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Houston’s Second-Quarter Commercial Activity Shows Office Struggle, Industrial Flourish

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Houston Office Market Summary

Houston’s commercial real estate market offers a mixed report: office continues to struggle while certain types of industrial continue to flourish, depending on location. That’s according to quarterly market research compiled by Commercial Gateway, the commercial division of the Houston Association of Realtors (HAR).

The second quarter reported direct negative net absorption of 88,768 square feet of office space, a major decrease when compared to the same quarter last year of positive 1.5 million square feet and this year’s first-quarter absorption of 905,855 square feet. Class B properties represent the bulk of the this quarter’s growth, 122,152 square feet, offset by Class A and C’s negative absorption of 110,920 square feet. However, to put this in perspective, both last year’s and last quarter’s positive absorption resulted from single-tenant and owner-occupied projects being completed and occupied.

Space left behind by various firms occupying those new properties are showing up as direct space and affecting the vacancy rate, which continues to climb. The current 15.4% direct vacancy rate is up from the 14.4% vacancy recorded last quarter, and also up from the 12.8% recorded during the same quarter in 2015. No submarket is reporting a single-digit vacancy rate, and only the Central Business District is reporting single-digit vacancy in Class A space. Class A space overall is 14.6% vacant.

The changing economy related to the energy downturn is clearly reflected in the record-level vacancy when it is combined with the additional 2.8 million square feet of sublease space added this quarter. One newly completed building representing almost 600,000 square feet of preleased space came on the market with its total square footage now being marketed as sublease space. More than 5.2 million net square feet has been added during the last 12 months, although we more than 700,000 square feet of sublease space has been reported as having been leased during the first half of the year. At the end of the second quarter, the Houston market recorded more than 10.1 million square feet of sublease space available and being marketed. Of that total, almost 8.1 million, or 80%, is Class A space.

For the quarter, seven new buildings were completed, adding almost 2.8 million square feet to the market. Five of the buildings have no pre-leasing while the other one entered the market preleased but is now available as sublease. The bright spot was the Phillip 66 headquarters complex being completed with 1.1 million square feet to be occupied during the next two months, which will improve the absorption total for the year.

Construction starts have idled for the most part since the first quarter, with only office buildings in mixed-use projects breaking ground. Overall, the Houston under-construction office market has 15 properties totaling 3.9 million square feet. Collectively, the under-construction buildings are about 47.4% preleased, with 13 properties classified as multi-tenant. Of those under construction, eight are scheduled for completion by yearend. Three of those are not bringing any availability to the market: BHP Billiton will be occupying its entire 600,000 square feet in Uptown, the Greater Houston Partnership and other local governmental type firms will be occupying the Partnership building, and the Dave Ward Building will be occupied by Crime Stoppers. The largest spec building under construction with the largest availability remains Hines’ 609 Main at Texas building, which is 28% preleased.

With construction on the decline, one major prelease announced during second-quarter was American Bureau of Shipping’s 300,000+-square-foot lease at CityPlace2 in Springwoods Village near The Woodlands. CityPlace2 is scheduled to break ground next year. ABS will leaving almost 259,000 square feet in Greenspoint Place. Other leases recorded during the second quarter included Patterson-UTI Energy’s 34,748-square-foot lease in Remington Square II along with two additional preleases for Amegy Bank Tower, which leaves that building with only 12,469 square feet to lease.
Concessions are becoming more commonplace in the market, even though quoted rental rates have seen averages increase. Rental rates showed an increase from the past quarter and the past year with the current overall averaged weighted rental rate of $28.04, up from last quarter’s $27.72 and $26.57 from last year. Class A rates, now at $33.54 citywide and at $41.04 in the CBD, experienced slight increases from last quarter from the same quarter in 2015. Rents for sublease space also increased slightly at $24.31 from last quarter’s $22.45 after showing consistent decreases for almost two years.

Houston Industrial Market Summary

Houston’s industrial market continued to expand with positive direct net absorption of 719,078 square feet during the second quarter despite manufacturing slowdowns and overall economic uncertainty, according to statistics released by Commercial Gateway.

This quarter’s absorption represents the 26th consecutive quarter – over six years – of positive absorption, with six quarters recording more than 2 million square feet each and more than half recording more than 1 million square feet. The second quarter’s net absorption clearly represents a slowdown from those quarters, but is in line with the first quarter’s absorption of 628,981 square feet. The warehouse-distribution segment recorded 865,302 square feet absorption in the second quarter, with manufacturing and light industrial offsetting that positive with a negative 184,304 square feet.

In addition to the most recent announcement that IKEA is planning up to a million square-foot distribution facility, Amazon has announced a large facility in the North along with the leasing of another 100,000 square feet of distribution space in the Northwest. Serta has also taken 268,407 square feet of space in Fallbrook Pines in the Northwest and FedEx moved into its new 303,335 square-foot build-to-suit in the Southwest. Applied Optoelectronics also moved into its expansion property totaling 111,600 square feet also in the Southwest.

Activity is slowing for some product in some areas, and due to several large properties coming online with little preleasing, the vacancy rate increased slightly to 6.3%, compared to 6.0% the previous quarter. Vacancy for warehouse/distribution space citywide is 6.4% with manufacturing space at a low of 3.8%.

More than 1.5 million square feet in 14 buildings came online during the second quarter, contributing about 600,000 square feet to the absorption total. 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, 62 buildings representing more than 10.7 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. The bulk of the remainder under construction is concentrated in the Southeast with 17 projects totaling more than 2.8 million square feet followed by the Southwest with eight projects totaling more than 1.1 million square feet. Overall, the under-construction market is 73.8% preleased.

Rental rates have increased 2.8% this quarter to $7.47 from $7.24 last quarter but are less than the $7.70 recorded during the same quarter last year.

Sublease space had been steadily increasing each quarter during the last couple years, but remained constant at 2.4 million square feet this quarter. The current quarter’s total is still almost double the square footage from 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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