Houston’s Economy Boosts Office and Industrial Leasing Activity, Construction

By Patsy Fretwell

Houston’s growing economy, especially in the energy-related sectors, continued to boost the commercial real estate market with positive absorption and numerous projects under construction in both the office and industrial markets during the first three months of 2013, according to quarterly market research compiled by Commercial Gateway, the commercial division of the Houston Association of REALTORS®.

Since the first quarter ended, leasing activity has reached unprecedented levels with two major energy-related deals alone totaling 1.3 million square feet signed in buildings either still under construction or not yet started in the city’s Energy Corridor submarket. ConocoPhillips has signed an 850,000-square-foot lease, taking all of the 550,000 square feet in Energy Center III at 935 N. Eldridge Parkway, currently under construction, and another 300,000 square feet in the currently proposed Energy Center IV. That announcement came three weeks after Technip USA Inc. reported signing a lease for 450,000 square feet in Energy Tower III at 11740 Katy Freeway, which had been one of the larger spec buildings to start construction without preleasing.

This leasing activity followed the first quarter recording 511,161 square feet of positive net absorption, marking the eighth consecutive quarter of positive absorption. Class A space is on top for 326,441 square feet absorbed, trailed closely by Class B with 236,927 square feet. Class C recorded a negative 52,207 square feet, continuing its second consecutive quarter of negative absorption.

Three suburban submarkets recorded positive net absorption of more than 100,000 square feet during the first quarter: the West submarket at 145,733 square feet followed by Uptown at 121,749 square feet and the Energy Corridor with 104,462 square feet. No major new office buildings have been completed yet in 2013, although five buildings totaling 947,080 square foot are scheduled for completion during the second quarter; all but one are 66% or more pre-leased.

Currently, 30 office properties totaling 52 buildings and almost 9.6 million square feet are under construction, with ExxonMobil’s estimated 3 million square feet and 22 buildings topping the list for overall size. Two BriarLake Plaza is the largest multi-tenant building at 331,689 square feet to start construction during the first quarter; however, 52% is leased to Samsung Engineering.

The current 11.4% vacancy rate is an improvement over the 12.4% vacancy recorded during the same quarter a year ago. Averaged weighted rental rates have inched up 4.0% during the first quarter to stabilize at $23.21 per square foot. As supply tightens, better properties in the stronger submarkets are already showing minimum $1 per square foot increases along with fewer concessions; however, some lesser quality properties have actually lowered their rates to attract tenants. Overall sublease space increased slightly to 1.7 million square feet this quarter compared to 1.6 million square feet last quarter.

Commercial Gateway Member/Broker Comments on the Houston Office Market

David Baker, Executive Vice President, Houston Operations, Transwestern “Houston’s office market continues to be about energy and engineering, witnessed by the recent major lease signed by Technip in Energy Tower III in the Energy Corridor. The trend for some of the larger campus consolidations and expansions are also energy and energy services-related and are occurring in both the west and north submarkets of the city.

“The majority of under-construction buildings on the west side are quickly getting leased up, and large blocks of Class A space are not available in this submarket or others. Some leasing is occurring in some of the better Class B buildings.”

Sanford Criner, Executive Vice President, CBRE “With a half million square feet of absorption in the first quarter, we have seen a slowdown this year, although it is still a very healthy office market. Clearly the suburban markets are the big winners for the quarter: major submarkets are boasting vacancies of less than 5% for Class A space with The Woodlands submarket at 0% vacancy. As available space decreases in the major submarkets, rates will continue to rise. Demand is keeping pace with construction.

“Existing CBD rental rates are now high enough to justify and support new construction; landlords are eager, but demand remains sluggish. You cannot get financing unless you have pre-leasing.

“The suburban market is healthy with absorption all over the city. Older buildings are acting as donors to new construction as they are demolished or repositioned. Those 30- to 40-year-old buildings are attracting fewer tenants; many may be scrapped to make way for new development.”

Trey Halberdier, Co-Founder, BANDIER Real Estate LLC “ExxonMobil’s multi-billion-dollar, mega campus and The Woodlands, Texas, need I say more? Commercial real estate will be flying high the next few years if the Class A office vacancy rate remains low – currently less than 2% in The Woodlands – and we continue to experience significant positive net absorption in most product types in our immediate trade area.

“In addition, most of our land listings are being acquired by an array of users, with the larger tracts taken by residential developers. We currently have a handful of listings being sold around the ExxonMobil impact radius for more than the asking price.

“Activity is extremely brisk from I-45 north of Louetta and up through Conroe. I feel the spike will occur in 2015 on most all commercial real estate prices up here — notwithstanding a macro-economic catastrophe! Playing it safe is now risky.”

Houston Industrial Market

Houston’s industrial market also continues to improve with strong positive net absorption, according to statistics compiled by Commercial Gateway. With a 13th consecutive quarter of positive absorption — the prior six each recording more than 1.3 million square feet — the industrial market appears to have stabilized, waiting for the next wave of new product to enter the market. Vacancy overall is up slightly to 7.1% from 6.7% last quarter although still lower than 7.4% a year ago. More than 1.3 million square feet in 15 properties came online during the first quarter, entering the market collectively at an 81.4% vacancy rate.

Net absorption in the first quarter totaled 1.1 million square feet, which is slightly less than the 1.4 million square feet recorded during the same quarter last year. Contributing to the absorption and leasing total is Schenker’s 267,201-square-foot lease at 10650 Okanella and Crane Worldwide’s 150,000-square-foot lease at 6501 Navigation. The largest industrial lease to-date is Exel’s renewal of more than 767,000 square feet in four buildings at 8607-8833 City Park Loop.

Rental rates have increased marginally during the last four quarters, with this quarter’s quoted, weighted averaged annual rental rate of $5.76 per square foot 2.3% higher than the $5.63 rate recorded a year ago. Rental rates continue to inch upward as supply remains limited. Sublease space has not fluctuated much during the last two years; 1.7 million square feet was reported in the fourth quarter, which represents a 208,000-square-foot drop from the same quarter a year ago.

Construction activity is still brisk, with warehouse/distribution projects accounting for almost 4.1 million square feet, or 90.1%, of the total buildings under construction. Currently, 55 buildings in 39 projects representing about 4.6 million square feet are under construction compared to 50 projects totaling 2.7 million square feet completed during 2012.

Two of the largest multi-tenant and multi-building business parks underway during the first quarter include Transwestern’s five buildings at Mason Creek Business Park totaling 384,900 square feet and Carson Companies’ three buildings at Commerce Center totaling 365,462 square feet; Carson Companies also started a speculative 365,727-square-foot building in Bayport North.

Commercial Gateway Member/Broker Comments on the Houston Industrial Market

Hunter Brown, Associate, InSite Realty Partners, L.P. “Houston’s industrial market is definitely becoming a landlord’s market as the current supply is unable to meet the increasing demand for available space.

“Specifically, we see demand picking up in the West submarket because of a lack of supply in the Northwest and Southwest markets, and several projects are under construction trying to match that demand. For example, EastGroup Properties is currently developing a 42-acre park, Ten West Crossing, just east of the Grand Parkway. Two buildings are currently under construction, a 45,000-square-foot service center, which is already 50% leased, and a 67,000-square-foot, dock-high, rear-load building. We are seeing lots of interest in both buildings, along with more development in the area. The market is really heating up.”

Larry Indermuehle, CCIM, Principal/Chief Executive Officer, ICO Commercial “As we see the economy continue to improve, we also realize a real shortage of existing free-standing buildings for the growing Houston-area industrial market. Most companies have spent the last five years ‘on-hold’ with the slow economy. Now, they are seeking to move forward with plans for purchasing a facility.

“Our clients want to see the existing buildings available, and it is a pretty short list — if any at all — depending on size. After a tour and an education, the next question is about constructing their own building. For a credit-worthy company, this is a good time to build while interest rates remain low. The next thought process turns to where? This problem exists pretty much across the entire Houston metro area, but I am focusing on the Highway 59/Southwest Freeway corridor, where business park sites are getting difficult to find again. The simple reason for locating in a business park is generally for utilities, drainage, and a set of restrictions that protect your investment long term.

“Few options exist in the major existing parks which all have little to nothing remaining in terms of available sites. The only current choices are more to the east at Beltway Crossing and Trammell Crow’s Lakeview Business Park. And today, even these parks have limited options as they are down to the last sections of about 50 or less acres. Either of these two are better locations for companies wanting to be closer to Houston and the east side.

“For those wanting to locate on the I-69 corridor (Highway 59), all new options now available are in Rosenberg. A new 184-acre industrial park on FM 2218 just south of Highway 59 has been announced and is about to start development. There are a few other small industrial park developments in the Rosenberg area, including a new 25-acre industrial park on Walsh Road just northwest of Highway 59 and Highway 36. This latter park is said to cater to the ‘steel building’ market.”

Glynn Mireles, First Vice President, CBRE “The market currently stands at 95% occupied. For owner-occupied properties, the challenge is to find existing buildings or start a build-to-suit solution since owner-occupied construction can get financing. The real issue has to do with the land component, where both the actual price of land and the costs of development have gone up and are driving rental rate increases. We have to go out further and further to find affordable land; I even heard one broker say he traveled to Waller to find a 28-acre site.

“Lenders are hesitant to finance for spec buildings, so REITS are the primary source of speculative construction. We will continue to see new supply constrained as long as financing for spec buildings remains difficult and Houston keeps on the current pace of growth.”

Mark G. Nicholas, SIOR, Executive Vice President and National Director, Jones Lang LaSalle “We have several clients, most of which are manufacturing clients in oil and gas, energy-related industries, who are constructing build-to-suits or design builds-to-own because they have outgrown their current facility and cannot find suitable expansion space. The majority of these expansions are a direct result of the energy boom.

“The 20,000- to 50,000-square-foot, free-standing, manufacturing building market with cranes and excess land for outside storage is still extremely active.

“With a 5% vacancy rate in the industrial market, clients are not finding properties that match their needs. This lack of space is obviously affecting the land market since companies have no choice but to build a new facility to accommodate their growth and expansion needs. One company I’m working with now is leasing temporary space until an existing available building either becomes available or they decide to build their own facility.

“I have seen more land activity in the last seven to eight months than the previous three years combined. Land pricing is starting to trickle up for the “shovel-ready” sites as companies are willing to pay a little more to be in a new facility in 10 to 12 months; they do not want to wait an additional four to six months to get a site ready for development.

“Close-in land sites are becoming more and more difficult to find within the beltway, and in many instances, you have to go out all the way to the Grand Parkway on the west and southwest sides of town. We are starting to see more activity way out Highway 290 toward Waller as the Grand Parkway is taking shape for a 2014-2015 opening.”

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.

Anthony Petry

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