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Houston’s Office Market Recovery Slow, Industrial Demand Remains High

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Houston Office Market Summary

Houston’s commercial real estate market is optimistic after grappling with Hurricane Harvey amid the continued energy recovery, according to quarterly market research compiled by Commercial Gateway, the commercial division of the Houston Association of Realtors (HAR.com).

For office space, direct negative net absorption of 39,995 square feet was recorded; Class A and C showed positive absorption of 246,119 square feet and 18,230 square feet, respectively, while Class B reported negative absorption of 304,344 square feet. Move-ins at 609 Main including four different firms who preleased space in the new building accounted for almost 263,000 square feet of the Class A positive absorption. Year-to-date overall totals are positive for the year primarily due to the first quarter occupancy of 600,000 square feet by BHP Billiton in its new headquarters building, although the firm is leaving behind more than 320,000 square feet that is currently on the sublease market.

Space left behind by various firms occupying new properties along with sublease spaces converting to direct space will continue to affect the vacancy rate. The current 16.7% direct vacancy rate is unchanged from last quarter, but up from the 15.5% recorded during the same quarter in 2016. Class A space overall is 16.0% vacant, Class B is 19.1% vacant and Class C is 11.4% vacant.

Total sublease space saw a slight decline this quarter with almost 9.1 million square feet compared to second quarter’s 9.4 million square feet and year-end’s 10.2 million square feet. Although some spaces have been leased, such as the largest block of 431,307 square feet taken by NRG in One Shell Plaza, others have turned into direct availability. Others have been taken off the market but are still available. NRG will be leaving vacant space and possibly adding to the sublease market in three buildings in the Central Business District (CBD): 1201 Fannin (GreenStreet), 1000 Main and 1300 Main.

The effects of Harvey resulted in sublease space taken as displaced companies and governmental entities lease short-term space. (Please see brokers’ commentaries for more detail.) But the amount of sublease space continues to play a large role in the dynamics of the marketplace. Today’s sublease space represents about 4% of our total tracked office market, but if counted as vacant, the overall vacancy changes from 16.7% to 21.0%. Currently, 83 of the sublease listings representing 2.3 million square feet have terms expiring by year-end 2018 while another 69 listings representing 1.4 million square feet are set to expire by the end of 2019.

The under-construction market in Houston currently totals 13 buildings and 2.4 million square feet and overall is 53% preleased. Properties completed during the third quarter include Generation Park’s first spec building at 250 Assay Street, which is about 80% preleased, along with two 25,000-square-foot buildings on Memorial, which are collectively 23% preleased. Four buildings totaling 354,499 square feet broke ground during third quarter, the largest being CityPlace 1 in Springwoods Village with 149,500 available square feet.

Concessions are becoming more commonplace in the market, even though quoted rental rates have remained steady. At $28.73 overall, rental rates showed a slight increase from the past quarter and from a year ago. Class A rates, now at $34.78 citywide and at $42.35 in the CBD, experienced slight increases from last quarter’s $34.30 citywide and $41.50 in the CBD. Quoted rents for sublease space decreased from $25.41 last quarter to $23.00 this quarter.

Houston Industrial Market Summary

Houston’s industrial market dominated the commercial market during the third quarter with expansions resulting in positive direct net absorption of almost 3.3 million square feet, according to statistics compiled by Commercial Gateway.

This quarter’s absorption represents the 31st consecutive quarter – more than seven years – of positive absorption, with four quarters recording more than 3 million square feet each and 10 recording more than 2 million square feet each. The third-quarter absorption totals were positive for all types and included almost 2.8 million square feet of warehouse-distribution space along with 265,857 square feet of net absorption of light industrial space. Manufacturing properties recorded 204,346 square feet while flex/R&D space absorption was 36,261 square feet. Overall, 24 properties recorded 50,000 square feet or more of absorption this quarter, with eight of those recording 100,000 square feet or more.

About 2.6 million square feet in seven buildings came online during the third quarter. The absorption of 2.4 million square feet of new space this quarter included both FedEx’s 1.1 million square-foot distribution facility in the Northwest near the Grand Parkway and U.S. Highway 290 and Amazon’s 855,000-square-foot fulfillment center off the Beltway in Pinto Park. Two other build-to-suits were also completed and occupied this quarter: Floworks International’s affiliated companies occupied its 225,000-square-foot facility in the South while Pepperl+Fuchs completed and occupied its 110,000 square-foot distribution center in West Ten Business Park in the west. For the year, 32 properties totaling almost 4.7 million square feet were completed and are currently 12.2% vacant.

Vacancy rates have decreased slightly to 5.8% from 6.0% last quarter but are the same as in Third Quarter 2016. Vacancy for warehouse/distribution space citywide is 6.2% with manufacturing space at 2.6%.

Construction activity has slowed when compared to previous years, with only 36 projects totaling more than 3.4 million square feet underway. The largest project currently is a build-to-suit project, Amazon’s 1.0 million square-foot distribution project in Katy, followed in size by Cedar Port’s 501,020 square-foot building in the Southeast. Including Amazon, eight warehouse-distribution projects with more than 100,000 square feet are underway with three 100% preleased.

The bulk of projects under construction is concentrated in the North/Northwest, with 14 buildings totaling 1.7 million square feet or 49.1% followed by the Southeast with six projects totaling 1.2 million square feet or 33.9% of the total. Overall, the under-construction market is 43% preleased.

New projects and large leases continue to be announced, with the most recent new project breaking ground in early October, a speculative 673,785-square-foot distribution facility being developed by Oakmont Industrial Group in Katy’s West Ten Business Park. Houston-based Pontikes Development has announced a 3-million-square-foot speculative project to be built in Baytown. Both Lowe’s and Home Depot recently signed leases up to 300,000 square feet to handle consumer demand, while other large deals are in the market.

Rental rates have increased this quarter to $7.22 from $6.48 last quarter but are similar to rents recorded in early 2016. Rates for sublease space dipped slightly to $6.45 from $6.52 last quarter.

Sublease space also decreased slightly this quarter to 3.5 million square feet but is a slight increase when compared to the same quarter last year.

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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