Houston Office Tenants Take Advantage of Lower Lease Rates

by CoyDavidson on April 11, 2011

Houston Office Market Report | 1Q 2011

The Houston Office Market posted 378,000 square feet of positive net absorption during the first quarter, with the suburban sector once again outperforming the Central Business District (CBD). Year-over-year vacancy rates decreased slightly from 16.2% to 15.9% citywide. Rental rates continued to decrease during the 1st quarter, with the citywide average rate dropping to $22.81 from $23.46 per square foot. Vacancy in CBD Class A properties continued to soften, reaching 12.6% compared to 8.8% a year ago. CBD Class B properties posted 19.6% vacancy, down from 20.8% in 1Q 2010. While the overall suburban vacancy rate remained in double-digits, Class A suburban vacancy actually dropped between quarters to 16.6% from 17.6%. By comparison, suburban Class B vacancy remained unchanged at 16.3%. First quarter leasing activity rose between quarters and consisted mostly of renewals and/or expansions, suggesting tenants took advantage of more favorable lease terms.

Macro factors driving the absorption of office space ultimately ties back to job count. According to the Texas Labor Market Review, total nonagricultural employment in Texas rose by 22,700 jobs in February, or 0.2%. Six of the eleven major industries grew over the month, with Professional and Business Service jobs contributing to more than half of the job gains. At the local level, Houston’s MSA had the largest monthly job increase, with 9,600 jobs added in February, followed by Dallas with 7,700 jobs added.

Looking forward, the outlook for the downtown office market reveals the potential for additional softness based on projected new vacancy in 2011, with approximately 1.2M SF of Class A space scheduled to become vacant during the next 12 months. This influx of new availability will add an additional 3.1% of vacancy on top of the current 12.6% registered in 1st quarter 2011. Additional large blocks of space coming on line during the year can be found in One Allen Center with 438,000 SF available in the third quarter and approximately 281,755 SF of sublease space in Two Allen Center available in April. The Continental / United Airlines merger is expected to reduce the need for the newly merged company’s 650,000 SF of downtown space. The company’s primary lease does not expire until 2014, but it is expected that some of the Continental space may come to market as sublease space in 2011.

Absorption, New Supply & Vacancy Rates

Vacancy & Availability

Overall vacancy levels were down for suburban properties and up for CBD properties. Houston’s citywide office vacancy for all property classes averaged 15.9% in the first quarter, compared to 16.2% this time last year.

Vacancy in CBD Class A properties continued to soften reaching 12.6% compared to 8.8% a year ago. CBD Class B properties posted 19.6% vacancy, down from 20.8% 12 months earlier. While the overall suburban vacancy rate remained in double-digits, Class A suburban vacancy actually dropped between quarters to 16.6% from 17.6%. By comparison, suburban Class B vacancy remained unchanged at 16.3%.

Citywide, a total of 52 office properties had a minimum of 100,000 SF available for lease in both direct and sublease space—25 of those properties have over 200,000 SF available—at the end of the first quarter. Sublease space totaled 3.1 million SF, including 1.2 million SF of vacant space and 1.3 million SF of subleases available for occupancy over the next 12 months. The largest sublease space being marketed is Devon Energy’s space, 282,000 SF in Two Allen Center and 121,000 SF in Three Allen Center (available for occupancy 4/2011) in the CBD. In Greenway, 5 Greenway Plaza has the largest suburban contiguous block of sublease space available, 82,300 SF.

Absorption & Demand

Houston recorded positive net absorption of 378,216 SF in the first quarter, compared to 408,209 SF of positive net absorption at the same time last year. Contributing to the quarters positive gain was Suburban Class A space with positive net absorption of 537,689 SF, followed by CBD Class B space with positive net absorption at 34,868 SF. Suburban Class B space had the largest amount of negative absorption in 1st quarter 2011 with 127,662 SF of negative net absorption followed by CBD Class A space with 33,540 SF of negative net absorption. Prevailing economic uncertainty is likely to negatively impact CBD absorption levels throughout 2011.

Rental Rates

Citywide rental rates continued to decline during the 1st quarter. On a year-over-year basis, CBD Class A average quoted rental rates dropped by 4.0% to $34.19/SF (from $35.57), while suburban Class A rates decreased 3.6% to $26.91/SF (from $27.88). CBD Class B rates dropped by 2.3% to $23.22/SF (from $23.76), while suburban Class B rates fell 1.9% to $17.80/SF on a full-service basis. Until demand outpaces supply, the current tenant-friendly market is expected to continue.

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