Houston Office Market Report | Q3 2016

by CoyDavidson on October 20, 2016

Skyline of Houston, Texas

Houston office market construction pipeline shrinks seventy-three percent over the year

Houston’s office market continues to struggle due to the downturn in the energy industry, leading to negative net absorption and decreased leasing activity. Leasing activity has dropped by 28.6% since Q3 2015 and by 13.8% over the quarter. Tenants are renewing existing leases, but more companies continue to contract than expand.

Houston’s office market posted 0.4M SF of negative net absorption during the third quarter. Even with the positive absorption year-to-date, because of the additional space completed and added to the market, Houston’s city-wide office vacancy rate rose from 16.2% to 17.1% over the quarter, and the annual rate rose significantly, increasing by 260 basis points from 14.5% in Q3 2015.

Available sublease space has increased from 7.1M SF to 12.0M SF, growing 68.6% over the year. The major energy firms, as well as the engineering companies and oilfield service firms that support them continue to suffer with the results of the significant drop in the price of oil. ConocoPhillips has almost 600,000 square feet of new, never occupied space on the market. Shell recently announced it will vacate the majority of its space in the CBD submarket, adding additional space on the sublease market. We are hopeful that Houston’s office market has hit the bottom and no more significant blocks of space will be added.

1.5M SF of new inventory delivered during Q3 2016 and 48.9% of this space is pre-leased. Houston’s office construction pipeline is shrinking and currently totals 2.9M SF, 73.0% less than the 10.8M SF under construction in Q3 2015. The majority of the new space is located in suburban submarkets and is scheduled to deliver over the next 15 months.

According to the U.S. Bureau of Labor Statistics, the Houston metropolitan area created 14,200 jobs (not seasonally adjusted) between August 2015 and August 2016. Most of the job growth occurred in education and healthcare, trade, transportation and utilities, and professional services.

Vacancy & Availability

Houston’s citywide vacancy rate rose 90 basis points from 16.2% to 17.1% over the quarter, and rose 260 basis points from 14.5% in Q3 2015. Over the quarter, the average suburban vacancy rate increased 80 basis points from 16.4% to 17.2%, and the average CBD vacancy rate increased 120 basis points from 15.6% to 16.8%.

The average CBD Class A vacancy rate rose 160 basis points from 11.8% to 13.4% over the quarter, while the average CBD Class B vacancy rate remained the same at 26.5%. The average suburban Class A vacancy rate increased 80 basis points from 18.3% to 19.1%, and the average suburban Class B vacancy rate rose 100 basis points between quarters from 15.3% to 16.3%.

Of the 1,701 existing office buildings in our survey, 142 buildings now have 100,000 SF or more of contiguous space available for lease or sublease. Further, 57 buildings have 200,000 SF or more of contiguous space available. Citywide, available sublease space totals 12.0 million SF or 5.2% of Houston’s total office inventory, two and one half times more than the 3.4M SF in Q3 2014 when oil prices dropped significantly.

Available Sublease Space

office-q3-2016 Houston

Absorption & Demand

Houston’s office market posted 0.4M SF of negative net absorption in Q3 2016, pushing year-to-date absorption down to around 0.3M SF.Suburban Class B space posted the largest loss, with 0.5M SF of negative net absorption, while Suburban Class A posted the largest gain,565,185 SF of positive net absorption. This positive absorption is the result of resulting from Phillips 66 occupancy of its namesake new building at 2101 Citywest Blvd in the Westchase submarket. The majority of Q3 negative absorption was due to tenants downsizing and consolidating in an effort to cut expenditures.

Rental Rates

The significant increases in vacancy rates in Houston’s office market have begun to have an impact on average asking rental rates. Although most rental rates remained relatively flat over the quarter, we witnessed several landlords with large blocks of space drop rental rates by $2.00 to $4.00 per square foot. In contrast, several buildings delivered over the quarter and those buildings are offering lease space with a higher than average asking rental rate.

Leasing Activity

Houston’s office leasing activity decreased 13.8% between quarters recording only 2.5 million SF of transactions in Q3 2016. When compared to the 3.5 million SF recorded in Q3 2015, quarterly leasing activity has fallen by 28.6% in just one year.

Sales Activity

Houston’s office investment sales activity has slowed significantly over the past year, dropping by 77.0% since Q3 2015. The average sales price has remained stable over the year and is currently $227 per square foot.

Office Development Pipeline

Houston’s construction pipeline contains 2.9 million SF of office space and 46.9% is pre-leased. Build-to-suit projects make up 23.2%of the pipeline, and the remaining 2.2M SF of spec office space under construction is approximately 32.7% pre-leased.

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