Equity Still A Hard Sell In San Antonio

San Antonio is in the middle of its biggest building cycle in 40 years, but investors still hesitate when it comes to putting down money on commercial real estate.

Putting together the equity deal for San Antonio's first downtown office tower in 25 years was tough, but all partnerships are tough, HFF Managing Director John Taylor told a sold-out Urban Land Institute luncheon crowd Tuesday.

The Frost Bank Tower is the biggest office project in San Antonio in 25 years. Taylor approached 60 investors and investment groups to finance the $175M 23-story downtown tower. Only three were interested, and the final deal was cut with Frost because the bank offered a favorable loan and was willing to sign a lease for 61% of the tower's floor space.

"Any time you're raising equity, it's rarely easy," Taylor said. "You're not just selling an asset, you're creating a partnership. You're going to have ups and downs. There's a certain amount of matchmaking that makes it a little bit harder and a little more challenging."

Taylor was on a panel discussing emerging real estate trends in San Antonio. PwC partner Mitch Roschelle headlined the event, which offered the annual overview of PwC-ULI's joint Emerging Real Estate Trends report.

The current real estate market is on a slow-glide path, one based on a jobless economic rebound, Roschelle said. Attitude toward the market remains, for a second year, fairly optimistic, if not over-the-top enthusiastic. Seattle and Austin top the list, with Dallas-Fort Worth in the top 10. San Antonio is No. 18 on the list, with Houston pulling up the rear at No. 60.

Number-crunching the annual trends produced a number of observations: The current exodus out of retail space and into cyberspace cannot be blamed on a single factor. It is probably a combination of both brick-and-mortar mistakes and choices in merchandise. Single-family construction does not come close to meeting anticipated population growth. Foreign investment is gravitating to secondary markets, especially in student housing. And a demand for new and different senior housing is gaining in momentum.

A real estate panel followed Roschelle.

HFF's Taylor talked about the difficulty pulling financing together for the Frost Bank Tower, noting it might have been cheaper to take on renovating an existing office tower, as USAA Real Estate plans to do. USAA Real Estate now has a stake in two downtown office towers and the Shops at La Cantera, among other investments.

USAA Chief Operating Officer Jim Hime said USAA had a good handle on the San Antonio market, but recognized that others were more leery of the city. Those who do not have San Antonio at the top of their minds for investment often think first about liquidity, he said.

"If you buy something like 300 Convent, how are you going to get out of a position? Who's going to take the other?" Hime said. "In our case, when we look at our balance sheet, we think about that, but we think we have answers to it."

San Antonio has not yet achieved the status it needs to attract investors, Hime said. That, in time, will change.

"We all see deals on the ground, the strong economy, the things that Mitch talked about," Hime said. "A strong economy, a good university, a light touch on taxes. ... This is a city that is very much a city of the future."

Roschelle spoke about a changing office sector, one more dynamic with a mix of older semi-retirees and young Gen Z workers in the same office. He predicted a lot less columnless open space and more offices with doors. Hime said that drive to create a space for a younger workforce also was a reason to pick up the downtown office buildings.

The workforce USAA wants is not tied to a vehicle or interested in a sterile insulated campus, Hime said. Those workers want walkable amenities and a downtown location.

"You just can't do that in the big campus location," said Hime, who joked his walkable amenity was his mailbox. "To attract people to whom that is important, who want to work in that setting, you've got to have that arrow in your quiver. Otherwise, they're going to go elsewhere."

But development, or redevelopment, does not come cheap. Only half of those employees lost in the last construction downturn returned to the market, Embrey Development Partners' Trey Embrey said. That means the industry entered the newest round of construction with 1 million fewer workers.

Construction costs are going up 20% per year, Embrey said. And, even beyond the increased cost, it is hard to find the labor, at any price.

"We've been fortunate. We've had double-digit rent growth," Embrey said. "I think [the question] today is how much more runway is there as we pick up the capacity we lost during the downturn."