- The 115th Congress is expected to see new policies and possible changes in the repeal/replace of Affordable Care Act, corporate and individual tax cuts and reforms, increased infrastructure spending, and trade policy and regulations.
- With increases in oil prices and rig counts, the energy sector has likely passed its bottom, and national, regional and local signs indicate a positive but bumpy improvement ahead.
- Gross domestic product (GDP) is anticipated to be 1.6% for 2016 and 2.1% for 2017, both slower than the 2.6% measure seen in 2015.
- U.S. employment remains steady in posting 156,000 new jobs in December, for a total of 2.2 million new jobs in 2016 (an average of 180,000 new jobs per month); though still strong, 2017 is anticipated to see a slightly lower 160,000 new jobs per month.
- Net absorption of 680,061 sq. ft. occurred in Q4 2016, which is more than double typical historic performance; total annual net absorption for 2016 was 1.25 million sq. ft., the highest of any year since 2006.
- Leasing activity of 430,223 sq. ft. in Q4 was statistically lower than the historic expectations, but total annual leasing activity in 2016 of 2.21 million sq. ft. is on par with annual average since 2006 of 2.54 million sq. ft.
- Vacancy at 13.9% and availability at 17.8% continue their steady declines, signaling an ever-stronger market with strengthening balance between supply and demand.
- Deliveries were 102,206 sq. ft., an increase of 14% QoQ but a decrease of 14% YoY.
- Continued growth in net absorption and declining vacancies indicate a strengthening market.
As the 115th Congress began alongside a new president-elect, some new policies and policy changes that may unfold include repealing/replacing the Affordable Care Act, corporate/individual tax cuts and reforms, increased infrastructure spending, and among others trade policy and regulations. Despite a very vibrant political cycle with some clear consequences, Trump’s election is not anticipated to influence gross domestic product (GDP) in 2017, which is expected to be about 2.1%. GDP may roll in for 2016 around 1.6%, lagging behind 2.6% in 2015. Proposed tax cuts tend to mostly lead consumers to reduce their debt, rather than increase consumer spending, which accounts for about two-thirds of GDP. Consumer spending did grow by 2.8% in the third quarter of 2016.
Job growth continues to be a strength of the U.S. economy. Employment in December increased by 156,000 new jobs, with particular strengths in health care, hospitality, government and manufacturing. In 2016, there was an average of about 180,000 new jobs added per month, for a total of 2.2 million new jobs and an unemployment rate of 4.7%. Job growth in 2017 is anticipated to slow but remain strong at around 160,000 new jobs per month. Increases in job openings and turnover further suggest a tightening labor market. Nevertheless, with more people entering the labor force, unemployment is expected to drop to 4.5% in 2017. Strong employment and job growth are big contributors to the likely two-to-three interest rate hikes anticipated to occur by the Federal Reserve in 2017. Personal income also rose in every state in Q3 2016.
Core inflation, excluding food and energy, is projected to be about 2.3% in 2017, a modest increase from 2.2% in 2016. However, energy prices are likely to increase modestly in 2017, for an overall 2.5% inflation in 2017, up from 2% in 2016. The question remains as to whether OPEC’s cuts will really manifest and if so, how much they will lead to the stabilization and increase in oil prices and the energy sector. Either way the oversupply of production and stored oil still persists and needs to be burnt off for WTI prices to see substantial shifts upward. The oil markets are likely to remain volatile in 2017, possibly stabilizing some during the latter half of the year.
Business spending was largely flat in 2016, but a modest increase of 3-4% may occur in 2017. Demand for factory-produced goods continues to strengthen after a lengthy lull. The Small Business Optimism Index of the National Federation of Independent Businesses (NFIB) increased substantially by 7.9 points in December and 10.9 points in November, following decreases over the past 12-18 months. Such positive swings indicate an expected stronger economy associated with possible easing of regulations. The ISM manufacturing index rose to 54.7, a two-year high on the heels of increases in production and new orders in December. In December, the ISM non-manufacturing index was unchanged at 57.2.
Indicators such as residential construction suggest that the housing market will strengthen in 2017, despite substantial drops in housing starts in November 2016. Inventory remains low, with more people looking to buy homes than are readily available. With political headwinds in 2016 in both the U.S. and U.K. leading to uncertainty, growth in private nonresidential construction spending is anticipated to be about 7.5% in 2016. The Dodge Momentum Index of non-residential construction increased 2.9% in December after downward revisions for November.
Export prices are expected to increase with the strong value of the dollar, which in turn will produce an anticipated increase in U.S. trade deficit by 4% in 2017. Meanwhile, import prices rose 1.8% in 2016. Though all data are not yet in, it appears that international trade in 2016 will fare better than initially anticipated with the shortfall on par with that of 2015. Retail sales were weaker overall than hoped for in December, marking an increase of 0.6% in December following 0.2% in November (compared to expectations of 0.5%).
San Antonio and Texas Economy
While the economy of San Antonio continues to strengthen, the economy of Texas appears to be poised to begin to see some positive changes in 2017, following the bottoming of the oil industry and its economic impacts. However, at the state level, we are likely to see some continued turbulence as we bounce back from the oil downturn. Oil prices and rig counts are moving in the right direction as the outlook for Texas begins to brighten. The Dallas Fed Energy Survey increased to 40.1 in the fourth quarter from 26.7 in the prior quarter, based on its responses of executives in the industry. Signs of recovery manifested in both employment and production.
Employment in Texas grew 2.1% in the second half of the year, compared to just 0.8% in the first half of the year. Overall, Texas employment will be about 1.5% for 2016, with a forecast of growth near 2.1% for 2017. San Antonio jobs grew 2.9% annualized from August to November, with strengths in most sectors other than construction, including leisure and hospitality, manufacturing, local government, health care, and trade. Unemployment in San Antonio decreased from 3.7% to 3.5%, lower than state and national levels.
The revenue index of the Texas Service Sector Outlook survey increased from 13.7 in November to 20.6 in December. Retail sales in Texas also increased according to the Texas Retail Outlook Survey, which rose from 6.0 to 19.2. Factory activity in Texas has increased consistently over the past six months, according to the Texas Manufacturing Outlook Survey. The index which measures manufacturing conditions increased to 13.8. The San Antonio Business-Cycle Index rose an annualized rate of 3.4% in November, moving above its long-term average of 3% for the first time since April.
Demand for office space is measured by net absorption, the change in occupied inventory including direct and sublet space. Figure 2 shows net absorption since 2006 by year and quarter for combined Class A and B office space. Positive net absorption of 680,061 sq. ft. occurred in Q4 2016, representing large increases of 499.2% QoQ 126.9% YoY (Table 1). The historic Q4 average (± 95% confidence interval) for net absorption is 168,104 sq. ft. (± 82,795). We are 95% certain that Q4 net absorption typically falls between 85,309 sq. ft. and 250,900 sq. ft. Thus, net absorption of 680,061 sq. ft. is more than double typical historic performance. Total annual net absorption for 2016 was 1.25 million sq. ft., the highest of any year since 2006.
Leasing activity, another measure of demand, is the total amount of space represented by direct leases, subleases, renewals, and pre-leasing of rentable building area. Figure 3 shows leasing activity since 2006 by year and quarter for combined Class A and B office space. Leasing activity of 430,223 sq. ft. occurred in Q4 2016, representing decreases of -417.1% QoQ and -47.2% YoY (Table 1). The historic Q4 average (± 95% confidence interval) for leasing activity is 649,315 sq. ft. (± 129,548). We are 95% certain that Q4 leasing activity typically falls between 519,767 sq. ft. and 778,863 sq. ft., indicating that current leasing activity is statistically lower than the historic expectations of Q4 measures. Total annual leasing activity in 2016 of 2.21 million sq. ft. is just below the annual average of 2.54 million sq. ft.
Availability and Vacancy
Vacancy and availability measure the supply of office space. Availability is a better measure of total supply because it includes vacant, occupied, and sublease space. Vacancy better measures empty space on the market, whether or not that space is leased or for rent. For Class A and B buildings combined, availability was 17.8%, representing decreases of -2.2% QoQ and -15.6% YoY (Table 1). Likewise, vacancy was 13.9%, for decreases of -10.3% QoQ and -13.1% YoY (Table 1). Overall, office supply continued its tightening with demand in Q4 2016 (Figure 4).
Figure 5 plots both gross and base (NNN) asking rents for direct and sublease space since 2004 for Class A and B buildings. Despite limitations of asking (vs. actual) rent, we can derive information on market conditions by examining the difference between direct and sublease base rents. Negative differences between direct and sublease asking rents indicate a strong, tight market in which sublease space is getting equal to or greater rents than direct space. Positive differences between direct and sublease asking rents can indicate a softening market if the slope of the QoQ sublet rent is negative. In such cases, market conditions are softer the greater the difference. However, if the slope is positive or flat alongside increasing direct rents, then business expansion and a strong market are occurring.
The difference between direct and sublease base asking rents for Class A buildings has decreased from $6.97 to $5.20 over the past four quarters (Figure 5B). Historically, Class A buildings have shown an average difference of $3.14 between direct and sublease base asking rents, with a 95% confidence interval of $2.44 to $3.83. At the current $5.20, Class A rents are outside this expected range. Note, however, the difference between direct and sublease asking rents is decreasing, suggesting a strengthening market. Historically, Class B buildings have shown an average of $0.84 difference between direct and sublease base asking rents, with a 95% confidence interval of $0.23 to $1.45. At the current $-0.10 difference, Class B rents are moving within this range, and negative, indicating a strong Class B market in which subleases are getting higher rents than direct spaces, likely due to limited supply.
Construction and Deliveries
Construction of new RBA is an important variable shaping the supply of office space. RBA delivered refers to completed construction, while RBA under construction refers to space under construction that has not yet been completed. As detailed in Figure 6, deliveries in Q4 2016 were 102,206 sq. ft., an increase of 14% QoQ but a decrease of 14% YoY (Table 1). RBA under construction was 374,190 sq. ft., decreases of -14.9% QoQ and -53.4% YoY (Table 1).
Figure 7 depicts changes in the inventory of Class A and Class B buildings since 2006, both in terms of RBA and the number of buildings. RBA inventory for Class A and B office space included 37.6 million sq. ft. for 865 buildings (Table 1, Figure 7). Note, only 94 of these buildings are Class A buildings, and of the Class B buildings, about 50% are <20,000 sq. ft. in size. Stock inventory is up 1.6% YoY.