Houston Office Building Values: Have We Hit the Bottom?

by CoyDavidson on January 21, 2010

Journalist Christina S.N. Lewis covers real estate development and the office sector for the Wall Street Journal. In her recent article Matter of Debate: Bottom in Commercial-Property Values she reports on the current debate among commercial real estate and investment professionals on whether commercial real estate values are beginning to stabilize?

The real valuation issue is that with very little recent sales activity in late 2009, there is a much smaller data population of actual sales to give substantial validity to any one expert’s opinion on the trend of real values. While there is no question that values are off from the peak of the market certainly some specifc commercial property sectors and local markets have fared better than others.

What about  the Houston office market?

Houston was a late entry into the recession as the Houston office market actually posted positive net absorption of office space in 2008 of 1.88 millions square feet. The 1.16 million square feet of negative office space absorption recorded in 2009 is a minor blow considering the total office market is 196 million square feet. In the Central Business District the average qouted rate for Class A office space dropped from $38.41 PSF to $37.36 year-over-year from year end 2008. Suburban Class A quoted rates dropped from $27.88 to $27.26 during the same period. This is a fairly mild weakening of market fundamentals compared to many other major markets around the United States.

Colliers International 4Q 2009 Houston Office Market Report

However, there is one huge drag on the Houston office market. Sublease space on the market has currently reached 4.7 million square feet with a significant amount of the sublease space being marketed at significantly reduced rates with extended terms beyond 3-5 years. In addition, the gap between actual strike price (rental rate) and the Landlord’s quoted rates has widened at many properties, often coupled with liberal concession packages of free rent, abated parking charges and healthy tenant improvement allowances. What is the net effect of all this on office values?

  • Required rates of return and cap rates have risen and in essence are probably shifting back to what many would label normalcy. The overall average cap rate has risen to 9.30% from 7.38% a year ago.
  • Any investor underwriting an acquisition is going to proforma lower net effective rents and higher leasing costs
  • Lenders will demand higher loan to value ratios requiring more equity

The bottom line is lower real estate values. However, until the state of the debt markets are more solidified and we actually see more office properties trade hands, what relative current values  are and which direction they are headed  is nothing more than a professional opinion, or should I say guess?

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