SUBLEASE SURGE: INSIDE AUSTIN’S GROWING SUBLEASE MARKETQ1 2016 Special Report

AQUILA Q1 2016 SPECIAL REPORT

A hot topic in the commercial real estate world recently has been the topic of sublease space. As the U.S. market comes off a historic year in 2015, analysts around the country are pointing to subleases as a leading indicator of what might be expected in the future. Often, an increase in sublease availability can be indicative of some other macro-level factor1. For example, in 2015, plummeting oil prices caused Houston’s sublease availability to grow to nearly 15% of its total available office space2, and San Francisco is seeing its highest sublease availabilities since 2010, due to slowing venture capital investments and overall hiring3.

Given recent interest in the topic, AQUILA decided to take a deeper dive into the data to understand the composition of Austin’s subleases and what effect these subleases may have on our overall market.

In examining a set of 200+ class A & B office buildings totaling 29,666,500 sf of rentable area in Austin’s three major submarkets (AQUILA’s “competitive set”), there is 728,849 square feet available for sublease this quarter—the highest amount since 2010. This accounts for 22.81% of total available space, but only 2.34% of total rentable area. Absorption in these buildings is consistently high, indicating that, while some tenants are putting sublease space on the market, there are more tenants ready to take those availabilities off the market.

Research Park Plaza IV

AQUILA Q1 2016 SPECIAL REPORT

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Figure 2: Competitive Set Market Size and AvailabilitySource: AQUILA Market Research

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Figure 2: Competitive Set Market Size and AvailabilitySource: AQUILA Market Research

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Figure 1: Competitive Set Sublease Availability as % of NRA vs Net AbsorptionSource: AQUILA Market Research

Net Absorption Sublease Availability as % of Net Rentable Area Average Sublease Availability as % of Net Rentable Area

Figure 1: Competitive Set Sublease Availability as % of NRA vs Net AbsorptionSource: AQUILA Market Research

AQUILA Q1 2016 SPECIAL REPORT

Subleases by Size

Less than 10,000 SF Greater than 10,000 SF

All Subleases

Non-Competitive Set Building Competitive Set Building

Subleases by Term Remaining

Less than 3 Years Greater than 3 Years

Sublessors by Industry

Technology Financial Services Other Business Services

Non-Competitive Set Building Competitive Set Building Less than 10,000 SF Greater than 10,000 SF

Less than 3 years Greater than 3 yearsTechnology

Other

Financial Services

Business Services

All Subleases Subleases by Size(Competitive Set Buildings)

Subleases by Term Remaining(Greater than 10,000 SF)

Sublessors by Industry(Greater than 3 years)

THE NITTY-GRITTY

AQUILA analyzed over one hundred individual subleases active as of January 2016 to get a better idea of what is happening on a more granular level with each availability. We sought to understand if there is a specific industry unloading the majority of space on the market (i.e. Houston or San Francisco) as well as determine how increased sublease availability competes with directly available space.

When analyzing the individual subleases, we first narrowed our focus to availabilities in competitive set buildings. Next, we broke them down by size ranges, determining that subleases greater than ten thousand square feet would have the most impact on the market, and then proceeded to break those down by years remaining on their term and the industry of the sublessor.

Out of the 115 subleases analyzed, 77 were in the competitive set buildings, 23 of those 77 were larger than ten thousand square feet (78% of total sf), and only nine of those 23 had more than three years remaining on their term, totaling 275,577 sf. A visual breakdown of these subleases by total square feet can be seen in Figure 3.

AQUILA Q1 2016 SPECIAL REPORT

NOT ALL SUBLEASES ARE CREATED EQUAL

Even though there has been an increase in the supply of available space for sublease, this does not mean that the universe of Austin sublessors are all putting their space on the market for negative reasons: downsizing; bankruptcy; moving to a different market; etc. Many of the smaller, shorter-term subleases (those with less than three years of remaining term) are available simply due to tenants signing new leases elsewhere near the end of their current leases. In fact, several of the larger, longer-term subleases are available due to a positive event within the company, such as outgrowing their current space. Some of the notable larger subleases are explained below:

• Charles Schwab (SCHW) has the largest competitive long-term sublease available: 96,334 sf at Research Park Plaza IV with a term through the end of March 2022. This large block of two full floors is not enough space for the financial services company’s expanding IT division, so it will be moving within the northwest submarket to its new campus near the Domain.

• Apple (AAPL) is listing its old 24,478 sf space at CityView Centre as the technology giant continues to grow and consolidate its presence in Austin to accommodate up to 7,000 employees. Apple currently occupies space in the northwest submarket at Riata Crossing and are waiting tenant finish-outs at Capital Ridge in the Southwest submarket, where it signed a 215,000 sf lease last spring.

• Main Street Hub took 47,000 sf at One Congress Plaza in October 2015, leading the company to sublease its four floors at Perry Brooks Tower with a term through February 2019. Two floors are already taken, with two remaining available, totaling 11,200 sf. The social media marketing company’s explosive growth resulted in it becoming one of the largest tech tenants in downtown Austin.

• Outbound Engine—another email and social media marketing company—is experiencing similar growth. It is currently marketing 11,199 sf for sublease at Lavaca Plaza after its recent expansion into 40,000 sf at San Jacinto Center. Its Lavaca space is available through April 2020.

• EZ Corp (EZPW) currently has the longest available term remaining on its sublease offering. The pawn shop chain eliminated its payday-lending service in August of 20154, less than a year after it signed a 140,000 sf lease in Rollingwood Center, unloading 2 full floors totaling about 65,000 sf on to the market with a term through August 2028. These large blocks of space are quickly getting absorbed, however, as Data Foundry signed for the second floor in February 2016, and another transaction is in the works to take part of the third floor as of March 2016.

• Dropbox is marketing the third floor at 501 Congress: 20,396 sf through August 2019. The San Francisco tech startup recently had its valuation cut from $10 billion to $2 billion as investors are skeptical about its growth potential in a competitive market5.

• Parsley Energy (PE) will be listing the 21st floor in Colorado Tower for sublease as it feels the effects of the recent drop in oil prices, less than a year after they relocated their headquarters from Midland, Texas to Austin. This 24,148 sf sublease—the largest downtown—accounts for less than twenty percent of their 135,000 sf footprint in the building and is only marketed as an 18-month term with a target commencement date of July 2016.

AQUILA Q1 2016 SPECIAL REPORT

WHAT DOES THIS MEAN FOR YOU?

Landlords: With an increased supply of product on the market, keep in mind that you might have more competition for your space. Because underlying rental rates for subleases could have been locked in years ago, their rates could be significantly lower than the direct market rates in comparable buildings. Also, with higher direct rental rates, tenants could be looking for shorter-term deals in hope of a slow-down in the market. It is also important to note that, despite the increasing supply of sublease availabilities, overall absorption is still healthy, signifying that, while tenants might be moving out of their spaces early, there are still plenty more looking for new office space. The sublease market should not be ignored, and we will certainly be keeping an eye on it to see how it affects the overall market in coming quarters.

Tenants: If you are looking for a smaller space that is less than 10,000 sf, you would be well-served to check out the sublease market – particularly if you are looking for lower rental rates. Also, because it is currently a landlord’s market, owners are pushing longer terms on new deals, so a sublease would allow for extra flexibility. However, proceed with caution, because after the sublease term is up, you will be brought up to market rate, likely with no options or rights to extend your lease.

1Weber, J. (2016, February 12). Availability of Sublease Space as an Economic Indicator. Retrieved from https://www.linkedin.com/pulse/availability-sublease-space-economic- indicator-jesse-weber

2Henry, M. (2016, March 11). Just how bad is Houston's sublease market? Retrieved from http://www.bizjournals.com/houston/news/2016/03/11/just-how-bad-is-houstons- sublease-market.html

3Vekshin, A. (2016, March 24). Tech Slowdown Seen in San Francisco's Commercial-Property Market. Retrieved from http://www.bloomberg.com/news/articles/2016-03-24/ tech-slowdown-seen-in-san-francisco-s-commercial-property-market

4Theis, M. (2015, August 10). After layoffs, EZCorp cuts back on HQ space; Rollingwood subleases available. Retrieved from http://www.bizjournals.com/austin/blog/real- estate/2015/08/after-layoffs-ezcorp-cuts-back-on-hq-space.html

5Manjoo, F. (2016, February 03). Dropbox May Not Be LeBron James, but It Is Still in the Game. Retrieved from http://www.nytimes.com/2016/02/04/technology/dropbox- may-not-be-lebron-james-but-it-is-still-in-the-game.html?em_pos=large

Capital Ridge by Miguel Segura, courtesy of Riverside Resources

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The information contained herein has been obtained from sources believed reliable. AQUILA Commercial, LLC makes no guaranties or warranties as to the accuracy thereof. The presentation of the property is submitted subject to the possibility of errors, omissions, change of price, rental or other conditions, prior sale, lease or financing, or withdrawal without notice. Included projections, opinions, assumptions or estimates, are for example only, and may not represent current or future performance of the property. Information is for guidance only and does not constitute all or any part of a contract.