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Houston’s 2015 Commercial Outlook Steady as Record-Level Absorption and Construction Close 2014

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Houston Office Market

Houston’s commercial real estate market outlook remains steady as record absorption and construction levels close out 2014, according to quarterly market research compiled by Commercial Gateway, the commercial division of the Houston Association of REALTORS®.

The fourth quarter reported office net absorption of 1.7 million square feet, representing the 15th consecutive quarter of positive absorption, to close out the year with a record-level 5.8 million square feet. The 2014 level tops the two previous years by more than 2.2 million square feet each. As in previous years, Class A properties represent the bulk of the growth, 91.2%, while Class B and Class C properties show limited absorption.

The market activity is clearly tied to job growth, substantiated by the Greater Houston Partnership’s just-released employment numbers: The Houston-Sugar Land-Baytown metro area led the state in employment growth, creating 125,300 jobs in the 12 months ending in November, according to the Texas Workforce Commission. Are falling oil prices going to have an effect on Houston’s energy-dependent commercial real estate market? For more insight, please review our expert broker commentaries and outlooks later in this release.

For the year, 33 new buildings were completed, adding 6.1 million square feet to the market. Of that total, 16 were single tenant or owner occupied and contributed 4.0 million square feet of absorption. By yearend, the new properties collectively were almost 84.3% leased with rental rates averaging $33.83, slightly higher than the Class A overall rate.

Contributing heavily to the fourth quarter’s absorption were two projects just south of The Woodlands: Southwestern Energy’s move into its new 515,000 square-foot headquarters’ building and 1 million square feet attributed to ExxonMobil’s occupied space in its new campus. The other largest absorption contributors earlier in the year were also energy-related and included Anadarko’s move into Hackett Tower, a 549,260-square-foot building adjacent to its headquarter’s building in The Woodlands, Shell’s occupying 672,000 square feet in the west, and Technip’s occupying 450,532 square feet in Energy Tower III in the west.

Construction starts continued during the fourth quarter, but at a slower pace. Overall, the Houston under-construction office market boasts 53 properties with 71 buildings totaling 17.4 million square feet. Collectively, the buildings are 56% preleased, with 42 buildings classified as multi-tenant. The multi-tenant properties represent about 9.1 million square feet or 54% of the under-construction total and are about 18% leased.

The largest project under construction remains ExxonMobil’s 3 million-square-foot campus, although employees have occupied about a third of the total so far. Phillips 66’s 1.2 million-square-foot campus in the Westchase area is the second largest project underway. The largest spec building under construction with the largest availability remains Hines’ 609 Main at Texas building with1.05 million square feet.

New spec starts this quarter with little or no preleasing included Stream’s Remington Square Phase II, a 201,000-square-foot building in the northwest; One Grand Crossing, a 172,000-square-foot building by Trammell Crow and Prudential in the west; and Park Place at Buffalo Bayou, a Pinto Realty Partners project near Memorial and Waugh with 18 floors and 250,000 square feet. Several smaller projects of less than 100,000 square feet also broke ground, while several larger proposed projects, specifically in the north, west and Central Business District (CBD), postponed their start dates.

The current 11.3% vacancy rate is a slight increase from the 11.1% vacancy recorded last quarter, and during the same quarter a year ago. Class A space overall is at 8.7%, with the Westchase submarket showing the lowest Class A vacancy of 4.2% followed by the Energy Corridor at 4.8% and the West submarket at 5.7%. The West submarket is recording the lowest vacancy of all submarkets at 5.6%. Seven of the 13 submarkets are recording single-digit vacancies in Class A space, with four of the 13 boasting single-digit vacancies overall.

Rental rate increases are modest, with the overall averaged weighted rental rate of $25.17 representing a 4.4% increase during the past year. Class A rates, now at $32.22 citywide and at $37.91 in the CBD, experienced a slight decrease from the previous quarter and only a 2.0% increase citywide and 4.2% in the CBD from the same quarter last year. Since most properties are quoting net rates, the overall rates will be determined by new estimated operating expenses currently being quoted for 2015.

Overall sublease space increased slightly from last quarter to just less than 3.2 million square feet this quarter, representing a 22.1% increase from the same quarter last year. Sublease space has seen gradual increases over the last two years as tenants expand into newly built space.

Houston Industrial Market

Houston’s industrial market continues to expand with strong positive net absorption of 3.4 million square feet during the fourth quarter of 2014, according to statistics released by Commercial Gateway.

This quarter’s absorption represents the 20th consecutive quarter – five years – of positive absorption, with 15 quarters recording more than 1 million square feet each. This absorption is 500,000 square feet more recorded compared to the same quarter last year and almost doubles that of last quarter. The annual 2014 absorption total of almost 9.0 million square feet surpasses all recent years, and is actually double the absorption recorded in 2011.

Warehouse/distribution properties continue to record the lion’s share of absorption with 86% of the total, or 3.2 million square feet, of absorption this quarter, continuing a six-year trend of positive absorption. Properties classified as warehouse/distribution represent about 73% of the total market.

Vacancy continues to fall with the overall rate of 5.8% the lowest vacancy on record in recent years, and down from the 7.0% reported during the same quarter last year. Vacancy for warehouse/distribution space citywide is 5.9% with manufacturing space 3.8%. Houston has been described as one of the healthiest industrial markets nationwide due to its balance of supply and demand.

More than 3.4 million square feet in 38 buildings came online during the fourth quarter, cumulating in 119 new buildings accounting for more than 10.4 million square feet of new space on the market during 2014. Collectively, the new buildings are currently 47.8% leased and represent about 4.4 million square feet of absorption, or a little less than half of the absorption recorded for the year. The five largest buildings completed during 2014 include Pinto Greens Crossing 1/HD Supply’s 600,750 square feet in the north, Weatherford Artificial Lift System’s 564,000-square-foot building in Katy, Fallbrook Distribution Center II’s 400,250-square-foot building in the northwest, Silver Eagle Distributor’s 400,000-square-foot facility in Pasadena, and DCT Northwest Crossroad’s Logistics Center’s 362,180 square feet in the northwest.

Construction activity is still setting records. Currently, 98 buildings are underway in 63 projects and represent more than 7.8 million square feet. Major spec projects without major preleasing include Fallbrook Pines’ 709,045 square feet, Mason Ranch Industrial Park’s 658,740 square feet, Fallbrook 1 Pinto Business Park’s 500,400 square feet, Beltway Crossing Northwest Building 7’s 441,000 square feet, Interstate Commerce Center’s 416,930 square feet and Bayou Bend Business Park’s 378,380 square feet.

Rental rates increased steadily during the past year and currently average $7.78 per square foot per year citywide, representing an 18.1% increase from the same quarter last year. More importantly, rents quoted for all new space completed in 2014 averaged $9.09 per square feet. Rental rates quoted are grossed up and weighted and averaged based on available space. Most new buildings are now quoting net rents and passing on the increased taxes and operating costs.

Sublease space increased 11% from last quarter to more than 1.5 million square feet, but is still much lower than the 1.9 million square feet reported during the same quarter a year ago.

Founded in 2001, Commercial Gateway, the commercial division of the Houston Association of REALTORS® (HAR) is a commercial information exchange of commercial real estate professionals engaged in every aspect of property sales and leasing, appraisal, property management and counseling.

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