase in opex for our CBD competitive set since 2010 is only 12%. Said differently, newly constructed buildings had 45% lower opex in the initial two years after opening compared to existing competing buildings.
At the end of this two year period, opex in these developments began to track closely with opex in comparable CBD buildings. 500 W 2nd, for example, was quoting an opex of $25.40/sf in 2Q 2019 at a time when our CBD competitive set’s average opex was $24.40/sf. For further comparison, Frost Bank Tower’s opex that quarter was $27.84/sf.
Because a large portion of opex is a building’s property taxes, the likely explanation for this is that these new developments were appraised at a lower taxable value for roughly two years after delivery. When a building delivers, the taxable value is based on the construction cost of the project (which is filed with the city during the permitting process). Properties are typically re-assessed every other year and the taxing authority gives new developments time to become “stabilized” for re-assessment, so it usually takes two to three years before the taxing authority begins to use the cap rate approach to value properties. Once the buildings are appraised at a more comparable level to their peers, the opex increases accordingly.
This can especially be seen in buildings constructed more recently, which seem to have experienced the most significant cost savings post delivery.
So, what does this mean for the tenant?
In the simplest terms, this means that tenants who signed leases prior to or soon after delivery of an office building in downtown Austin received a benefit in the form of a lower opex payment at the beginning of their lease compared to what they would have paid in a similar, pre-existing building. Depending on the size of the tenant and the amount of opex the building is passing through to its tenants, this could result in significant cost savings over the term of the lease.
For example, consider a 20,000-sf tenant leasing space in a newly developed building for five years. If the building’s opex remains steady at $15/sf for the first two years, then increases by 45% to $21.75 for the remainder of the lease, the tenant will pay a total of $1,905,000 in opex over the term of the lease. Had the tenant leased space in an existing building and not received the 45% opex benefit, the opex cost would be $2,175,000. The result is an opex savings of $270,000 in new construction vs existing product.
While leasing space in a new downtown highrise may not be the best option for every tenant, and there is no guarantee that every new development will experience the same opex trend, those who are considering downtown and weighing the pros and cons of existing versus new construction should consider this potential cost savings as they evaluate options.
To find out what’s under construction or delivering soon in Austin’s CBD, download our Downtown Austin Emerging Projects report.