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Office market will be longest to rebound

Houston’s office market has been affected by the oil decline more than other sectors in real estate, and will be the lengthiest to rebound. Houston’s overall vacancy rate rose to 20.5% in Q2 2017, an increase of 40 basis points quarter-over-quarter and 260 basis points year-over-year. Net absorption remained in the red at negative 532,205 sq. ft. as of the quarter’s end, adding up to 1.3 million sq. ft. of negative absorption year-to-date. Currently, overall occupancy in the Houston office market continues to drop, sitting at 79.5%, the lowest level since NAI Partners began tracking occupancy in early 1999. Both Houston citywide overall rent and leasing activity are up marginally from last quarter, but remain significantly down from a year ago. However, despite the market slowdown, available sublease space continues to ease down slightly, and the amount of space in the construction pipeline has declined by 60.0% year–over-year.

Economy continues to grow despite low oil prices

Overall, the outlook for Houston is hopeful about the future. May data was varied for the Houston metro area. The business-cycle index continued to indicate a modest expansion. Labor market data suggested job growth, improvement in the energy sector and low fuel prices helped consumers. Houston’s unemployment rate was 5.1% in May, down from 5.4% in April and below its year-to-date average of 5.5%. Other positive indicators are the Houston Purchasing Managers Index, which registered at 54.1 in May, signaling economic expansion in metro Houston for the eighth consecutive month, and the Baker Hughes U.S. Rig Count, which rose for the 23rd straight week totaling 941 rigs. Conversely, increasing costs and moderate oil prices may soften the course of the rig count. The recent forecast by the Energy Information Administration estimated oil (WTI) will average $51 in 2017 and $55 in 2018, while market experts state the industry needs $60 to $65 per barrel oil for sustained growth and success.

Broker’s Perspective

While both overall rents and leasing activity have risen slightly, the Houston office market continued at a slower pace than we have been accustomed to through the second quarter of 2017. While Houston has made significant strides in diversifying its economy, the city’s fortunes remain primarily driven by activity in the energy sector. With that in mind, I predict Houston will stay entrenched as a tenant’s market until commodities pricing not only stabilizes but increases.

On the availability front, sublease space still dominates the conversation between clients and real estate professionals alike. Larger blocks of sublease space are either sitting vacant or are being pulled off of the market altogether, with one or two exceptions. Conversely, smaller spaces, those less than 20,000 SF with remaining term on their leases seem to be attracting the most of amount of activity.

As far as direct leasing is concerned, most tenants are looking for a Class A building at Class B pricing, coupled with a healthy concession package. While those opportunities do exist, options can be limited and tenants need to be comfortable with looking toward the Energy Corridor. However, there are recent instances where tenants have chosen to upgrade without the appearance of cost-saving, underscored by two new Class A buildings in the CBD with strong direct leasing activity: at 609 Main, multiple professional services firms; and owner Hines itself—have chosen to follow United Airlines lead and lease space in the new tower. Additionally, Bank of America announced it will be relocating from its current namesake tower at 700 Louisiana to Skanska’s new development located at 800 Capitol Street, where the bank has entered into a long-term lease for 210,000 sq. ft. Again, it’s worth noting that these tenants were already in Class A product and are moving into newer, more sophisticated Class A product, along with the price tag that this kind of space carries. It will be interesting to see how the older CBD Class A space fares with the addition of these new buildings.

For the market as a whole unfortunately, early optimism about a full-scale market recovery in 2017 appears to be wishful thinking.

Taylor Wright
Vice President
NAI Partners


Heavy supply and slow demand pushing vacancy up

The overall availability rate, which measures the total amount of space being marketed for lease, rose to 26.2%, an increase of 50 basis points from the 25.7% rate it was at during the previous quarter. Available sublease space has dipped from a peak of 12.0 million sq. ft. as of third quarter 2016, down to 11.5 million sq. ft. at the end of 2016 and now staying around 11.0 million sq. ft. as of second quarter 2017. However, as we begin to see a spark of hope, the downside will be in the form of direct vacancy, with more than 2.0 million sq. ft. to be returned to landlords during the next 24 months. Of the 2.0 million sq. ft. of sublease space, 1.3 million sq. ft. is Class A space. On average, these owners of Class A direct space are now asking $33.94 per sq. ft., compared with $18.17 for similar sublet space. Tenants willing to sublet can get a substantial discount, sometimes in the same building.

Net absorption still negative

Houston ended the second quarter of 2017 with negative 532,205 sq. ft. of net absorption. Direct space represented negative 318,215 sq. ft. of that total, and sublease space was responsible for negative 245,166 sq. ft. This marks the fourth consecutive quarter of negative absorption. BHP Billiton, the second-largest employer in the Galleria/Uptown area according to the HBJ 2017 Largest Employers List, moved into its new 593,850-sq.-ft. tower at 1500 Post Oak Blvd. during the quarter. BHP migrated from 1360 Post Oak—also in the Four Oaks Place complex—placing 320,349 sq. ft. of sublease space on the market. Demand is measured by the change in occupied space, and given recent signs of a bottom in the oil industry and as new deliveries decline, net absorption will likely continue its current track throughout 2017, although at a less marked rate than in the last few years.

Construction pipeline grew with start of Capitol Tower

There is currently about 2.5 million sq. ft. under construction in the Houston office market, with about half of that space available for lease. Construction is up from last quarter, in part as New York-based Skanska USA Commercial Development announced in April it will begin building Capitol Tower, the 35-story, 778,000-sq. ft. building located in the CBD, now that it has an anchor tenant. The foundation was poured at the Capitol Tower site in August 2015, but construction was halted waiting for improved market conditions and leasing commitments. Bank of America inked a deal for nearly 210,000 sq. ft., helping to get the construction started again (and also acquiring naming rights for the building). The tower is expected to take two years to build, with completion projected for the second quarter of 2019. The tower will be on the site of the former Houston Club Building at 811 Rusk St., which was demolished in October 2014. Buildings underway with more than 100,000 sq. ft. of available space include 3200 Kirby, a 13-story, 200,000-sq.-ft. Class A office building that is part of the Kirby Collection mixed-use development in River Oaks scheduled to deliver in the summer of 2017; and The Post Oak at 1600 West Loop South, a 38-story mixed-use tower, with more than 100,000 sq. ft. of boutique office space in the Galleria/Uptown area, scheduled to deliver in the Fall of 2017.

Encouraging investment sales and steady leasing activity

A recent $1.2 billion deal substantiates The Bayou City’s buoyancy albeit an unsure energy industry. The Canada Pension Plan Investment Board is buying Houston-based Parkway, the owner of widely recognized Greenway Plaza. Parkway’s portfolio also includes Phoenix Tower in the Greenway Plaza submarket and CityWest Place in Westchase, in addition to Post Oak Central and San Felipe Plaza in the Galleria/West Loop area. The major tenants in Parkway’s buildings include Apache Corp., Invesco Management Group, Occidental Oil & Gas Corp., Statoil Gulf Services, and Transocean Offshore Deepwater Drilling.

Leasing activity has remained steady during the second quarter with a total of 2.7 million sq. ft. leased in the overall Houston market. Direct space fulfilled 2.4 million sq. ft., while sublease space realized about 300,000 sq. ft. These amounts are almost unchanged quarter-over-quarter, although year-over-year leasing activity is down notably from 4.1 million sq. ft. Significant tenants that signed lease agreements this quarter include Bank of America, with 210,000 sq. ft. at 800 Capitol St. in the CBD; Archrock, with 73,128 sq. ft. at 9807 Katy Freeway; and Siemens taking 29,361 sq. ft. of space at 15375 Memorial Drive. The two submarkets with the most leasing activity this quarter were the Galleria area at over 630,000 sq. ft., or 23%; and the CBD at almost 525,000 sq. ft.

Average asking rent remained relatively flat

The market saw overall full-service average rates, fall $0.09 per sq. ft. quarter-over-quarter to close at $28.00 per sq. ft. at the end of Q2 2017. Sublease rates dropped at $20.58 per sq. ft. quarter-over-quarter, compared to Q1 2016 at $21.18 per sq. ft. A larger decline took place from a year ago when average rates were at $23.71. While leasing activity remained steady quarter-over-quarter, the year-over-year decline was at 33.8%. Tenants took advantage of 300,000 sq. ft. of quality sublease space at reduced rates during the second quarter of 2017 across the Houston market.

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