Sublease Term and Submarket Shape Houston's Sublease Glut of Office Space
February 2016 I Vol. 2, ISSUE 2 I Download PDF
Houston is currently experiencingunprecedented levels of subleaseavailability. Over 650 subleases in Class Aand B buildings represent over 8.77 millionsq. ft. of rentable building area (RBA).Despite thoughts of a diversified economy,34.4% (or 3.02 million sq. ft.) of the 8.77million sq. ft. of sublease space is fromjust 13 energy companies, representing allof the 17 blocks of sublease space that are>100,000 sq. ft., including 350,000 sq. ft.recently put up by Shell. Here, we examinethe distribution and duration of subletsacross Houston’s submarkets in an effortto assess the effects of the sublet glut onsubmarket conditions.
Of all of Houston’s sublease RBA, 73%occurs in just four submarket clusters,namely Katy Frwy East/West (2.21 millionsq. ft.), Downtown (1.90), Westchase (1.22),and West Loop/San Felipe (1.03) (Figure 1).Within certain submarkets, sublease spaceis representing an increasingly larger portionof availability (Figure 1), including 32.6% ofWestchase total availability, 28.4% of KatyFrwy East/West total availability, 18.3%of Downtown total availability, 18.4% ofWest Loop/San Felipe total availability, and16.5% of Woodlands total availability. Otherimportant submarkets maintain much lowersublease availability ranging from 3-8%,including Southwest/Sugarland, GreenwayPlaza, NASA/Clear Lake, and Northwest.
Submarkets dominated with short-termsubleases may not soften as much in the nearterm as those submarkets with more longtermsubleases. This is because subleaseswith longer remaining terms compete morewith direct space for prospective tenants. Tothis end, >50% of sublease space in Katy FrwyEast/West, Downtown, Westchase, and WestLoop/San Felipe submarkets has remainingterms longer than 2 years. On the other hand,Southwest/Sugarland, Greenway Plaza,NASA/Clear Lake, and Northwest submarketsare largely dominated by short term leases <2years in remaining duration. Overall, althoughsublease spaces are distributed across manysubmarkets of Houston, their effects on localsubmarket conditions are most prominent inKaty Frwy East/West, Downtown, Westchase,West Loop/San Felipe, and Woodlandssubmarkets.
Figure 1. Percent sublease availability and number of sublease spaces for 10 submarket clusters.The value on top of each bar is that submarket’s sublease space in millions of sq. ft. of rentablebuilding area (RBA). The dashed line with open circles is sublease in a given submarket as apercent of all of Houston’s sublease (i.e., submarket sublease divided by all Houston sublease).The solid line with filled circles is sublease in a given market as a percent of total submarketavailability (i.e., submarket sublease available divided by submarket total available). The stackedbars are the number of sublease spaces, stacked by colors corresponding with term remaining onthe lease (number of years).
Houston’s office market began the falling phase of its current market cycle in the third and fourth quarters of 2014. This coincided with the beginning of the current downturn in oil prices. While vacancy and subleases tend to increase with the falling phase of market cycles, the current increase in sublease space has been exacerbated by the decline in oil prices, which has led to many office tenants in the oil industry to put their office space on the market.
Houston's office market currently has over 650 sublease spaces among its Class A and B buildings. These spaces collectively represent 8.77 million sq. ft. of rentable building area (RBA), greatly exceeding Houston's historic average of 3.33 million sq. ft. This large volume of sublease space represents 16.1% of the available leasing market. Of the 8.77 million sq. ft. of sublease space, 3.02 million sq. ft. (or 34.4%) is accounted for by just 13 energy companies that are responsible for all 17 blocks of sublease space >100,000 sq. ft., including 350,000 sq. ft. recently put on the market by Shell. By competing with direct availability, sublease space can soften an office market, leading to tenant rather than landlord favored conditions.
The extent to which the office market softens with subleases can vary among submarkets and with the duration of the remaining terms on the subleases. If oil companies are concentrated in particular submarkets across Houston’s overall metropolitan statistical area (MSA), then their subleases can have disproportionate influences on those office submarkets while yet other submarkets remain stable with much less sublease space. Moreover, short-term subleases (0 - 2 years) may be less attractive to prospective tenants and get passed up for longer-term direct leases or other intermediate (3 - 5 years) and longer term (6+ years) subleases. To this end, if a submarket has many short-term subleases, then it may soften less than a submarket with many longer term subleases.
Here, we examine the distribution of Houston’s sublease space among key submarkets and the duration of the remaining term on these subleases. Specifically, we identified 10 submarket clusters (see map and methods), for which we evaluate (1) the amount of sublease space compared to direct space; (2) the distribution of sublease space among submarkets; and (3) the extent to which the sublease spaces have short (0-2 year), intermediate (3-5 year), or long (6+ years) terms remaining on their leases. These analyses help to identify which submarkets office tenants may be able to improve upon their leases and those in which landlords remain on solid ground despite Houston’s overall sublease glut.
Percent Sublease Availability Among Submarkets
Table 1 shows the current direct and sublease availability for Houston's entire MSA and 10 major submarket clusters. These 10 submarkets account for 92.6% of all of Houston's sublease space. For the overall Houston MSA, sublease availability currently accounts for 16.1% of total availability for Houston's MSA, leaving direct availability at 83.9%. In Figure 1, the dashed line with open circles shows sublease in a given submarket as a percent of all of Houston's sublease, that is the submarket sublease divided by total Houston sublease. The submarkets of Katy Frwy East/West, Downtown, Westchase, and West Loop/San Felipe have 2.21, 1.90, 1.22, and 1.03 million sq. ft. of sublease RBA, respectively, which represent 25.2%, 21.7%, 13.9%, and 11.7% of Houston's 8.77 million sq. ft. Collectively, these four submarkets account for 73% of sublease availability in Houston.
Percent Sublease Availability within Submarkets
Consider the percent of availability in a submarket that is sublease, that is sublease RBA divided by total available RBA in the submarket (solid circles, solid line in Figure 1). This may well be the most critical indicator of which submarkets are softening with the surge of sublease space, as it is the increase in sublease relative to direct space that can most strongly impact submarkets. Submarkets with particularly large amounts of sublease include Westchase with 32.6% of its total availability as sublease, Katy Frwy East/West with 28.4% of its total availability as sublease, Downtown with 18.3% of its total availability as sublease, West Loop/San Felipe with 18.4% of its total availability as sublease, and Woodlands with 16.5% of its total availability as sublease. Southwest/Sugarland, Greenway Plaza, NASA/Clear Lake, and Northwest submarkets maintain much lower sublease availability ranging from 3-8%.
Houston Office Submarket Map
Duration of Remaining Sublease Term
We further evaluated differences in sublease availability within and among submarkets based on the number of sublease spaces per submarket and by the duration of the remaining term of the sublease (stacked bars, Figure 1). The number of sublease spaces within a submarket is partitioned by those of short (0 - 2 years, red bars in Figure 1), intermediate (3 - 5 years, blue bars) and long (6+ years, green bars) periods remaining on the lease. The total number of leases in a given submarket is proportional to and closely tracks the percent of all of Houston’s sublease space in that submarket (dashed black line with filled circles). For the submarkets of Greenway Plaza, Southwest/Sugarland, Northwest, and NASA/Clear Lake, most subleases are short term of 0 - 2 years and fewer subleases are intermediate or longer term. Other submarkets, including Katy Frwy East/West, Downtown, Westchase, and West Loop/San Felipe, have a much larger portion (often >50%) of subleases with intermediate to longer terms remaining on the leases.
Commercial real estate data on office space were obtained from CoStar in February 2016. Data for Class A and B buildings were combined for office space. 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/.Houston’s office market has 47 submarkets and 37 submarket clusters, as demarcated by CoStar. For the purposes of our analyses, we simplify these submarkets into 10 prominent office markets: Downtown (yellow on map), which includes the central business district (CBD) and Midtown submarkets; Greenway Plaza (turquoise on map); Katy Freeway East and West (orange on map); NASA/Clear Lake (purple on map); North Belt (blue on map), which includes Greenspoint/IAH and Greenspoint/North Belt West; Southwest/Sugarland (light green on map), which includes Southwest Beltway 8, Southwest/Hillcroft, and East Fort Bend County/Sugar Land; Westloop/Galleria/San Felipe (red on map), which includes Galleria/Uptown, Post Oak Park, Riverway, and San Felipe/Voss; Westchase (dark purple); and Woodlands (light purple on map).
J. Nathaniel Holland, Ph.D., Chief Research and Data Scientist
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.