First Quarter 2020
The first quarter of 2020 started strong, until the COVID-19 pandemic hit in the last weeks of March. The shutdown caused a significant decrease in economic activity while reflecting a steep decline in hiring and a related surge in unemployment. Initial unemployment insurance claims ballooned to unprecedented levels, signaling even higher joblessness in the second quarter. Manufacturing and service sectors saw huge slowdowns in business activity, according to survey data. Export values fell nearly 10 percent due to supply-chain disruptions and falling consumer demand. Home sales contracted 4 percent amid reduced buyer and seller confidence, the negative employment shock, and growing wariness of visiting and showing homes for sale. Texas' energy sector struggled with decades-low oil prices due to diminished global demand during the pandemic, a sharp contrast to its role during the Great Recession. While preliminary coronavirus effects were visible in the March economic data, even more severe impacts are expected to appear in the second quarter. The severity of the economic shock due to the pandemic will likely result in losses that overshadow the damages from the 2008-09 financial crisis. For additional commentary and statistics, see Outlook for the Texas Economy.
The Texas Nonresidential Construction Coincident Index, which measures current construction activity, depicts a slight decline in activity in 1Q2020. Future construction activity is expected to remain steady in coming months, as indicated by the Texas Nonresidential Construction Leading Indicator. Although the indicators for Austin office, DFW warehouse, Houston retail, and San Antonio office declined slightly, overall, the leading indexes by MSA and commercial sector are following trends that indicate neutral to positive growth in the future. See Figures 1-5 for the Nonresidential Coincident Index and Leading Indicator for Texas and the four major metros.
In March, Texas' initial unemployment insurance claims soared in a two-week span to 567,500, with a worrisome number of people expected to file for unemployment in coming months. Using data from the Department of Labor and the Employment and Training Administration, the Real Estate Center estimates that from March 21 to March 28, nearly 123,900 seasonally adjusted claims were filed in Dallas-Fort Worth. That is the highest of Texas' major metros. In Houston, Austin, and San Antonio, an estimated 107,900, 44,500, and 41,200 claims were filed during that time, respectively.
The initial coronavirus-induced layoffs resulted in Texas' nonfarm employment shedding 50,900 jobs in March, the steepest decline since the Great Recession. Meanwhile, the unemployment rate shot up to 4.7 percent, a three-year high. State and metropolitan joblessness rose more than 1 percentage point, with Texas and every major locale except Fort Worth reporting an unprecedented jump in unemployment. Hit particularly hard by critically low oil prices, Houston's metric climbed to 5.2 percent. Dallas and Fort Worth unemployment increased to 4.3 and 4.4 percent, respectively, while San Antonio posted 4.2 percent. Austin fared relatively better with joblessness of 3.6 percent. The unemployment rate is important because of the strong relationship it has with commercial real estate (CRE) vacancy rates. As the unemployment rate rises (decreases) generally, so will CRE vacancy rates (see Figures 6-9). Unemployment rates are expected to increase in second quarter 2020, pushing up vacancy rates in the major metros.
Every major metro reported net layoffs in March, but Fort Worth reported the worst of it, shedding a record-breaking 19,900 jobs for a percentage loss of 1.8 percent. Nearly all the subsectors had cutbacks except for manufacturing and government, which posted negligible increases. The Central Texas MSAs registered their worst month in series history, contracting by 8,400 jobs in Austin and 5,500 in San Antonio, marking the metro areas' second consecutive month of negative growth. Similar to Dallas employment, which decreased by 11,100 positions, leisure/hospitality accounted for most of the total reductions, especially in San Antonio.
In Houston, the leisure/hospitality, construction, and manufacturing industries were mainly responsible for the overall 18,200 jobs contraction. Counterintuitive to plummeting oil prices, mining/logging expanded by 1,400. However, this may be a slight correction to a ten-month decline. Houston's energy-related employment is expected to fall if oil prices remain in the $20-30 per barrel range, since Houston has experienced only a partial recovery from the 2015-16 oil bust. There simply is not an abundance of excess positions employers can eliminate with sweeping, extended layoffs.
The ability of a metro's labor force to work remotely is a factor in job losses during this recession; the more remote-compatible an occupation is, the greater chance workers will continue to work during the shelter-in-place. The Dallas Fed estimates Texas' Urban Triangle has a greater proportion of workers who can work remotely than other areas in the state (28 percent). Austin leads the major metros with 48 percent of its workers who can work remotely, followed by DFW and Houston with 42 and 40 percent, respectively. San Antonio lags with 37 percent of its employees able to work remotely. While this bodes well for overall employment, it may be a precursor to problems in office occupancy rates if businesses decide they do not need as much space.
Due to the domestic coronavirus outbreak, the Federal Reserve cut interest rates a total of 150 basis points in March, taking the targeted federal funds rate to 0-0.25 percent. It also cut the discount window rate by 150 basis points and promised unlimited, open-ended asset purchases (quantitative easing). The liquidity injection by the Federal Reserve to financial markets, in conjunction with gloomy future growth expectations and low inflation expectations, caused interest rates to fall dramatically. In addition, capital flows seeking positive returns and low risk have flooded the Treasury market, pushing the ten-year Treasury bill further down to 0.9 percent in March. The fall in the ten-year yield at the end of 2019 caused the spread in commercial capitalization rates to increase, indicating increased risk and profitability in commercial real estate during 2019. The increase in the spread is projected to continue in 2020 as commercial real estate risks may increase further due to the COVID-19 pandemic.
Office cap rates (Figure 10) in the Major Texas MSAs, with the exception of Austin, registered an increase at the end of 2019. San Antonio and Houston remained the highest in 2019, with both cap rates increasing in 2019. DFW also registered an increase last year, with Austin trailing the other major MSAs. In 2019, Austin became the least risky market for office real estate based on the spread with the ten-year Treasury bill.
Retail cap rates (Figure 11) generally increased in 2019 in the major MSA markets, with the exception of San Antonio. Austin and DFW had the greatest increases, followed by Houston and San Antonio. The spread in the ten-year Treasury bill also increased in 2019. Austin and San Antonio are the least risky and lowest return markets for retail real estate.
Industrial cap rates (Figure 12) for San Antonio and Austin were the highest in 2019. San Antonio cap rates increased for the year until 4Q2019, while in Austin they were unchanged. Houston and DFW registered an increase in cap rates in 2019. Similar to the other two commercial markets, the spread in the ten-year Treasury increased in all four markets. DFW is the least risky and lowest return market for industrial real estate based on the spread with ten-year Treasury bill.
For an analysis of Austin's, DFW's, Houston's, and San Antonio's commercial markets (including tables and figures), download the full report.
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