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Houston’s Third-Quarter Commercial Activity Slows, Reflects Changing Economy

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Houston Office Market

Houston’s commercial real estate activity has begun to show more visible signs of adjusting to changing economic factors, according to quarterly market research compiled by Commercial Gateway, the commercial division of the Houston Association of Realtors.

For the first time in more than four years, the third quarter reported slightly negative office absorption of 55,300 square feet, although absorption through the first three quarters remained positive with direct net absorption totaling more than 2.0 million square feet. As in previous years, Class A properties represent the bulk of the growth, offset by Class B properties reporting a negative 1.0 million square feet for third quarter. Class C properties came out on the positive side, with 297,390 square feet of positive absorption for the quarter. Contributing heavily to the negative absorption in Class B is the new availability of 1.3 million square feet in 800 Bell after ExxonMobil vacated and moved to the company’s new headquarters in the north.

Keeping the direct absorption positive primarily results from large companies occupying their new space in recently completed build-to-suit and/or owner-occupied properties. The largest is the recent move-in by Conoco Phillips Lower 48 Business into the newly-completed Energy Center Three, a 547,628 square-foot building. Ten submarkets recorded positive absorption for third quarter but only seven submarkets recorded positive direct net absorption year-to-date.

The changing economy related to the oil and gas downturn is also shown by the increasing amounts of sublease space on the market; and when that sublease space enters the picture, the absorption totals change dramatically. However, sublease space appears on the market for many reasons, including downsizing and consolidations, but rent is usually being paid for the space whether it is occupied or vacant. And that situation could easily change if a company’s business volume changes. At the end of the third quarter, the Houston market currently has almost 6 million square feet of sublease space available, and another 2 million square feet being marketed but not yet available – with almost half Class A space. This total represents almost double the same period last year. Firms looking to move or expand will be able to take advantage of reduced rates with limited terms, which could affect both the overall leasing activity for the new buildings being completed in the next two years and certainly could play a factor in delaying the starts of new buildings.

For the quarter, six new multi-tenant buildings were completed, adding almost 1.4 million square feet to the market. The two largest multi-tenant buildings to be completed this quarter were 3737 Buffalo Speedway, a 400,000-square-foot building in the Central Northwest which is 27.6% leased, and Enclave Place, a 300,900-square-foot building in the Energy Corridor with all space available. To date through third quarter, 41 buildings in 26 projects have been completed this year. Collectively, the new buildings are currently 69.1% leased and contributed almost 5.2 million square feet of net absorption. To date, the new properties collectively completed in 2015 added more than 8 million square feet to the market with rental rates averaging $30.02, less than the overall Class A rate of $32.46.

Construction starts halted during the third quarter, with only one property, Grandway West Building 2, breaking ground. Overall, the Houston under-construction office market boasts 30 properties with 35 buildings totaling almost 9.8 million square feet. Collectively, the under-construction buildings are 45% preleased, with 20 properties classified as multi-tenant. The multi-tenant properties represent almost 5.7 million square feet or 59.2% of the under-construction total and are currently reporting 23.2% preleased space. Of the multi-tenant spec properties, 11 of the 20 are less than 10% preleased.

The largest project under construction is Phillips 66’s 1.2 million-square-foot campus in the Westchase area, while the largest spec building under construction with the largest availability remains Hines’ 609 Main at Texas building with 1.05 million square feet.

The current 13.4% direct vacancy rate is an almost 1.0% increase from the 12.5% vacancy recorded last quarter, and even more than the 11.0% recorded during the same quarter a year ago. Class A space overall is 11.4% vacant, with the North/The Woodlands/Conroe submarket showing the lowest Class A vacancy of 4.7% followed by the Westchase submarket at 8.3% and the Fort Bend County submarket at 9.1%. Five of the 13 submarkets are recording single-digit vacancies in Class A space, but only three of the 13 boast single-digit vacancies overall.

Rental rates represent a 7.5% increase during the past year with the current overall averaged weighted rental rate of $26.93. Class A rates, now at $32.46 citywide and at $39.66 in the CBD, experienced a slight decrease from the same quarter last year. Sublease space overall is continuing to increase but the rental rate for sublease decreased 9.5% from second quarter, reporting a current average of $24.56. Concessions are reportedly being offered to entice some tenants, but none are being offered across the board.

Houston Industrial Market

Houston’s industrial market continues to expand with positive direct net absorption of almost 1.8 million square feet during the third quarter of 2015 despite economic uncertainty, according to statistics released by Commercial Gateway.

This quarter’s absorption represents the 23nd consecutive quarter – over five years – of positive absorption, with seven quarters recording more than 2 million square feet each. Although almost half of the previous quarter, the third quarter absorption is about the same when compared to the same quarter last year and is clearly a positive sign in today’s marketplace of energy layoffs and cutbacks.

Major deals recorded during the quarter include preleasing in Port 225 by Abrasive Products, 102,508 square feet, and a 207,000-square-foot deal by Niagra Water in Bayou Bend Business Park, along with two leases in Apex Business Park, Dawn Food Product’s 89,710-square-foot lease along with Eleganza Tile’s 44,130-square-foot deal. Slay Industries also signed a 100,000-square-foot deal at 2902 E. 13th.

Net absorption was shared by all industrial types except high tech/R&D during the third quarter with warehouse/distribution properties accounting for the bulk of absorption, 1.6 million square feet or 91.4% of the total. High tech/R&D space experienced a slightly negative quarter with a negative 10,736 square feet recorded after four quarters of positive absorption.

Activity is slowing but not enough to cause a large bump in the vacancy rate, which increased to 5.6% from 5.5% the previous quarter. This rate is a drop from the vacancy rate of 6.2% recorded during the same quarter a year ago. Vacancy for warehouse/distribution space citywide is 5.6% with manufacturing space at 4.4%.

More than 1.4 million square feet in 20 buildings came online during the third quarter. Collectively, all industrial buildings completed to date are currently 37.7% leased and represent more than 1.6 million square feet of absorption for the year. The largest spec buildings completed during the third quarter with little preleasing include Interstate Commerce Center’s two buildings at 416,916 square feet and Mason Ranch Industrial Park Building 1 at 373,860 square feet. All other completed spec buildings were smaller than 100,000 square feet.

Construction activity is still high and may get higher with over 31 proposed properties, half of which are planned for more than 100,000 square feet. Currently, 66 buildings are underway in 50 projects representing almost 10.4 million square feet. Major spec projects without major preleasing include the newest project, Bay Area Business Park Phase II’s 829,805 square feet, Fallbrook Pines’ 560,312 square feet, Fallbrook 1 Pinto Business Park’s 500,400 square feet, Bayou Bend Business Park’s Phase II with 378,380 square feet, and several recent projects that broke ground in the Southwest. The two largest BTS projects remain Daiken’s 4 million square foot facility off Highway 290 and FMC’s new project at Generation Park in the Northeast.

Rental rates have taken a minimal drop this quarter to $7.60 from $7.66 last quarter but are still 2.7% higher than the $7.40 recorded during the same quarter last year. 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 has been steadily increasing throughout the year, but only slightly from last quarter for a current total of 1.9 million square feet. This quarter’s total is an increase of 37.7% from the same quarter a year ago, but is still below square footage totals in 2013 and back through 2010.

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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Sam Scott

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