By Patsy Fretwell

Office Market Summary:

Following a year that closed out with record absorption and construction levels, the 2015 Houston office market is less robust primarily due to the oil and gas slump. Third-quarter statistics report slight overall negative absorption of 55,300 square feet, although overall absorption is positive. This negative absorption reverses a four-year positive trend, according to research by Commercial Gateway, the commercial division of the Houston Association of REALTORS®.

In addition to reduced overall leasing activity, many companies, primarily energy-related, are cutting back on contracted space, resulting in large blocks of sublease space – some brand new and never occupied – hitting the market. This sublease space has been the most talked about subject both locally and nationally when discussing Houston’s office space picture. Although some reports are predicting up to 10 million square feet available by early next year, Commercial Gateway’s statistics currently show almost 6 million square feet available today, with a total of more than 7 million square feet being marketed. Although either total is more than any quarter in recent memory, sublease space represents about 3.0% of all space currently available. When combined with direct space, availability rates increase to 16.1%.

Sublease space as a whole is a positive for tenants in the market by offering more options, and in this case, quality-space options, at reduced rates. Little change is being reported in quoted rental rates at the direct level, although some landlords are offering various concessions, like a few months of free rent, more frequently to get the deals closed sooner rather than later. However, overall, sublease space rental rates are showing an almost 10% drop from second quarter to third quarter, which perhaps signals a more competitive spirit among those marketing this shorter-term space. Please see graph showing vacancy and rental rates for the last five years.

Some brokerage firms also report an overall positive outlook. A recent report by CBRE said that “after a year of sliding and volatile oil prices, the commercial real estate fallout in Houston is mixed across submarkets and by property type, but fears about widespread adverse impacts have not been realized.” Robert C. Kramp, director of research and analysis for CBRE, said, “Despite the headlines, Houston’s regional economy is buoyant.” He cited stats from June reporting local realtors setting residential sales records along with auto dealers experiencing their best sales figures.

The positive longer-term outlook continues on other fronts. During a recent presentation to members of the local chapter of the Society of Industrial and Office REALTORS®, Patrick Jankowski, senior vice president of research for the Greater Houston Partnership, said the Houston area’s long-term economic outlook is bright even though “five years of remarkable expansion” is coming to a close. He cited concerns over the large amount of sublease space, predicting brokers will be challenged to lease office space over the next 12-18 months.

Jankowski also reported that Houston’s population growth will continue along with positive job creation of 20,000 to 30,000 new jobs this year. However, the outlook for 2016 remains cloudy, and certain industries will fare better than others. For specifics, he cited the manufacturing segment as suffering the largest loss in jobs since last December, but reported healthy gains in the health care and leisure and hospitality sectors. He also noted that Houston historically, for the last 20 years, gains an average of 29,000 jobs each fourth quarter followed by an average loss of 45,000 jobs every January; however, the area has historically recouped those early-year losses fairly quickly.

Commenting on the drop in the value of building permits, Jankowski said construction has peaked for office development. Houston’s total under-construction office market is 45% preleased with almost 9.6 million square feet, representing a little more than half of the total under construction recorded last year at this time. Of the 32 buildings, 11 are 100% preleased or owner-occupied. Please see chart for a list of buildings under construction.

Some brokers and developers share Jankowski’s concerns. If preleasing remains limited, a majority of the almost 4.2 million square feet of new office space could enter the market vacant next year, with another 1.3 million square feet coming on line in early 2017. And while office projects continue to be announced in some submarkets, substantial preleasing appears to be a must before any ground is broken.

Industrial Market Summary:

By comparison, Houston’s industrial market is still weathering the energy slump by focusing on the area’s petrochemical industry and port business. Absorption slowed from the second quarter but is still positive with a total of 6.2 million square feet through the third quarter. This compares favorably to the 5.6 million square feet recorded during the first three quarters in 2014, according to quarterly market research compiled by Commercial Gateway.

Construction activity is still high and may get higher with over 35 proposed properties, about half of which are planned for more than 100,000 square feet. Currently, 68 buildings are underway in 51 projects representing more than 10.4 million square feet. The largest project to start in third quarter was Stream’s Bay Area Business Park Phase II with 829,805 square feet in four buildings. Other major spec projects include 14 with more than 100,000 square feet available, with two projects, Fallbrook Pines Buildings 3 and 4 and Fallbrook 1 Pinto Business Park, with over 500,000 square feet available. The largest BTS project remains Daiken’s 4 million square foot facility off Highway 290.

More than 1.4 million square feet in 20 buildings came online during the third quarter. Collectively, all new buildings completed in 2015 are currently 37.7% leased and represent almost 1.7 million square feet of absorption through the third quarter.

Rental rates remain steady with a minimal drop this quarter to $7.64 from $7.67 last quarter but are 3.7% higher than the $7.40 recorded during the same quarter last year.

Similar to office but at not quite the volume, the industrial sublease space increased 35.7% from the same quarter last year to more than 1.9 million square feet for third quarter. Although higher than recent quarters, this amount of space falls below square footage totals in 2013 and back through several quarters in 2010.