Crane-Served Buildings Experience the Brunt of the Oil Pullback in Houston’s Industrial Real Estate Market
September 2016 I Vol. 2, ISSUE 9 I Download PDF
Vacancy is a key metric in commercial real estate which reflects overall shifts in supply and demand by measuring changes in net absorption, new deliveries, and existing inventory. While Houston’s 5.6% vacancy for the industrial market as a whole remains below its historic 95% confidence interval of 6.1 - 6.8%, the 10.5% vacancy of crane-served buildings is well above its historic confidence interval of 7.3 - 8.6%. This reflects the substantial imbalance in the supply and demand of crane-served buildings in Houston’s industrial market (Figure 1) that has arisen following the downturn in oil prices.
Demand for crane-served buildings persists at its second lowest annual level in 17 years, nearing one million sq. ft. of negative net absorption. Low demand is further imbalanced with continued new deliveries, including 508,000 sq. ft. delivered thus far in 2016 and still another 355,000 sq. ft. under construction. Negative net absorption coupled with growing inventory continues to lead vacancy of crane-served buildings to rise. On average, vacancy has risen to 10.5% for all crane-served buildings, but ranges from 15.1% for crane-served buildings less than 30,000 sq. ft. in size to 7.6% for buildings greater than 100,000 sq. ft.
Sublease availability of crane-served buildings has now spiked to nearly 1.4 million sq. ft., almost double that of any prior quarter in the past 10 years. However, this glut in sublease space has been declining for the past two to three quarters for buildings less than 100,000 sq. ft., possibly signaling a bottom in vacancy as the manufacturing industry rebalances itself with new national and international trends in the oil industry. Meanwhile, the Dallas Branch of the Federal Reserve Bank reported that Texas factory activity increased in August, but broader business conditions were still fairly pessimistic.
Vacancy is a key metric in commercial real estate, a composite variable measuring changes in supply through new construction, demand through net absorption, and existing stock inventory. Vacancy is empty space in sq. ft. of stock inventory of rentable building area (RBA) that is not occupied by a tenant, whether or not that space has a lease obligation or is available for lease or sublease. When expressed as a percentage, vacant sq. ft. is divided by total sq. ft. of stock inventory to produce a percent of market that is vacant.
For Houston’s industrial market as a whole, vacancy is currently 5.6%, below the historic average of 6.4% and the 95% confidence interval of 6.1 - 6.8%. This suggests that the industrial market as a whole is within its normal bounds of performance. Likewise, for just the manufacturing sector of the industrial market, vacancy is currently 3.2%, below the historic average of 3.7% and the 95% confidence interval of 3.3 - 4.2%. For crane-served buildings, however, vacancy is currently 10.5%, well above the historic average of 7.9% and the 95% confidence interval of 7.3 - 8.6%. In Houston, many of these crane-served buildings—largely a subset of manufacturing buildings—are those that serve the oil and gas industry, which has had a dramatic slowdown leading to business declines and less demand for this product type.
Here, we examine trends in the supply and demand of crane-served industrial buildings through changes in net absorption, new deliveries, and existing inventory. Figure 1 shows past and current trends in vacancy given net absorption and deliveries, with the key take away that demand for crane-served buildings is nearing one million sq. ft. of negative net absorption, a very low demand that is further imbalanced by new deliveries, including 508,000 sq. ft. delivered thus far in 2016 and an additional 355,000 sq. ft. under construction. Negative net absorption coupled with growing inventory is leading vacancy of crane-served buildings to continue to rise. Below, we examine these trends in more detail.
Net absorption measures demand for real estate through the change in occupied inventory, including direct and sublease space. Figure 2 shows net absorption of crane-served buildings in Houston by quarter per year from 2000 - 2016. In 2014 at the onset of the current downturn in the oil industry, Houston saw the greatest demand for crane-served buildings dating back to 2000. Since 2014, however, net absorption has steadily declined from nearly 2.0 million sq. ft. in 2014 to a little more than 1.0 million sq. ft. in 2015 and currently 971,000 sq. ft. of negative net absorption for 2016 year-to-date. This demand is substantially lower than that experienced in the aftermath of the Great Recession in 2009 and 2010.
Supply of new commercial real estate is determined by existing stock inventory plus deliveries of new construction minus any demolition of older buildings. Buildings under construction contribute to the pipeline of new deliveries and can help gauge how supply will grow in coming quarters and years. Figure 3 shows new supply of crane-served buildings in Houston from 2000-2016. Following the Great Recession, Houston experienced substantial expansion in the supply of crane-served buildings, with each subsequent year from 2010 through 2015 experiencing increasing square footage of new deliveries and buildings under construction. Even though oil and oil-service businesses are one of the primary tenants of crane-served buildings, 2016 still appears to be on track to produce an above-average year of new deliveries of crane-served buildings, including 508,000 sq. ft. delivered thus far and another 355,000 sq. ft. still under construction.
Vacancy (Figure 4) tracks overall shifts in demand and supply by measuring changes in net absorption (Figure 2) and new deliveries and construction (Figure 3). With the increase in new deliveries and construction of crane-served buildings from 2010-2014, overall vacancies fluctuated only modestly from 5-8%. However, with the start of the oil downturn in late 2014, demand for crane-served buildings did not keep up with new deliveries or existing supply as oil and oil-service businesses contracted. In late 2014 and early 2015, vacancies of crane-served buildings began to steadily climb to their current 10.5% (Figure 4, black circles), well above the historic average of 7.9% and the 95% confidence interval of 7.3 - 8.6%.
Vacancies of crane-served buildings differ by building size (Figure 4). Smaller crane-served buildings tend to have higher vacancies than larger crane-served buildings. Those buildings less than 30,000 sq. ft. have the highest vacancies, currently at 15.1%. Intermediate sized buildings are currently running 10-11% vacancy. On the other hand, large crane-served buildings greater than 100,000 sq. ft. have remained relatively stable until the most recent quarter in which vacancy jumped from 4.7% to 7.6%, with three oil-service companies putting less than 400,000 sq. ft. of space on the market.
As with the Great Recession, both buildings less than 30,000 sq. ft. and those 30,000 - 49,999 sq. ft. are showing the greatest up tick and response to the oil downturn. But unlike the Great Recession, all building sizes are now showing increased vacancies with the change in the oil industry, whereas those larger (greater than 50,000 sq. ft.) buildings have previously not seen vacancies climb like the smaller buildings. Buildings less than 30,000 sq. ft. and between 50,000 sq. ft. and 99,999 sq. ft. in size are seeing vacancies at levels not seen in the past 10 years.
Availability measures the amount of real estate that is ready to be leased (or purchased) which is vacant, occupied, direct and sublet space, typically expressed as a percent of stock inventory. Figure 5 shows sublease availability for crane-served buildings from 2006-2016. While Houston has previously experienced peaks in sublease availability on the order of 0.7-0.8 million sq. ft., it has not in the recent past seen sublease availability near 1.4 million sq. ft. (Figure 5). However, this glut in sublease space has been in a downward trend for the past 2-3 quarters for buildings less than 100,000 sq. ft., possibly signaling a nearing bottom in vacancy as the manufacturing industry rebalances itself with new national and international trends in the oil industry.
Commercial real estate data on industrial space were obtained from CoStar in late August 2016. The statistical analyses and data visualization were performed using the R software and programming language:
R Core Team (2014). R: A language and environment for statistical computing. R Foundation for Statistical Computing, Vienna, Austria. URL http://www.R-project.org/.
Dr. J. Nathaniel Holland is a research scientist with 20 years of experience in using the scientific method to extract information from complex multi-dimensional data. He joined NAI Partners in 2014 as Chief Research and Data Scientist. At NAI Partners, Nat leverages his sharp intellectual curiosity with his skills in statistical modeling to guide data-driven business decisions in commercial real estate. Like many data scientists in the private sector, Nat joined NAI Partners following a career in academia. Prior to taking up data analytics at NAI Partners, he held professorial and research positions at Rice University, University of Houston, and the University of Arizona between the years of 2001 and 2014. Nat is the author of more than 50 scientific publications, and he has been an invited expert speaker for more than 60 presentations. Trained as a quantitative ecologist, he holds a Ph.D. from the University of Miami, a M.S. from the University of Georgia, and a B.S. from Ferrum College.