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Despite strong economy, Texas cities grapple with excess office space

As remote and hybrid working become the new normal, major Texas cities are facing a decline in office tenants. It’s too soon to tell what that means for the vitality of downtowns.
Posted: 6:12 AM, Nov 29, 2023
Updated: 2023-11-29 07:12:10-05
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TEXAS (Texas Tribune) — Texas office workers are back in person more than their counterparts across the country — but a lot of the state’s urban office space is still sitting empty.

The Austin, Dallas-Fort Worth and Houston areas have office vacancy rates that range from 21% to 25%, vacancies that could complicate the post-pandemic recoveries of downtown areas, which depend on office workers to support restaurants and retail businesses. But whether the glut of space at a time when developers are continuing to construct more office buildings foreshadows a brewing economic storm remains to be seen.

“Is it soft? Yes. Is it a challenge? Yes. Is there a crash coming? I would not say that that’s the situation we are in,” said Julie Whelan, who heads a research team that studies trends in commercial real estate for the firm CBRE Group.

Texas’ relatively strong economy, growing labor force and high number of workers returning to the office has buoyed hopes that the office market isn’t facing dire straits.

Still, some real estate and office market analysts worry about what are called “shadow vacancies.” Even as employees spend more time in the office, they’re not there as often — or in such high numbers — as they were before the pandemic. That means office space that looks occupied on paper could be sitting relatively vacant — and that companies won’t renew their leases, bumping up vacancy rates.

“The return to the heyday where everybody was in the office four or five days a week, that's just not happening ever again,” said Steven Pedigo, director of the University of Texas at Austin’s LBJ Urban Lab, which focuses on urban policy.

“The perfect storm”

Fewer than 6% of Texas employees worked from home before COVID-19 hit, according to the U.S. Census Bureau. Last year, remote employees accounted for more than 15% of the state’s workforce — a percentage that’s even higher in the state’s urban areas.

The Austin area has a greater share of remote workers than other Texas metros thanks to its tech sector. That 28% figure has fallen only slightly even as its workers return to the office at higher rates than elsewhere in the country.

Before the pandemic, the Austin area’s office vacancy rate sat below 10%, according to CBRE. At the end of the third quarter this year, that rate was nearly 22%.

Some of that vacancy comes from some major employers scaling back their office plans. Some 11% of the Austin central business district’s 15 million square feet of office space is available to “sublease” — a result, real estate analysts say, of employers pulling back on how much office space they need.

Meta, the parent company of Facebook and Instagram, had planned to move into 589,000 square feet of offices in downtown Austin. Instead, it nixed those plans and will lease the space to other tenants — along with 100,000 square feet elsewhere in downtown the company planned to occupy.

“What’s happening is that companies just realize, ‘Hey, now that we’re measuring utilization (of office space), we don’t need all the space,’” said Phil Mobley, national director of office analytics at CoStar, a company that tracks commercial real estate. “So they're taking the opportunity, when leases expire, to reduce their space and they're placing a lot of space on the sublet market.”

In Austin, more than 5 million square feet of office space is under construction, nearly half of it downtown. Much of it was planned when builders wagered, given the city’s strong economic pull, that demand for new space would be there when those buildings eventually open.

“The environment in which those buildings are going to be delivered into looks different than the environment in which they were initially begun,” Mobley said.

Less than a quarter of the space under construction has leased to tenants, according to a recent report from Cushman & Wakefield.

Austin is “having the perfect storm of falling demand with rising supply,” Mobley said.

In Dallas-Fort Worth and Houston, the rise of remote work exacerbated already-high vacancy rates brought on by overbuilding in the ‘80s and ‘90s that still casts a shadow on the current office market.

“Dallas, like many Texas cities, built beautiful, high-rise, shiny buildings that were enormous,” said Jennifer Scripps, who leads the economic development group Downtown Dallas Inc. “They weren't full when they opened and they never filled up.”

A key driver of the current vacancies: Employers are trying to lure their workforce back to the office by leaving their old spaces to set up shop in sleeker, more modern digs. It’s a trend office market observers call “flight to quality.”

In Dallas, Bank of America plans to swap its space in the most prominent tower on the downtown skyline for a newer building just outside the central business district. There, it will join JP Morgan Chase, which made a similar move in 2021.

In downtown Houston, NRG Energy plans to move its headquarters in 2026 to a recently renovated skyscraper billed as an “urban, mixed-use office campus” that has a luxury gym and access to the downtown tunnel system.

But that “flight to quality” has left older, less attractive space unoccupied. More than a quarter of Houston’s downtown office space is sitting empty, according to CBRE. Roughly half of that vacant space is basically “unmarketable” because it’s so out-of-date, said Kris Larson, president and CEO of Central Houston Inc.

Newer buildings or those that have recently undergone renovations “are performing much better than the older building stock, which is losing a lot of its tenants to these basically newer [additions] to the marketplace,” Larson said.

Few options to turn things around

High office vacancies in other parts of the country like New York and San Francisco have spurred fears of an urban “doom loop.” That’s a term used to describe economic downturns in which offices shuttering lead to closures of nearby businesses like restaurants and shops that rely on traffic from office workers. That many closures can lead to blight, lower property tax revenues and declining city services as a result.

Houston City Controller Chris Brown said office vacancies alone — if they persist — could lead to lower commercial property values, which in turn could hurt the budgets of cities and school districts that heavily rely on property taxes.

“Those are huge assets,” Brown said of downtown office buildings. “So how do we project our tax base growth? We have to be more conservative about our assumptions. But you never know what could happen.”

Some Texans are bullish that the state’s major urban areas are safe from any kind of “doom loop.” For one, the state’s economy is booming and its population growth is strong. Its workers are already back in the office in higher numbers than in other major cities. The number of people living in Texas downtowns have surpassed pre-pandemic levels, according to a report from the Center City District in Philadelphia. Tourists also have returned to downtowns even if workers still lag behind, the report found.

Still, the glut of empty office space poses a major challenge. And that’s true across the globe. In nine major cities including Houston, demand for office space could be as much as 20% lower in 2030 than it was in 2019, according to a recent report from consulting firm McKinsey & Company.

If demand for office space ever returns to pre-pandemic levels, it could take decades, the report found. In the meantime, falling demand stands to wipe out $800 billion in property values in those nine international cities, McKinsey found — posing a major challenge for local governments’ property tax collections.

And owners of office buildings with lots of vacancy have few options to turn things around, said Harold Hunt, a research economist who studies commercial real estate at the Texas Real Estate Research Center at Texas A&M University. They can keep the building as-is and deal with diminishing returns or upgrade it in order to compete with glitzier office properties, Hunt said. Owners can also sell the building or demolish it.

Building owners can also convert their empty office space to residential housing, Hunt said, an idea that’s gained a lot of attention as the nation faces a glut of vacant offices and shortage of housing, Hunt said. But not every office building is a suitable conversion candidate.

“What do you do with a million and a half square feet if nobody wants it anymore?” Hunt said. “Everybody just sort of scratches their head.”

Disclosure: Bank of America, Facebook, NRG Energy, Texas A&M University and University of Texas at Austin have been financial supporters of The Texas Tribune, a nonprofit, nonpartisan news organization that is funded in part by donations from members, foundations and corporate sponsors. Financial supporters play no role in the Tribune's journalism. Find a complete list of them here.

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