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Houston Office and Industrial Markets Continue to Recover with Positive Absorption and New Construction

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Houston Office Market

Houston’s office and industrial markets continue to show signs of recovery as net absorption turns positive and speculative construction projects break ground, according to quarterly market research compiled by Commercial Gateway, the Commercial Division of the Houston Association of REALTORS®.

Citywide, the office market recorded overall positive net absorption of 86,108 square feet in the second quarter of the year, with Class A space recording its fifth quarter of positive absorption of 217,351 square feet. Class B buildings offset the leasing activity in Class A, accounting for negative absorption of 108,597 square feet, the fourth consecutive quarter of negative absorption, with a total negative 553,690 square feet to date. The effects of the space program’s downsizing are becoming visible in the Southeast sector as one entire 158,627-square-foot building, formerly occupied by United Space Alliance, entered the market as available for sale and/or for lease.

However, optimistic and even encouraging signs in Houston’s office market point to new development in several areas. Joint developers Redstone Companies and Stream Realty recently broke ground on Houston’s newest office project, a 312,000-square-foot building in the Uptown/Galleria submarket; BBVA Compass has committed to almost half of the space. And the news that Exxon Mobil finally confirmed its long-awaited plans for a new campus on 385 acres in The Woodlands and is slated for occupancy in 2014 could spur additional development in the area’s north sector. Other projects have been discussed but none yet started.

Several large office renewals were announced during the second quarter and included Chevron, which both renewed a 311,000-square-foot space in 1600 Smith and completed its purchase of 1400 Smith, a 1.4 million square-foot building the company occupies. Leasing activity is up overall but is tempered by several large company downsizings, including Chevron’s recent renewal, looming on the horizon for the next 12-24 months.

The current 14.6% vacancy rate is marginally higher than last quarter’s but also higher than the 13.8% vacancy rate of a year ago. This could be the result of some sublease space re-entering the market as direct space with rental rates decreasing slightly. The overall annual weighted averaged gross rental rate quoted for this quarter of $23.01 per square foot is 1.9% lower than the same quarter last year, which was $23.46. By contrast, the Central Business District’s (CBD’s) quoted rental rates showed a 2.7% increase to $30.84 per square foot from a year ago’s $30.04.

Rental rate concessions vary across the board, but some sublease rates in quality spaces with long terms are close to matching rates quoted for direct space. Overall sublease space decreased by about 45,000 square feet or 1.6% from last quarter; however, it has fluctuated each quarter for the last two years with a high of almost 4 million square feet two years ago in the second quarter of 2009 to the current low of 2.8 million square feet, a decrease of 1.2 million square feet. This fluctuation is due to downsizings and several blocks of sublease ending their term and becoming direct space. But with the consolidation of Continental and United Airlines, the move of Hess into its new building during third quarter, Chevron’s downsized renewal, Devon Energy and other firms’ ongoing space realignment, the effects of anticipated sublease space on the Houston office market have yet to be fully realized.

Houston Industrial Market

Houston’s industrial market also recorded positive absorption with several large deals and renewals, including the largest in recent memory, a 436,410-square-foot lease signed by Jacobson Warehouse to be the first tenant in Building II at the Interport Distribution Complex on Bay Area Boulevard. This quarter’s positive absorption of 398,080 square feet shows improvement from first quarter’s negative absorption of 22,282 square feet to bring the mid-year absorption to a positive 375,798 square feet, according to statistics released by Commercial Gateway. The majority of positive absorption has occurred in warehouse/distribution properties, which recorded 898,910 square feet of net absorption this quarter, offsetting the negative absorption recorded in the other three industrial classification types.Vacancy overall is 8.5%, the same as last quarter, but an improvement when compared to 8.9% a year ago. Construction is also on the rise, with more than 1.5 million square feet of mostly build-to-suit properties while rental rates continue to show a slight overall decrease of 2.8% from last quarter but at $5.22, a 5.6% decrease from the same quarter last year.

Properties classified as high-tech/R&D, the smallest segment of the market, are reporting the lowest vacancy rate of 4.7%. Manufacturing facilities are reporting the second lowest vacancy rate of 5.2%, with crane-ready buildings in short supply. Both high tech/R&D and flex-service centers, commonly referred to as office/warehouse, showed positive absorption for the quarter at 150,600 square feet and 106,543 square feet, respectively.Sublease space reported in the second quarter represents an increase of 113,399 square feet from last quarter but a substantial drop of 524,628 square feet from this same time a year ago.

Patsy Fretwell is a senior market analyst with Commercial Gateway and has more than 20 years of experience in real estate market research. She can be reached at patsy@commgate.com.

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