The most recent quarterly market research compiled by Commercial Gateway, the commercial division of the Houston Association of REALTORS® (HAR), shows commercial activity slow-moving in early 2017. Confidence is increasing but leasing options are still plentiful for the near future and perhaps through the next 18-24 months.
Key office market takeaways from the first-quarter statistics summary:
- Direct net absorption of 120,524 square feet of office space primarily due to the 600,000 square-foot occupancy of BHP Billiton’s new building, which completed in late 2016.
- Three larger buildings were completed this quarter with preleasing of 44%. Amegy Bank occupied its new 269,258-square-foot space in its namesake building in Uptown while Hines’ 1.06 million-square-foot 609 Main at Texas office building in the Central Business District (CBD) is complete with no move-ins yet; the building is 63.1% preleased with United Airlines the major tenant along with five other firms. A new Metronational building at 10100 Katy Freeway also completed in first quarter with Cemex preleasing about 35% of the 240,000-square-foot project.
- Space left behind by various firms occupying these new properties along with sublease spaces showing up as direct space is evident in the climbing vacancy rate. The current 17.0% direct vacancy rate is up from 16.4% last quarter and from the 14.3% recorded during the same quarter in 2016.
- The amount of current sublease space, 9.9 million square feet, is slightly down from last quarter but plays a large role in the dynamics of the marketplace as landlords have to compete. When combined with direct availability, the availability percentage jumps to 21.6%. Regarding location, the five submarkets representing more than 76% of the total are CBD, Energy Corridor, Westchase, Uptown and Greenspoint. With 13 sublease listings offering contiguous blocks of more than 100,000 square feet, Shell Oil’s 877,026 square feet in One Shell Plaza is the largest sublease available.
- The under-construction market in Houston has reached the lowest square footage total in many years, with only seven buildings totaling 736,951 square feet currently underway. But that number will soon change. The big news right after first quarter ended was Skanska opting to break ground again on its long-proposed 750,000-square-foot Capitol Tower after securing a 210,000-square-foot commitment from Bank of America. In addition, three build-to-suit properties will be breaking ground soon in Springwoods Village in the north: 303,127 square feet for Houston-based American Bureau of Shipping and two buildings totaling 378,000 square feet for HP.
- In leasing news, Targa Resources signed for 127,734 square feet in 811 Louisiana, representing one of the largest new deals in an existing multi-tenant building this year.
- Concessions are becoming more commonplace in the market, even though quoted rental rates have remained steady, with the current overall averaged weighted rental rate of $28.74, up from last quarter’s $28.33 rate and up from $27.83 from last year’s first quarter.
Commercial Gateway Member/Broker Comments on the Houston Office Market
Mario A. Arriaga, First Group
“Options remain plentiful for office tenants in the market for new space or relocations. Sublease space is most likely the first option, with almost 9 million square feet of Class A space currently in the market.
“Although the large amounts of sublease office space will continue to affect the overall office market well into 2019, almost half of the current sublease available will convert to direct space next year if not leased as terms expire. Landlords will then be able to make deals based on market conditions rather than having to compete with the usually more favorable terms of sublease space. Once the majority of the sublease office space is either leased or back on the market as direct, office space fundamentals will change even though office tenants will continue to have numerous available and attractive options.”
David Baker, Executive Vice President, Transwestern
“While office absorption was slightly positive for the first quarter, activity is picking up as tenants are starting to sense that it is time to lock rates on a new lease as rates are likely at the bottom. Non-energy and non- engineering companies are more likely to lock in long terms as we are seeing stability and growth in the financial and accounting sectors.
“The recovery is underway in the energy and engineering sectors but companies in this area are generally still cautious and more likely to do shorter term leases. There is also a significant uptick in office investment sales activity due to the improving office fundamentals.”
Coy Davidson, Senior Vice President, Colliers International
“Is the Houston office market really in a recovery? Well I guess it depends on your perspective. It does appear that the worst is over and the office market has bottomed out from the weakened energy market that has plagued the Houston office market over the last couple of years….
“However there are some bright spots in the Houston office market’s first quarter 2017 performance. The glut of available sublease space created by the energy downturn after a record amount of new office construction in the city has declined for two consecutive quarters as layoffs in the energy sector have dissipated. Houston’s construction pipeline has shrunk by 50% from a year ago.
“Houston’s average asking rental rates remained relatively flat over the quarter. …The office market remains a tenant’s market for now and the foreseeable future as office occupiers enjoy the leverage of landlord-aggressive rent concessions. Office rents are a function of supply and demand. However, with new supply diminishing, stabilizing oil prices and new job growth beginning to accelerate, the Houston market should continue to show signs of gradual improvement in 2017.”
Matt Gaby, Associate Broker, NAI Partners Houston
“In the first quarter of 2017, the Houston office market showed some encouraging signs as it began to lift itself out of the soft environment that has lingered in many of its submarkets. During the two years prior to 2017, we witnessed an onslaught of sublease space being added to the market, totaling more than 12 million square feet. Today, we are on our way down from that mark … This is due in part to the rising rig counts (nearly double that of Q1 2016), rising oil prices, other non-energy related industry growth, and natural lease expirations.
“While I won’t go so far as to forecast what I think will happen going forward, by recognizing trends in the market one can position oneself to take advantage when opportunity arises. Market indicators such as sublease availability, vacancy rates, and absorption rates are all critical data points when evaluating the future strength of the office market. Looking at the trends seen in 2016 and thus far in Q1 2017, I feel comfortable saying the market softening has ‘bottomed out.’ “
”Tenants in the market for space now or over the next few years can take advantage of landlords taking an increasingly aggressive approach when vying for prospective tenants….As the trend continues for tenants to take on new or additional space or renegotiate existing leases, the market will once again shift back to favor landlords. A very realistic prediction of when this shift might happen is over the next 14 to 18 months (think Q2 to Q4 2018). …
“Based on where we are in the current market cycle – the Houston commercial real estate market historically operates in seven- to eight-year cycles – office tenants today have tremendous negotiating leverage. To that end, on average we are now seeing longer lease terms signed, even for smaller companies, who wish to capture the favorable market terms for as long as possible. Timing, as they say, is everything.”
John Spafford, Executive Vice President, Director of Leasing, PM Realty Group
“Houston’s office market continues to experience the effects of the energy downturn even though positive indicators suggest that the worst may be in the rearview mirror.
“Since the office market typically lags the overall economy by up to 12 months, it should come as no surprise that Houston’s office market fundamentals remained soft … While leasing activity in early 2017 remains relatively slow, increasing tour activity has demonstrated signs of renewed tenant interest and optimism, likely leading to an actual increase in leasing volume during the remainder of 2017. Small and mid-sized leases above the 10,000-square-foot threshold continue to account for the bulk of activity, with 64% of the cumulative space leased in the trailing 12 months occurring in the 10,000- to 50,000-square-foot-size range.
“Houston’s office leasing market fundamentals are expected to remain soft as tenant consolidations and downsizings coupled with several remaining new construction deliveries could further decrease the citywide direct occupancy rate near 81.6% by year-end 2017, absent any significant new leasing. The market will face additional downward pressure as sublease listings begin to roll over to direct space as their agreements expire, further impacting the direct occupancy rates. Concessions such as free rent and higher tenant improvement allowances will remain prevalent in the market as long as leasing volume remains sluggish and landlords fight to maintain rental rate levels.
“On the bright side, landlords that receive direct space are back in the driver’s seat and no longer have to compete with tenants willing to sublease their premises at very low recovery rates. Even though office-using employment growth is expected to return by 2018, future demand from the energy sector will likely remain suppressed with the abundance of sublease and shadow space that must be dealt with before tenants will lease additional space.”
Houston Industrial Market
Commercial Gateway reported Houston’s industrial market continues to expand during the first quarter with positive direct net absorption of almost 3.6 million square feet.
Key industrial market takeaways from the first quarter’s statistics:
- This quarter’s absorption represents the 29th consecutive quarter – over six years – of positive absorption, with this quarter’s totals positive for all industrial types.
- Vacancy rates have increased slightly to 6.8% from 6.6% last quarter and from 6.0% in the same quarter last year due to both slower leasing activity in some areas along with several projects coming online with no preleasing. Vacancy for warehouse/distribution space citywide is 7.4% with manufacturing space at 3.9%.
- About 2.1 million square feet in 20 buildings came online during the first quarter. The newly completed projects are collectively 79% leased and contributed almost 1.6 million square feet of absorption.
- The largest projects to be completed and occupied during first quarter include IKEA’s two buildings in Cedar Port totaling 996,482 square feet; Maintenance Supply Headquarters of 209,000 square feet and Homelegance’s 175,000 square feet, both in Beltway Southwest Business Park; and Aker BioMarine Manufacturing’s 144,800 square feet at 4494 Campbell.
- Construction activity has slowed, with only 32 projects totaling more than 3.5 million square feet underway that are is 75.0% preleased. The largest build-to-suit is FedEx’s new 800,000-square-foot distribution facility in the Northwest near the Grand Parkway and west of U.S. Highway 290. The bulk of the remainder under construction is concentrated in the Southeast and Northwest.
- Warehouse distribution projects are the major projects under construction as e-commerce giants come to Houston. Amazon has also announced another 1 million-square-foot project in Katy in addition to the 855,000-square-foot project in Pinto Park in north Houston, and DHL Supply Chain is adding another building, this one 222,000 square feet, to its two buildings on State Highway 225.
- Rental rates have decreased this quarter to $6.42 from $6.65 last quarter and are also lower than the $7.23 recorded during the same quarter last year.
- Sublease space had been steadily increasing each quarter during the last couple years, but decreased slightly to 3.4 million square feet this quarter, but representing a 48% increase from the same quarter last year.
Commercial Gateway Member/Broker Comments on the Houston Industrial Market
Chris Caudill, SIOR, Partner with NAI Partners
“Houston’s industrial market as a whole is relatively healthy but certain markets along with certain types – like manufacturing, primarily crane-served buildings – are continuing the negative absorption trend based on 1st quarter statistics. The dock-high, distribution markets are doing fairly well, except for two submarkets, the North and Southwest, which have some vacancy issues. Landlords are getting aggressive in these submarkets with their concessions. This will continue in these two areas for the foreseeable future with overall lower rents.
“One positive trend I see is owner-occupied industrial real estate sale prices remain healthy, probably due to the continued lower interest rates. We have not seen the downturn in sale prices like we have seen the 20- to 30-percent drop in some lease rates.”
Faron Wiley, First Vice President, Industrial and Logistics, CBRE
“Positive absorption totaled over 3 million square feet during the first quarter for industrial properties. The overall economy, with $50 oil, is rebounding, and oilfield companies are finally starting to see the light. Some sublease space has been taken off the market, and most sublease still being marketed represents companies looking to upgrade or those getting out of the business.
“The industrial market overall is showing a 5% vacancy, although some softness in the market is the institutional grade product, which may be more at 8% vacant. To compete successfully, this product type will be built and enter the market vacant but the space will be on the ground ready to go when needed. Typical building characteristics of this type of institutional or investor grade product is concrete construction, 24’ to 36’ clearance, modern sprinkler system, and built for single-tenant but flexible for multi-tenant in a location of growth and opportunity. This is the type of product good enough to fund your retirement.
“The rest of the year will see more e-commerce companies leasing large distribution spaces for consumer products in the North/Northwest, Katy, Southwest and near the Port. Several companies are active in the market looking to add warehouse space closer to the ‘final destination’ of the consumer who is buying the products.”