HOUSTON OFFICE | Q2 2018 Quarterly Market Report JULY 2018 HOUSTON | AUSTIN | SAN ANTONIO Market Indicators Current Q2 2018 Prior Quarter Q1 2018 Year Ago Q2 2017 Vacant Direct 19.2% 18.9% 18.3% Vacant Total 21.7% 21.5% 20.4% Available Direct 22.5% 22.1% 21.6% Available Total 26.4% 25.7% 26.0% Net Absorption (SF) -469,788 -1,435,065 -611,858 Leasing Activity (SF) 2,957,706 4,127,049 5,363,067 Construction (SF) 1,552,713 1,278,675 2,501,684 Deliveries (SF) 83,076 240,224 254,796 Avg Asking Rent (Gross) $28.28 $28.23 $28.06 Inventory (SF) 230,175,956 230,092,880 228,847,919 0% 5% 10% 15% 20% 25% -4.0 -2.0 0.0 2.0 4.0 6.0 Q2 2008 Q2 2009 Q2 2010 Q2 2011 Q2 2012 Q2 2013 Q2 2014 Q2 2015 Q2 2016 Q2 2017 Q2 2018 Millions (SF) Net Absorption Completions Vacancy Supply & Demand www.naipartners.com EXECUTIVE SUMMARY Office market occupancy falls again Houston’s overall vacancy rate increased to 21.7% in Q2 2018, up 20 basis points quarter-over-quarter and 130 basis points year-over-year. Although net absorption ended Q2 2018 at negative 469,788 sq. ft., this was a substantial improvement from the -1,435,065 sq. ft. mark tallied in Q1. Direct space was responsible for negative 723,583 sq. ft., and sublease space represented positive 260,808 sq. ft. Overall occupancy in the Houston office market remains below 80%—the current rate of 78.3% is the market’s lowest historical level recorded since NAI Partners began tracking office market activity in 1999. The overall average asking gross rent is up $0.05 at $28.28 per sq. ft. from last quarter, and $0.22 from a year ago. Houston economic indicators suggest a continued positive outlook In May, a landmark 3.1 million workers were on payrolls throughout the region, according to the Texas Workforce Commission. For the 12 months ending May 2018, metro Houston created 79,200 jobs, for a 2.6% increase. Employment services, construction and manufacturing led job growth with the three sectors accounting for 45.6% of the jobs created. Houston’s unadjusted unemployment rate was 4.2% in May, unchanged from 4.2% in April and down from 4.8% in May 2017. In addition, the price of West Texas Intermediate crude rose from the low $60s per barrel in the early months of 2018 to an average of $70 in May, while growth in the U.S. rig count has picked up, reaching a near-three-year high in early June with 1,062 rigs.
EXECUTIVE SUMMARYOffice market occupancy falls again
Houston’s overall vacancy rate increased to 21.7% in Q2 2018, up 20 basis points quarter-over-quarter and 130 basis points year-over-year. Although net absorption ended Q2 2018 at negative 469,788 sq. ft., this was a substantial improvement from the -1,435,065 sq. ft. mark tallied in Q1. Direct space was responsible for negative 723,583 sq. ft., and sublease space represented positive 260,808 sq. ft. Overall occupancy in the Houston office market remains below 80%—the current rate of 78.3% is the market’s lowest historical level recorded since NAI Partners began tracking office market activity in 1999. The overall average asking gross rent is up $0.05 at $28.28 per sq. ft. from last quarter, and $0.22 from a year ago.
Houston economic indicators suggest a continued positive outlook
In May, a landmark 3.1 million workers were on payrolls throughout the region, according to the Texas Workforce Commission. For the 12 months ending May 2018, metro Houston created 79,200 jobs, for a 2.6% increase. Employment services, construction and manufacturing led job growth with the three sectors accounting for 45.6% of the jobs created. Houston’s unadjusted unemployment rate was 4.2% in May, unchanged from 4.2% in April and down from 4.8% in May 2017. In addition, the price of West Texas Intermediate crude rose from the low $60s per barrel in the early months of 2018 to an average of $70 in May, while growth in the U.S. rig count has picked up, reaching a near-three-year high in early June with 1,062 rigs.
“While not quite
the “best of times,”
particularly when
compared to the
boom days of 2011-
2014, it’s hard to
ignore the sustained
improvement in
Houston’s overall
economy. ”
The working title for Houston’s office market would likely harken Charles Dickens’ “A Tale of Two Cities”—an interesting dichotomy between increasingly positive economic conditions and
continuously stagnant office fundamentals.
While not quite the “best of times,” particularly when compared to the boom days of 2011-2014, it’s hard to ignore the sustained improvement in Houston’s overall economy. The second quarter saw a record 3.1 million workers on the regional payroll, with 79,200 jobs created for the 12-month period ending May 2018 —a 2.6% YTY increase. With unemployment down year-over-year to 4.2% from 4.6% May 2017 (although still above the national level of 3.8%), there is a persistent level of optimism the likes of which we haven’t seen in years.
Helping fuel that optimism is the relative stability of the price of oil over the past 12 months, steadily increasing along a positive pricing trendline. This time last year oil was hovering around $45—today that number is flirting with $75. Not to go too far out on a limb, but Houston is still an oil-and-gas town at heart, and a 60% increase in the price of oil is a sight for many sore eyes in the region.
All of the above typically wouldn’t portend an erratic—often negative—office market, but the numbers certainly bear that out. And although by no means the “worst of times,” we are seeing historically high vacancy, continued negative absorption including ongoing large-scale lease dispositions and an occupancy rate at its lowest level in 30-plus years. Yet, overall asking rents are up $0.22 per sq. ft. year-over-year—talk about dichotomy.
The answer isn’t as perplexing as one would think, though. Although most brokers will tell you tenant activity levels are as strong as they’ve seen in years, there are a handful of mitigating factors at work. One is that average deal size has dropped significantly since the boom years—companies of all types are doing more with less. Advances in technology and workforce preferences are trending to denser and more flexible office usage. Two is the undeniable reduction in major office expansions by large energy and energy-related companies, many of which are still struggling to offload significant blocks of space they leased in a starkly different environment. Take the latest—Occidental Petroleum—opting to place 814,000 sq. ft. at Greenway Plaza on the sublease market in favor of acquiring Conoco Phillips’ former HQ in the Energy Corridor.
But while the market as a whole struggles to gain traction, perhaps the most interesting factor has been the unmistakable flight to quality, a trend that shows no signs of slowing down due to increasingly competitive corporate recruitment and retention. 609 Main, delivering in one of the weakest office markets in recent memory, is sitting at near-99% occupancy. Down the street, Capitol Tower is inching towards 50% preleased with delivery still a year away. Fresh off 609 Main, Hines is rumored to kick off yet another 1 million-sq.-ft. tower on Block 58, site of the former Houston Chronicle, with both a major law firm and a Big 4 accounting firm reportedly taking down a combined 50%.
This paradigm shift in the distinction between traditional Class A buildings and the newest breed of Class “AA” or “A+” towers has forced traditionally comfortable Class A landlords into reevaluating their assets, often committing to large capital improvement projects to remain competitive in the market. These capital commitments, along with competition from the more expensive “AA” towers, have allowed landlords to buoy their quoted rates even in an overall slow market. Make no mistake, though—the delta between quoted rates and actual effective rates ultimately negotiated—can be significant.
Ultimately, I believe we can expect a continuation of the current tenant-favorable market, because if there’s anything these dichotomous conditions can create for the savvy tenant it’s one thing—opportunity.
Broker’s PerspectiveQuarterly Market Report
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HOUSTON OFFICE | Q2 2018
Alex TaghiVice President
NAI Partners
MARKET OVERVIEWNegative net absorption decreases in Q2 2018
During the second quarter of 2018, Houston’s office market still had more tenants moving out of space than tenants moving in, but less of them compared to Q1 2018. The aggregate effect of these net occupancy losses was just under 500,000 sq. ft. of negative absorption. That lack of demand has led to vacant office space reaching 21.7%, or to put it another way: 50 million sq. ft. of office product lies empty.
More than one-quarter (26.4%) of total office inventory is being marketed for lease. The difference between this figure and the vacancy rate reflects expected future move-outs. Space being marketed for sublease represents 9.4 million sq. ft. (4.1%) of the 230.2 million-sq.-ft. total inventory figure. Although vacant sublease space is still financially occupied because rent is being paid, it is available to tenants, and therefore competes with both direct and new space.
The Greater Houston area will need to start absorbing more of the vacant supply to create less risk for developers who would not want to be left sitting with empty buildings. Houston’s office market will continue to struggle through decreased absorption until increased economic growth returns long enough to stimulate ongoing demand.
New construction remains disciplined
Office construction is at 1.5 million sq. ft. in eight buildings with 50% of the space underway in Capitol Tower at 800 Capitol St. The 35-story, 778,000-sq.-ft. building, includes anchor tenant Bank of America—obligated to 210,000 sq. ft.—plus future availability of 495,115 sq. ft., with a delivery date in mid-2019. Also under construction is City Place 2, at 1701 City Plaza Dr. in the Woodlands, a 10-story, 326,800-sq.-ft. office building, at 93.9% leased with a scheduled delivery date of October 2018; and City Place 1, at 1700 City Plaza Dr., a 5-story, 149,500-sq.-ft. available office building with a scheduled delivery date of April 2019.
One property delivered during Q2 2018, located at 4450 Harrisburg Blvd. in the Gulf Freeway/Pasadena submarket. The 4-story, 83,076-sq.-ft. BakerRipley Central office/retail building was approximately 65% leased at the time of completion. Over the last few years, developers have shown control as the construction pipeline has minimized and most spec developments have been put on hold, as the Houston office market tries to regain momentum.
Historic Downtown tower has new owner
One of downtown Houston’s historic office buildings, 1001 McKinney Tower, is under new ownership. TRC Capital Partners and Amstar America has acquired 1001 McKinney, a 375,440-sq.-ft., 23-story office
Net Absorption Direct & Sublease
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
Q22008
Q22009
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Q22011
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Q22013
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Milli
ons
(SF)
Direct Sublease
Construction by Submarket
0 200 400 600 800
Sugar Land/E Ft Bend
NASA/Clear Lake
FM 1960/Hwy 249
Woodlands/Conroe
CBD
Thousands (SF)
Pre-Leased Space Available Space
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0%
5%
10%
15%
20%
25%
30%
Q22008
Q22009
Q22010
Q22011
Q22012
Q22013
Q22014
Q22015
Q22016
Q22017
Q22018
Direct Sublease
26.4%
Availability Rates
Quarterly Market ReportHOUSTON OFFICE | Q2 2018
building in Houston’s central business district. The building is located at the corner of McKinney and Main, constructed in 1947, now a historic landmark on the National Register of Historic places. The property was sold by Cameron Management and Silverpeak Real Estate Partners and was 76% occupied at the time of the sale. Real Capital Analytics data reports year-to-date office sales volume for 2018 in the Greater Houston area at $1.1 billion, resulting in a year-over-year change of -45.4%. The majority of the buyer composition is made up of 49% institutional and 44% private.
Leasing activity down, NAI Partners Sublease Index up
Leasing activity during the second quarter of 2018 was at 3.0 million sq. ft., down 28% quarter over quarter, and dropping 45% compared to the amount of activity year-over-year. Class A space fulfilled 1.5 million sq. ft., while Class B space realized 1.3 million sq. ft., with direct space representing 90% of all transactions.
The NAI Partners Sublease Index—measured by the amount of sublease space as a percentage of total available space—increased 100 basis points to 15.3% in June. Space being marketed for sublease now represents 9.3 million sq. ft. of the 61.2 million-sq.-ft. total availability figure. The Sublease Index has hovered between 14% and 16% since last October.
A significant amount of the increase is due to Occidental Petroleum placing close to 814,000 sq. ft. of sublease space on the market at 5 Greenway Plaza (746,070 sq. ft.) and 3 Greenway Plaza (67,525 sq. ft.) this month. In April, Occidental Petroleum was said to be in discussions to purchase ConocoPhillips’ Energy Corridor campus, but word on a final decision has not yet been released. In addition, Sheridan Production Co. listed 71,346 sq. ft. of sublease space at 9 Greenway Plaza.
In Houston’s Energy Corridor, Kiewit Engineering Group Inc. signed a 52,834-sq.-ft. office sublease for the 14th and 15th floors of Energy Tower IV at 11750 Katy Freeway. The new office location will accommodate the company’s oil, gas and chemical engineering group. BASF, the sublessor, is the largest tenant in the 429,157-sq.-ft. Class A office building, occupying 83,000 sq. ft.
Despite slower leasing activity, average asking rents increase
The market saw overall full-service average rates increase $0.05 per sq. ft. quarter-over-quarter to close Q2 2018 at $28.28 per sq. ft. Year-over-year asking rents grew by $0.22 per sq. ft.—although concessions such as free rent and tenant improvement allowances make posted rents less meaningful as a market indicator. Brokers report net effective rents, what a landlord ultimately gets to keep from a deal, dropping significantly once negotiations begin.
Historical Average Gross Asking Rent
$10
$15
$20
$25
$30
$35
$40
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Class A Direct Class A Sublease Class B Direct Class B Sublease
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HOUSTON OFFICE | Q2 2018
Total Leasing Activity by Submarket over 100,000 SF
0 100 200 300 400 500
Woodlands/Conroe
FM 1960/Hwy 249
Southwest
West Belt
Greenway Plaza
Greenspoint/North Belt
Westchase
Katy Freeway
Galleria/West Loop
Energy Corridor
CBD
Thousands (SF)
0
1
2
3
4
5
6
J F M A M J J A S O N D
Billio
ns (S
F)
2018 2014 2015 2016 2017
Cumulative Monthly Sales Volume Houston OfficeSource: Real Capital Analytics
Class A 1,985,563 15.6 16.8 -41,044 -21,251 17,684 51,614 28.28
Class B 5,131,395 24.4 24.7 19,456 58,588 73,687 0 19.48
North Loop West Total 4,423,520 19.7 23.7 -51,704 -32,588 44,986 0 24.15
Class A 1,188,544 30.8 43.4 -9,875 7,504 0 0 26.34
Class B 2,767,996 17.0 17.4 -28,069 -49,577 44,249 0 22.58
Northeast Total 2,332,510 14.5 17.2 -8,520 -20,627 8,208 0 18.82
Class A 122,923 17.7 17.7 6,355 10,881 0 0 -
Class B 1,472,060 18.7 20.8 -13,289 -30,128 8,208 0 19.35
Northwest Total 3,952,543 22.9 25.3 -14,712 -10,933 70,041 0 17.67
Class A 797,237 43.4 53.2 -18,457 -9,801 12,536 0 19.44
Class B 2,277,443 20.0 20.5 47,808 42,159 56,681 0 16.30
Pearland/South Total 1,803,710 8.8 9.5 -1,428 23,703 5,683 0 27.50
Class A 670,318 4.3 6.1 2,284 809 5,683 0 28.20
Class B 882,785 11.9 12.1 -5,416 -14,406 0 0 27.29
Southwest Total 11,789,711 18.7 24.2 61,297 -47,602 121,422 0 17.07
Class A 2,053,918 22.8 29.8 31,693 49,721 12,646 0 18.81
Class B 7,148,203 20.0 25.9 40,462 -73,089 91,993 0 16.92
Sugar Land/E Ft Bend 6,600,635 11.4 15.3 69,924 -115,253 66,851 38,599 25.41
Class A 3,489,860 11.2 16.2 57,466 -103,814 16,658 0 26.33
Class B 2,836,057 12.4 15.5 12,458 -11,439 49,193 38,599 24.39
West Belt Total 5,114,561 32.9 40.8 -253,581 -408,097 127,824 0 26.22
Class A 3,359,700 36.8 45.9 -175,953 -348,097 127,824 0 29.01
Class B 1,667,232 26.7 32.7 -77,628 -60,000 0 0 19.44
Westchase Total 15,459,683 22.7 30.3 -88,684 -223,538 189,875 0 27.18
Class A 8,790,557 29.1 37.2 18,532 -131,906 86,961 0 31.84
Class B 6,492,461 14.5 21.4 -102,428 -91,632 102,914 0 19.14
Woodlands/Conroe Total 12,331,276 14.8 17.3 140,695 201,641 100,164 498,252 29.33
Class A 5,853,687 18.8 21.1 113,843 180,880 33,161 476,300 32.06
Class B 5,633,825 11.9 14.8 6,968 4,221 46,368 21,952 26.28
Suburban Total 190,999,736 21.2 25.5 -599,856 -1,570,561 2,528,155 774,369 26.00
Class A 91,400,179 25.4 30.9 38,085 -412,767 1,255,748 683,914 30.57
Class B 83,672,660 18.2 21.6 -576,675 -1,057,087 1,132,740 90,455 20.76
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HOUSTON OFFICE | Q2 2018
Information and data within this report were obtained from sources deemed to be reliable. No warranty or representation is made to guarantee its accuracy.
90
90
90
59
45
Sam H
ouston Tollway
West Park Houston Tollway
Westheimer99
99
99
99
288
6
6
6
Fort Bend Tollway
10
10
10
90
225
59
59
290
290
MARKET OVERVIEWHouston Office Submarkets
1. CBD
2. Bellaire
3. Energy Corridor
4. FM 1960
5. Galleria/West Loop
6. Greenspoint/North Belt
7. Greenway Plaza
8. Gulf Fwy/Pasadena
9. Katy Freeway
10. Katy/Grand Pkwy W
11. Kingwood/Humble
12. Medical Center
13. Midtown
14. NASA/Clear Lake/SE
15. North Loop West
16. Northeast
17. Northwest
18. Pearland/South
19. Southwest
20. Sugar Land/E Ft Bend
21. West Belt
22. Westchase
23. Woodlands/Conroe
Quarterly Market Report
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HOUSTON OFFICE | Q2 2018
HOUSTON OFFICE | Q2 2018
Quarterly Market ReportJULY 2018
NAI Partners Houston Office 1900 West Loop South, Suite 500 Houston, TX 77027
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