Stronger market means higher-risk models are gaining ground

Round Rock and Pflugerville's continuous growth has begun to renew the area's appetite for speculative office space construction, but developers and real estate professionals are rethinking their approach after learning some hard lessons from the recession.

Speculative or spec building is a practice in which investors and developers commit to building new properties without lease contracts in place. Spec building is based on the assumption that the market's high demand will make it easy to lease a building either during or after construction.

Demand for vacant space must be high—and supply low—for the gamble to pay off. When timed properly, spec building gives developers move-in-ready space to offer large clients rather than asking them to wait for a custom build.

Robert Shore, vice president at Round Rock–based commercial real estate firm Don Quick & Associates, said the practice was in vogue prior to the recent recession.

"The market was on fire. People didn't want to miss out. Spaces were leasing up quickly, and we saw occupancy rates over 90 percent," Shore said, adding that developers built quickly to meet the demand.

But when predictions about the market turn out to be wrong, buildings can sit empty for years and cost their owners money every day a lease is not signed. The spec-built office spaces at Frontera Vista in Round Rock, which were completed in 2009, sat empty for two years until Emerson Process Management moved into the space in 2011.

That high-profile misstep as well as general economic malaise caused local spec building to fall out of fashion for a time, Shore said. Hutto Mayor Debbie Holland said her city avoided incentivizing spec building because it was too unpredictable. But she also added that the pendulum might be swinging back.

"Even if we had had the money four years ago, we would not have done it because it was very high-risk, and you didn't know what the game was going to be," Holland said. "Now that the economy is more fluid and there are more businesses moving [to Central Texas], the risk is not as high."

With property values rising and occupancy rates creeping up, spec building could be seeing a rebound, Shore said. But if spec building returns, it is likely to be in a more conservative form.

Builders now are more likely to establish company-by-company and case-by-case rules that determine the minimum percentage of a planned building's space that must be pre-leased in order to begin construction, Shore said.

"A lot of times, [developers] are not willing to break ground on a building unless it's 50 percent [pre-leased], and a lot of times companies are looking for a stronger commitment," Shore said. "They're learning from past mistakes in the sense that they're not just going to spec space right now. They at least want to have a tenant to kick off the building."

Shore said the threshold also depends on the property. Don Quick & Associates will soon be in charge of leasing out Summit II, an 82,000-square-foot Class-A office building scheduled to go up near the intersection of Hesters Crossing Road and La Frontera Boulevard.

Shore said his team might break ground with as little as 25 percent of the building pre-leased because Class-A offices, which include top-of-the-line building materials, are in short supply in Round Rock.

But not everyone in the local market is being so cautious with the model. The Pflugerville Community Development Corp., which is spearheading the construction of mixed-use and light industrial space at 130 Commerce Center near SH 130 and Pecan Street, is willing to use the pure spec model more liberally.

To kick-start development at 130 Commerce Center, the PCDC pre-leased the first half of the first building on the new site. That assurance was enough to convince the developer to break ground, PCDC Executive Director Floyd Akers said. The development's second building was then built entirely on spec, he said.

"It's one of those 'If you build it, they will come' scenarios where we got on the forefront of the economy starting to expand here in Austin once again," he said. "We think that's going to continue for at least the next two or three years."