Houston We Have a Problem

by CoyDavidson on March 6, 2011

Clear Lake Office Market Vacancy Expected to Balloon

In January of last year I posted my thoughts on President Obama’s vision and proposed budget for NASA and how it might impact the Clear Lake office market. The president’s proposed budget contained no money for the Constellation program, the next-generation human-launch system to replace the space-shuttle program. This sent Texas lawmakers preparing for a major political battle to protect Houston jobs and the Johnson Space Center and created significant uncertainty regarding the real estate market in Clear Lake, often referred to as Bay Area Houston.

Some were confident the Constellation program could be saved, I was not one of them, but I did believe some type of compromise would be reached that wouldn’t totally devastate the Bay Area Houston real estate market. Despite the compromise to me that is still very sketchy, I expected that the Clear Lake office market was going to suffer and the only question was how much? You could not ignore these facts:

  • NASA Contractors made up 39% of the total office inventory and 47% of the then occupied space in the Clear Lake office submarket.
  • United Space Alliance the prime contractor the Space Shuttle Program which was ending had over 800,000 square feet of leases expiring in 2010 and 2011 and big layoffs were expected.

These facts combined with my opinion that Johnson Space Center would not be the President’s preferred base site for any new NASA programs given Texas is not a battleground state, that will surely go Republican in the next election. The Texas congressional delegation would face a challenge keeping NASA jobs in Houston.

NASA | Clear Lake Office Market (March 2011)

Source: The Tenant Advisor

The near-term outlook of Johnson Space Center is still sketchy to me despite asking clients and friends within the Aerospace community, as well as Economic Development leaders, what the consensus most-likely scenario is. I think it is entirely “too fluid” of a situation for anyone to get a handle on. However, if you use the office market as a barometer the picture is not too pretty.

  • The former United Space Alliance Headquarters building at 1150 Gemini (160,000 SF) is now on the market and there is still several hundred thousand square feet USA occupies in question.
  • Boeing has placed 140,000 square feet actively on the market from two buildings they are owner occupants and it is believed they would lease more.
  • Jacobs Engineering recently exercised a termination option for a 36,000 square foot lease tied to a NASA contract.
  • Several other NASA contractors have exercised termination options or consolidated spaces.

Current vs Projected Vacancy (Square Feet)

* Source: CoStar – based on space currently on the market

Looking at space that is currently leased versus what has been actively placed on the market and is available in the near term for lease, the projected vacancy rate is expected balloon to over 20% from its current level of 9.1%. There is approximately 1.3 million square feet of office space available for lease in a submarket with total inventory only slightly less than 5.9 million square feet.

The Good, Bad & the Ugly

The Good: The cost of office space is a pure supply and demand dynamic and in Clear Lake with the the supply of available office space about to dramatically increase and current demand sluggish, from the office tenant’s perspective they should be able to capitalize on much softer market conditions. This translates into lower asking rents and increased concessions. However, to what degree will depend very much on the size of the space requirement. Let me explain by elaborating on the nature of the expected new vacancy and the profile of Clear Lake office tenancy.

The Bad: For the multi-tenant office building owner looking for a silver lining, the one factor that may soften the impact of deteriorating fundamentals is the fact that a significant proportion of the office space being vacated by NASA contractors is in buildings that have historically been single tenant buildings. These buildings owners are not likely at least in the short term to make the capital investment to convert these buildings to multi-tenant or attempt to fill the vacated space with 2,000-5,000 square foot leases. That being said, some of the new projected vacancy is suitable for multi-tenant occupancy.

Once you get beyond the major NASA contractors there are only a handful of office tenants in the Clear Lake area who have more than a full floor of office space. So for the average Clear Lake office tenant better leasing terms will be available but not to the extent they might expect.

The Ugly: I have represented tenants and building owners in the Clear Lake office market for over twenty years, completing in excess of one million square feet of transactions and I have seen the area bounce back fairly quickly from two separate shuttle disasters. I suspect the Clear Lake office market will bounce back again, but I don’t expect it to happen anytime soon with a national economy that is improving sluggishly and a President in office who is clearly not going to direct any policy to benefit a state in which he has no chance of capturing the electoral vote.

The Bay Area Houston economy lacks a prominent secondary industry cluster to drive significant absorption in the office market. When the Clear Lake office market begins to recover likely does not hinge as much on improvement in economic conditions, as it does the outcome of the next presidential election and consensus from Congress and the White House on the vision and mission of NASA for the next ten years. Should the incumbent win re-election it could be a very long road back for the Clear Lake office market.

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