Houston Office Market Report | Q3 2017

by CoyDavidson on October 13, 2017

Houston’s office market vacancy rate continues to struggle amid $50 crude prices

Houston’s office market continues to struggle as U.S. crude prices waiver around $50 per barrel. According to the U.S. Energy Information Administration (EIA), they are expected to stay in this range through 2018. With no indication that prices will rise substantially over the next few years, vacant office space placed on the market by firms in the energy industry will take longer to absorb. Recent news articles indicate that some of the large energy giants reported profits in the second quarter. However, profits were largely driven by lean budgets and staff reductions.

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Fortunately, most of the proposed projects that were in the construction pipeline when the oil slump hit were put on hold. Companies such as Bank of America, American Bureau of Shipping and HP, have signed leases in proposed buildings that have either recently begun construction or will begin in the very near future. Once these projects deliver, those companies will vacate their existing space, leaving more than 1.0 million square feet for landlords to backfill.

During the third quarter of 2017, Houston faced one of the worst natural disasters in history. Hurricane Harvey, a Category 4 hurricane, slammed the Texas coast and dumped over 50 inches of rain in parts of Houston. The event caused widespread flooding, destroying homes, businesses and infrastructure. Several large refineries were shut down due to the flooding and off-shore drilling was stopped once the storm entered the Gulf of Mexico. This event stalled business for several weeks, but Houston was resilient and quickly went back to work. This was a temporary set-back for many, but has had permanent ramifications for others. A joint industry survey confirmed that less than 7% of Houston’s office inventory suffered damage. Of that amount, approximately 45% were repaired and back on-line within the first month. Another 30% reported repairs to be completed by the end of the year and the remaining properties were so severely damaged they could not report a time frame for repairs.

According to the U.S. Bureau of Labor Statistics, the Houston MSA created 53,500 jobs (not seasonally adjusted) between August 2016 and August 2017, an annual growth rate of 1.8%.

VACANCY & AVAILABILITY

Houston’s citywide vacancy rate rose 30 basis points from 18.8% to 19.1% over the quarter, and rose 200 basis points from 17.1% in Q3 2016. Over the quarter, the average suburban vacancy rate increased 30 basis points from 18.5% to 18.8%, and the average CBD vacancy rate increased 60 basis points from 19.8% to 20.4%.

The average CBD Class A vacancy rate increased 100 basis points from 17.3% to 18.3% over the quarter, while the average CBD Class B vacancy rate fell 50 basis points from 28.7% to 28.2%. The average suburban Class A vacancy rate remained steady at 21.4% between quarters, while the average suburban Class B vacancy rate rose 50 basis from 16.4% to 16.9%.

Of the 1,709 existing office buildings in our survey, 91 buildings have 100,000 SF or more of contiguous space available for lease or sublease. Further, 28 buildings have 200,000 SF or more of contiguous space available. Citywide, available sublease space totals 10.0 million SF or 4.3% of Houston’s total office inventory, and 18.2% of the total available space. Available space differs from vacant space, in that it includes space that is currently being marketed for lease, and may be occupied with a future availability date. Whereas vacant space is truly vacant and is and may still be immediately available.

HISTORICAL AVAILABLE SUBLEASE SPACE

ABSORPTION & DEMAND

Houston’s office market posted 669,517 SF of negative net absorption in Q3 2017. Suburban Class B space recorded the largest loss, with 406,747 SF of negative net absorption, while Suburban Class A posted the largest gain with 61,218 SF of positive net absorption. Some of the tenants that moved during the quarter include Kirkland & Ellis (104,025 SF) in the CBD submarket, ABM Industries Incorporated (62,457 SF) in the E Fort Bend Co/Sugar Land submarket, and Apache Industrial Services Inc. (33,128 SF) in the Northeast Near submarket. Over the last two years, Houston’s office market has suffered due to downsizing by large energy companies, and some of these firms moved from leases in third-party buildings into an owned property, thus creating a glut of vacant sublease space. However, available sublease space has decreased over the last four quarters, primarily due to lease expirations and space going back to the landlord. There were a few instances where the sublease space was withdrawn by the sublessor. The majority of the sublease space in the market now has three years of term or less remaining.

RENTAL RATES

Houston’s average Class A asking rental rate increased over the quarter from $35.50 per SF to $35.31 per SF. The average Class A rental rate in the CBD remained steady over the quarter at $44.36 per SF, while the average Suburban Class A rental rate decreased from $33.16 to $32.74 per SF. The current average rental rate, which includes all property classes, for Houston office space is $29.34 per SF gross.

LEASING ACTIVITY

Houston’s office leasing activity decreased 18.7% between quarters, dropping from 3.4 million SF in Q2 2017 to 2.7 million SF in Q3 2017.

SALES ACTIVITY

Houston’s office investment sales activity increased substantially over the year, increasing by 3.4% since Q3 2016. With most of the investor community believing the downturn in the energy industry has reached the bottom and has begun to rebound, they now see Houston as offering limited downside and the potential for healthy returns. The average sales price per square foot increased over the quarter but is still below the historical average.

OFFICE DEVELOPMENT PIPELINE

2.2 million SF of office space is under construction, of which 47.3% is pre-leased. Build-to-suit projects make up 36.5% of the pipeline, and the remaining 1,374,315 SF is spec office space under construction which is approximately 23.4% pre-leased.

▸ Click here to download the report as a PDF.

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