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Houston’s First-Quarter Commercial Activity Continues to Slow Amid Economic Downturn

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Houston Office Market Summary

Houston’s commercial real estate market appears to be weathering the storms — both the rains and sublease ones — despite slower leasing activity as the economic downturn continues. That’s according to quarterly market research compiled by Commercial Gateway, the commercial division of the Houston Association of Realtors.

The first quarter reported direct positive net absorption of more than 1.0 million square feet of office space, comparing favorably to the same quarter last year of 676,602 square feet and double the average quarterly direct absorption recorded during all of 2015. However, the statistics would paint a different picture without the move-ins by local firms into their build-to-suit, single-tenant office buildings, which represented almost 1.5 million square feet. As in previous years, Class A properties represent the bulk of the growth, offset by Class B’s negative absorption and Class properties reporting 146,952 square feet of positive absorption to start the year.

Specifically, keeping the direct absorption positive during the first quarter primarily results from FMC moving into its new building at Generation Park, National Oilwell Varco occupying the company’s new 441,000-square-foot Millennium Tower II in Westchase, Nalco Champion occupying its new 133,000-square-foot expansion building in Sugar Land, and Hilcorp completing a move into its namesake Energy Tower in the Central Business District. Rounding out the larger absorption recorded this quarter is Stage Store’s occupation of the company’s new 168,000-square-foot offices at 2425 W Loop S. On the negative side, Hilcorp left behind about 145,000 square feet in the Central Business District and BMC Software consolidated offices in CityWest, leaving behind in excess of 200,000 square feet.

For the quarter, nine of the 13 submarkets recorded positive absorption, with four of the submarkets recording more than 200,000 square feet each. At the top of the list is the Westchase market, which recorded 460,249 square feet of net absorption, primarily due to the National Oilwell Varco move in. Coming in second is the smallest market area, the Northeast, which contributed 360,056 square feet, also primarily due to one company, FMC Technologies, occupying their new building. The Greenspoint submarket recorded the largest negative absorption, a negative 280,151 square feet for the quarter, due to space left behind by ExxonMobil and Noble Energy and now available.

The changing economy related to the energy downturn is also shown by the increasing amounts of sublease space on the market. About a million square feet has been added each quarter during the last 12 months, and the numbers keep climbing, with estimates ranging in the 9 to 10 million square-foot range. At the end of the first quarter, the Houston market recorded 7.2 million square feet of sublease space available and being marketed. Of that total, 5.4 million, or 75%, is Class A space. This total represents almost double the sublease space available during the same time last year.

For the quarter, four new buildings were completed, adding almost 1.5 million square feet to the market. All four were either single-tenant or owner-occupied so no new available space entered the market.

Construction starts halted for the most part during the first quarter, with only office buildings in mixed-use projects breaking ground. Overall, the Houston under-construction office market has 23 properties totaling 6.5 million square feet. Collectively, the under-construction buildings are about 40% preleased, with 20 properties classified as multi-tenant. The multi-tenant properties represent almost 4.8 million square feet or 72.9% of the under-construction total and are currently reporting 56.5% preleased space. Of the multi-tenant spec properties, three of the 20 are reported 90% or more available.

The largest project under construction is Phillips 66’s 1.2 million-square-foot campus in the Westchase area. The largest spec building under construction with the largest availability remains Hines’ 609 Main at Texas building, which did recently announce a 225,000-square-foot prelease to United Airlines to add to the 62,000-square-foot one reported earlier.

The current 14.2% direct vacancy rate is slightly up from the 13.3% vacancy recorded last quarter, and also up from the 12.5% recorded during the same quarter in 2015. Only one submarket, Fort Bend County, at 9.4%, reports a vacancy lower than double digit. Class A space overall is 12.3% vacant, and only four submarkets report vacancy rates under 10%.

Rental rates represented a 5.3% increase during the past year with the current overall averaged weighted rental rate of $27.70, down from last quarter’s $28.64. Class A rates, now at $33.40 citywide and at $41.01 in the CBD, experienced slight decreases from last quarter but still higher than the same quarter in 2015. Sublease space overall is continuing to increase along with the rental rates; the current average of $24.75 shows a 7.9% increase from last quarter. During the past year, the average sublease rate dropped 16.7%.

Houston Industrial Market Summary

Houston’s industrial market continued to expand with positive direct net absorption of 723,030 square feet during the first quarter despite manufacturing slowdowns and overall economic uncertainty, according to statistics released by Commercial Gateway.

This quarter’s absorption represents the 25th consecutive quarter – over six years – of positive absorption, with seven quarters recording more than 2 million square feet each. The first quarter’s net absorption clearly represents a slowdown, although slightly lower than last quarter’s 792,552 square feet, but considerable lower than the previous years.

In addition to the most recent announcement that IKEA is looking to build up to a million square foot distribution facility, several other major announcements for large build-to-suits and speculative projects have resulted in several large deals recorded during 2016, which included Advance Auto Parts’ 441,000-square-foot lease in Beltway Crossing Northwest, Plastic Express’ 394,489-square-foot lease in Port 225 among two build-to-suits in Beltway Southwest: Maintenance Supply’s 209,000-square-foot building and Homelegance’s 175,000-square-foot building.

Activity is slowing for some product in some areas, but due to several build-to-suits coming online, the vacancy rate decreased to 5.9%, compared to 6.2% the previous quarter. Vacancy for warehouse/distribution space citywide is 6.1% with manufacturing space at a low of 3.1%.

More than 1.9 million square feet in 17 buildings came online during the first quarter, with the largest being Aldi’s 650,000-square foot project in the Southwest and FMC’s project in the Northeast. The five largest multi-tenant buildings completed this quarter are divided between Gateway Southwest Business Park and Beltway Southwest Industrial Park, both in the Southwest, and Interstate Commerce Center in the north. Collectively, all industrial buildings completed this year entered the market 46.9% leased.

Construction activity is still high with many projects underway and many other proposed properties announced. Currently, 64 buildings representing almost 10.1 million square feet are underway. The two largest BTS projects are Daiken’s 4 million square foot facility off Highway 290 and FedEx’s new 800,000-square-foot project near the Grand Parkway in the Northwest.

Rental rates have taken a slight drop this quarter to $7.25 from $7.54 last quarter and are less than the $7.69 recorded during the same quarter last year.
Sublease space had been steadily increasing throughout last year, but remained constant at 2.4 million square feet. The current quarter’s total is an increase of 48.6% from the same quarter a year ago, and is starting to rival the larger square footage totals in 2013 and back through 2010.

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