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The vacancy rate in the Houston office market was close to unchanged quarter-over-quarter, up 10 basis points from Q2 2019. The amount of vacant office space on the market is approximately 51.1 million sq. ft.—comprised of 47.6 million sq. ft. of direct space and 3.5 million sq. ft. of sublease space.


EXECUTIVE SUMMARY

Vacancy rate at 21.6%

The vacancy rate in the Houston office market was close to unchanged quarter-over-quarter, up 10 basis points from Q2 2019. The amount of vacant office space on the market is approximately 51.1 million sq. ft.—comprised of 47.6 million sq. ft. of direct space and 3.5 million sq. ft. of sublease space. The Central Business District vacancy rate is at 24.9%, up slightly from this time last quarter at 24.7%, while the Energy Corridor vacancy rate is at 32.7%, down 70 basis points from 33.4% in Q2 2019. Net absorption moved into positive territory at 58,000 sq. ft. compared to this point last quarter when the total was negative 700,000 sq. ft. The increase was primarily due to significant move-outs in Q2 2019 that included HP vacating 260,000 sq. ft. at 11403 Compaq Center W. Dr. and BP vacating nearly 195,000 sq. ft. at Three Eldridge Place in the Energy Corridor. Of the almost 2.5 million sq. ft. currently under construction—57% of which is being constructed downtown, about 35% of that space has been spoken for. The overall Houston average asking full-service rent has steadily grown over the past years to its current rate of $29.32 per sq. ft., while the Central Business District is averaging $41.41 per sq. ft.

Job growth remains healthy

The Houston metro created 81,900 jobs, a 2.7% increase, in the 12 months ending August 2019 according to the Texas Workforce Commission. The sectors adding the most jobs over the past 12 months were professional, scientific, and technical services (21,100); manufacturing (11,500); and other services (9,700). Houston’s unemployment rate was 3.9% in August, down from 4.4% in August of last year. The Texas rate in August was 3.6%, the U.S. rate 3.8%. The rates are not seasonally adjusted. The U.S. Energy Information Administration (EIA) reported that the closing spot price for a barrel of West Texas Intermediate (WTI) averaged $56.16 per barrel during the second week of September 2019, down 18.6% from $68.96 for the same period in 2018. Monthly WTI prices averaged $54.81 per barrel in August 2019. Looking ahead, the EIA forecasts WTI to average $62 per barrel in the second half of 2019 and $63 in 2020.

Houston Office Commercial Real Estate Market Data and Information - Supply and Demand graph

Houston Office Commercial Real Estate Market Data and Information - Economic Indicators table


Broker’s Perspective

Stop us if you’ve heard this story before, but the Houston office market continues to be a mixed bag as we head into the 2019 home stretch. The Houston metro created 81,900 jobs in the 12 months ending August 2019, representing a 2.7% increase—healthy numbers to be sure. Unfortunately, that job growth is doing little to subside the high levels of office vacancy that has been the hallmark of the Houston office market since the oil crash of 2014. To compound matters further, the current economic environment, from both an energy perspective and a broader global perspective, is ripe with uncertainty and, in some instances, recessionary conditions.

Taking a look solely at office market fundamentals, Houston continues to see high vacancy due to struggling leasing absorption. With vacancy hovering above 50 million sq. ft., positive quarterly absorption of 58,000 sq. ft. does little to move the needle. Although the availability of sublease space has dropped precipitously, a lot of the space has simply rolled back to landlords who are now tasked with filling that space on a direct basis. In addition, major M&A activity, like that of Occidental’s purchase of Anadarko; restructurings such as HP, McDermott and Weatherford; and major office space dispositions, such as Southwestern Energy, will all have negative effects on office fundamentals. Further convoluting matters is the continued premium in land and construction prices.

A continued bright spot, however, has been the performance of new, Class “AA” buildings. The term “flight to quality” has been repeated so many times as to almost become cliché, but there is plenty of truth to it. Companies see the value in offering best in class amenities for their employees and understand it’s simply a cost of doing business. The increased reliance on technology and mobility has allowed these companies to do more with less space, though, so efficiency is the name of the game. Take for instance 609 Main, Bank of America Tower, and the now under construction Texas Tower. Their success is leading owners of older, more traditional Class A buildings to invest heavily in upgrades to stay competitive. This battle between AA and A has led to a quoted rental rate inflation not indicative of poor overall market fundamentals. In other words, the delta between quoted rental rates and actual rates remains, as it has for years, quite high.

With all that said, the big takeaway for office occupying tenants is simple—be proactive and be aggressive. A “down” office market means a favorable office market for those looking. Don’t accept status quo or “waiting it out” if you don’t have to. The cost to kick tires is literally nothing, especially if you have the right representation. Kick long enough and you’ll likely find that Beamer at a Buick price.

Alex Taghi

Alex Taghi
Vice President
NAI Partners


MARKET OVERVIEW

Positive net absorption in Q3 2019

During the third quarter of 2019, Houston’s office market saw net occupancy gains with 58,000 sq. ft. of positive absorption with direct space responsible for 139,000 sq. ft., and sublease space represented by negative 131,000 sq. ft. The amount of total office inventory that is being marketed for lease rose by 50 basis points quarter-over-quarter to 26.1%. The difference between this figure and the vacancy rate reflects expected future move-outs. Direct space being marketed represents 55.7 million sq. ft. or about 90% of the 62.3 million-sq.-ft. total availability figure. Limited activity from the energy sector has kept Houston’s office market absorption low, although the outlook for Houston’s economy remains generally positive. According to the latest employment numbers, Houston added 81,900 jobs over the past 12 months still well above the area’s historical average of about 47,000 jobs per year.

Development and redevelopment

Office construction is close to 2.5 million sq. ft. across 16 buildings, with 1.6 million sq. ft. (64.6%) available for lease. The downtown area, including the Central Business District (CBD) and Midtown, account for 888,000 sq. ft., or over one-half of the total space available. The new Bank of America Tower delivered 781,000 sq. ft. in the second quarter and is about 86% leased as of the end of the third quarter. In addition, Hines’ Texas Tower is expected to deliver in late 2021 and is 35% preleased. In an upsurge of 1980s epoch office towers seeing major renovations, downtown Houston is experiencing its fair share. The list includes a major refurbishment of Heritage Plaza, a 1.1 million sq. ft., 53-story, building built in 1986 at 1111 Bagby St. In addition, there are major upgrades underway to Houston Center, a 4.2-million-sq.-ft. office and retail campus, and the $50 million redevelopment of Allen Center, as well as the 1.1 million-sq.-ft. Total Plaza at 1201 Louisiana St. Meanwhile, 717 Texas, a 33-story, 697,195-sq.-ft. Class A office tower in the northern downtown’s theater district has undergone major renovations, along with 700 Louisiana, a 1.2 million-sq.-ft., 56-story tower built in 1983, previously known as the Bank of America Tower.

Outside of downtown, Insperity, Inc. is under construction with a 270,000-sq.-ft. build-to-suit at its campus in Kingwood, while Stonelake Capital Partners is under construction with Park Place | River Oaks Tower in Post Oak Park. The 15-story, 200,000-sq.-ft. office building is nearly 20% preleased to anchor tenants Compass Real Estate, Charles Schwab and developer Stonelake. Also underway is The Howard Hughes Corporation’s 180,000-sq.-ft. build-to-suit for Alight Solutions in The Woodlands; MetroNational’s 160,000-sq,-ft. spec building at Memorial City; and Freeway Properties’ 150,000-sq,-ft. Katy Ranch Phase II in the Katy/Grand Parkway West Submarket

Investment sales activity

Real Capital Analytics data reports quarterly office sales volume for Q3 2019 in the Greater Houston area at $259 million, down compared to this time last quarter at $828 million. The primary capital composition for buyers in 2019 was made up of 59.2% private, 15.6% cross-border, and 13.9% REITl/listed. For sellers, the majority was 39.2% private, 25.6% institutional, and 20.9% REIT/listed. A recent noteworthy property going up for sale, Hines and CalPERS, are putting 609 Main at Texas on the market. The 1.1-million-sq.-ft. tower was built in 2017 and is 94% leased to tenants such as United Airlines, Kirkland & Ellis, Goldman Sachs, McKinsey & Co. and the Royal Bank of Canada.

Top Leasing Activity – Q3 2019

  • In the Energy Corridor, Kiewit Engineering signed a 156,828-sq.-ft. lease at 585 N. Dairy Ashford Road. The property, Energy Center I, is now over 50% leased. AMEC Foster Wheeler vacated the property in 2018.
  • 1360 Post Oak, a 25-story, 496,608-sq.-ft., Class A office tower has new tenants to add to its roster. Engie, a French energy utility company, subleased 112,024 sq. ft. from BHP Billiton in the Galleria/West Loop submarket. Engie will occupy the fourth through ninth floors and will move into the building in December. In addition, commercial real estate firm NAI Partners subleased 20,143 sq. ft., occupying the entire 19th floor.
  • In the Bellaire submarket, Houston Methodist Hospital’s administrative office will be the new anchor tenant at 4800 Fournance Place, signing a 100,812-sq.-ft. lease. When Houston Methodist moves, in January of 2020, it will occupy the top three floors of the 10-story building that was built in 1976 with a total of 452,370 sq. ft.

Average asking rents

The Houston overall full-service average rates are at $29.32 per sq. ft., an increase of $0.12 from $29.20 a year ago. Asking rates for overall Class A space are $34.83 and Class B are $22.13 per sq. ft. Rent growth has varied across Houston’s submarkets. Asking rents in the Katy Freeway submarket averaged about $31.00 per sq. ft., which is 5.8% higher than the metro average as a whole and ranked in the top five among Houston submarkets as of Q3 2019. This can be expected from a leading West Houston office submarket, as rents in the Energy Corridor also grew by 5.5% year-over-year, thanks in part to improved leasing activity.


Leta Wauson
Director of Research
leta.wauson@naipartners.com
tel 713 275 9618

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