Are Houston Office Tenants Leaving the Burbs?

by CoyDavidson on December 16, 2010

CBD Office Buildings are Outperfoming Suburban Properties Exiting the Recession

There have been two articles published this past week in both National Real Estate Investor and the Wall Street Journal discussing the recent performance of office buildings located in central business districts (CBD) versus office properties located in the suburbs. As the economic recovery takes hold, several office markets around the country appear to have bottomed out and are showing signs of life. In many of these markets there is a noticeable difference in market fundamentals among these two office asset classes.

Nationally data indicates the impact of the recession was much deeper on suburban markets than CBD’s and evidence of recovery is appearing in downtown office markets while suburban markets continue to struggle.

What About Houston?

Interestingly enough the Wall Street Journal chose a picture of the Houston CBD skyline for their article and cited BG Group’s relocation to MainPlace downtown as an an example of companies opting to leave the suburbs for downtown. On the surface, the trend in Houston appears to mirror aspects of the broader U.S. office market.

Houston: Class A Vacancy Rates (CBD vs  Suburban)

You can see from the chart above the Houston CBD is in fundamentally better condition than the suburban office market, but based on recent indicators there is no hint of a recovery that exists for downtown and is absent from the suburban office market.

Overall, the suburban market without question has fared much worse than the CBD recording 1.9 million square feet of negative net absorption since the 1st quarter of 2009 as compared to 270,000 square of negative absorption in the CBD. I should note the sign of a downturn in the Houston office market did not appear until the first quarter of 2009 much later than many major office markets around the country.

Houston: Net Office Space Absorption (All Classes)

However, when you take a closer look at just Class A office space which makes up over 70% of the total inventory in the CBD, the numbers are less compelling.

In fact, through the first three quarters of this year, the “Suburban Class A” office market has been the stronger performer recording 113,324 square feet of positive net absorption as compared to 419,702 square feet on the negative side of the ledger in the CBD. Taking a sneak peak at the 4th quarter absorption numbers with just a week left in the year,  you will see a significant positive absorption number in the suburbs and negative figure in the CBD.

Since the beginning of 2009, the Class A Suburban office market in Houston has registered 651,000 square feet of negative absorption as compared to 363,000 square feet of negative absorption downtown. On a relative basis, this is not a significant difference considering the total suburban Class A inventory totals 68.5 millions square feet as compared to 26.7 square feet downtown. Based on absorption statistics, it is hard to draw the conclusion that downtown is significantly outperforming the suburbs during the downturn based on preferred demand for office space in the CBD.

The reality is the Central Business District was the superior performer in the previous expansion cycle and entered the market downturn (1Q-09) in much stronger condition than the suburban market.

At the beginning of 2006, the Class A vacancy rate in the CBD  was 19.9 % and 12.9% in the suburbs and by the end of the 4Q of 2008, basically the “height of the market” the Class A vacancy rate was at 8.1% in the CBD as compared to 11.1% for the suburban market. The deeper deterioration of the suburban market was enhanced by a supply issue in the suburbs, as more new inventory came online from construction that had started at the tail end of the market peak. The CBD only accounts for approximately 1.8 million of the 20 million plus square feet of new office space that has been delivered to the marketplace since 2006.

Recent Office Space Deliveries Since 2006

Fast forward to the end of the 3rd quarter this year and the Class A vacancy rate has reached 19.3% in the suburbs as compared to 10.1 % downtown. My conclusion is that the CBD’s stronger fundamental position today is a result of outperforming the suburbs pre-recession and less exposure from an over-supply aspect.

The Resurgence of the CBD

The articles in National Real Estate Investor and The Wall Street Journal discussed the reversal of the “flight to the suburbs” trend by corporate office tenants that existed until the late 90’s. Office vacancies in suburban markets were lower than vacancies in CBD office markets from 1993 to 1998, the result of a large-scale demographic shift of flight to the suburbs by households.

The resurgence of CBDs materialized in the late 1990s. City governments took steps to steps to address declining downtown employment bases. Those of us in Houston witnessed a similar resurgence for downtown Houston. There is no question it became a more attractive place for companies to locate their offices, with less crime, more amenities and nearby housing options.

The NREI and WSJ articles talk about a changing demographics of the workforce and younger employees desires to live and work in an urban environment. I would not argue this is a factor companies are beginning to consider when selecting office locations. However, I would attribute some of the stronger performance recently in downtown markets around the country to office tenants who are trading up to higher quality properties in CBD’s, while rents are lower and Landlords are offering attractive concessions.

In the short term, Houston’s CBD has some question marks as merged airline, United-Continental and several large Energy concerns are candidates for space reductions. In the long term, I expect the Houston CBD to be a strong performer. The WSJ article paints a picture of the BG Group relocation from the Galleria to the CBD as an emerging trend. Earlier this year KBR scrapped plans for a suburban campus, and renewed their lease in the CBD.

In contrast, the rumors of a massive Exxon-Mobil Campus just south of the Woodlands is widely believed to be happening. Houston is a big office market and the CBD is in much better position to return to pre-recession fundamentals than the suburbs once job growth accelerates. However, I also expect “close-in” submarkets such as the Galleria and Greenway Plaza to rebound quicker than most submarkets. Further out in the suburbs, the Energy Corridor and the Woodlands will perform well in the long term as the Houston area population continues its growth West and North. There are still alot of people who like living in the suburbs and many employers will remain there.

In Houston, is the CBD becoming more a desirable location at the suburban office market’s expense?  One really large user opted to stay and another significant company chose to relocate there, but I think the jury is still out as to whether we see several other large suburban office tenants make a real estate decision to move or consolidate downtown.

  • Great post Coy,

    Thank you providing another example of why local expertise is so important when talking about specific markets.

  • CoyDavidson

    Thanks John, the WSJ almost painted the Houston market as a poster child for this trend, but I knew as soon as I read it wasn’t that cut and dry in regard to the Houston market.

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