How Long Will the Tenant Friendly Office Market Last for Houston?

by CoyDavidson on December 27, 2010

The Market Dynamics for Large Houston Office Space Users Will Turn First

The 16.6% citywide office vacancy rate for Houston will not move significantly lower based on a preliminary review of 4th quarter leasing activity. However, when our year-end office market report is released in early January expect to see positive net office absorption reported both for the 4th quarter and the year.

There is no argument that it is a tenants’ market characterized by abundant supply and downward pressure on rents. Landlords are generally very flexible on terms and remain extremely aggressive both in their efforts to attract new as well as retain existing tenants. One segment of the market that could transition into a landlord’s market more quickly is available inventory to accommodate large office users.

Where are the Large Blocks of Available Space?

Citywide in Houston there are presently fifteen (15) blocks of contiguous Class A office space available that can accommodate a user with a 200,000 square foot office space requirement, with three (3) options in the Central Business District (CBD), three (3) in the Energy Corridor and the remainder dispersed throughout various suburban submarkets. The volume of larger office lease transactions in excess of 100,000 square has increased in 2010 with thirteen (13) reported as compared to nine (9) in 2009, and there are several large tenants still believed to be in the market actively evaluating office space options.

Below is current data on blocks of available Class A office space for 100,000 square foot users and 20,000 square foot users segregated by submarkets. What can be observed is the majority of the opportunities for either a single full-floor or multi-floor users exist in the CBD and the largest suburban office markets.

While this is not completely unusual, what is different this time around is with relatively little new supply expected to come on-line in the foreseeable future, and as the remainder of the primarily suburban Class A space built at the tail end of the market peak is filled, what will remain available will be scattered across many buildings and many floors, as opposed to new construction which is almost always found in large blocks of contiguous space. Furthermore, big tenants can’t rely on large speculative developments that might provide relief in the next 2-3 years.

Downtown and The Energy Corridor Have Options

I don’t think that it comes as any surprise that the availability of options for larger space users is more prevalent in the market areas which have seen the most recent new construction. However I also consider this a temporary symptom rather than long-term ailment based on the fundamentals of these market areas. The CBD office market is the healthiest citywide, the clustering of large oil and gas companies in the Energy Corridor is a long term trend and there is no credible evidence of significant “flight to downtown” by suburban office tenants.

Large Blocks of Available “Class A” Office Space

20,000 SF Blocks of Available “Class A” Office Space

Source: Colliers Research

When Does the Market Change?

The market value of office space rents are impacted almost solely by supply and demand. In Houston where the barriers for new development are minimal, the only significant constraints to new supply are economic conditions and the dynamics of the capital markets. Given our city’s historical track record of experiencing rapid periods of economic and employment growth primarily driven by the Energy industry, it seems we are rarely at the point of equilibrium in the market cycle for long.

We are certain when demand exceeds supply, prices go up. We are at point in time in Houston when office space supply is expected to remain constrained for the next two to three years, and the economy is clearly improving albeit slowly. With such a scenario almost upon us, higher rents are almost guaranteed, perhaps not imminently, but likely within the next couple of years.

This will mark the beginning of the next development cycle, usually with a limited number of build-to-suits or self-funded developers leading the way. In the interim, rents for the modest number of large blocks of space available to lease can only go up as the market improves. Modest economic growth is a prerequisite for the unfolding of such events but a key point is an economic boom is not required. The market for the large space user will be the first to transition to a Landlord’s market. In Houston, the Energy industry creates the real potential to intensify economic growth and accelerate the transition through the market cycle in the Landlord’s favor.

The wounds of the Great Recession were not as severe on the Houston office market as many cities around the country. 2011 will be an interesting time in the Houston office market as we will enter the new year void of a spectacular performance in 2010, but with momentum.  Landlords may be able to move tenants around to accommodate any large requirements in the market for the next year or so. When the “Tenant Friendly” market ends will depend on how big of an office space user you are and the pace of economic recovery. It’s all supply and demand, but it’s not the same for every tenant.

Stay tuned for our 4th Quarter 2010 Market Reports.

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