Three Reasons the Houston Office Market Will Not Improve in 2010

by CoyDavidson on December 9, 2009

Houston skyline at sunset

Houston  has historically proven to be a resilient city and based on the conversations I have had with leasing agents and real estate types at the numerous holiday parties I have recently attended, some of my commercial real estate peers still seem to hold on some glimmer of optimism the market is going to improve in 2010. However, there are three key reasons the Houston office market will not see significant improvement if any in the coming year.

Job Growth

Recovery in the office market is dependent on expansion of office jobs and the office markets tend to lag economic growth for 1-2 quarters.  The unemployment rate for the Houston area currently stands at 8.5% which is well below the national average of 10.2%.

The consensus forecast is that Houston will not see any upward trend in employment until at least the 3rd or 4th quarter of 2010 with the less bullish economists predicting 2011 before we see any significant job growth in the Houston area. So even under the most optimistic scenario the earliest we can expect increased office space demand in Houston is 2011, with even 2012 a plausible scenario in the opinion of some.

Natural Gas Prices

Houston is perceived as an oil town and to a large degree this is true. However, natural gas surpasses crude oil as key to Houston’s economy; of the area’s 2008 top 10 publicly traded companies, half are natural gas producers.

  • After peaking at $10.82/ mcf (thousand cubic feet) in June 2008, natural gas dropped 66.9% to $3.58/mcf in June 2009 (see chart below)
  • Correspondingly the peak of the Houston office market strongest period of performance was 2005-2008 when natural gas prices were at their peak levels.
  • U.S. Energy Information Administration EIA expects the annual average natural gas Henry Hub spot price for 2010 to be $4.62 per thousand cubic feet (mcf).

Historical Natural Gas Prices per MCF 1990-2009

gas chart

 

 

 

 

 

 

While, we have not seen dramatic job losses in the upstream energy sector. I do not expect to see any office space expansion from the city’s many natural gas producers until gas prices reach higher levels than what is predicted for 2010. However, should natural gas prices trend higher than expected we could see some economic expansion in the latter part of 2010.

Tenant Perception

Houston didn’t really begin to feel the brunt of the economic recession until the 4th quarter of 2008 and over the past year many companies have taken a “wait and see” attitude when it comes to their real estate facilities. 2009 was a year we began to see moderate rental rate decreases and office Landlords slowly get more aggressive with concessions packages to attract and retain tenants

Up until now, most recession-pinched companies have been too pre-occupied cutting employees or dealing with other economy-related problems to focus on their real estate and  were reluctant to make long term office leasing decisions. Preservation of capital and short term lease commitments have been the norm as tenants waited on a better picture of where their business and the economy was headed.

While I do believe many companies are beginning to have increased optimism in economic recovery and the future direction of their business, only tenants with near term lease expirations have looked to take advantage of lower lease rates and more aggressive concession packages offered by Landlords. We have yet to see a significant number of stable companies begin to take a more long term approach and grab office space at a perceived “value”.  I expect this trend to continue at least for the first two quarters of 2010 until tenants perceive that the office market has bottomed out.

What’s Ahead?

In summary, 2010 will still be a great year for Houston office tenants to be in the marketplace. In Houston office buildings have fared much better than most parts of the country but even Houston Landlords are suffering from flat rental revenues and a more competitive market for stable tenants. Houston is clearly a tenant’s market, but not to the degree of other markets in major cities around the United States.  The good news for Houston office building owners is this real estate recession was demand driven and in Houston’s case is not compounded by excessive over supply of office space. The $64,000 question is when will demand return and start to swing the pendulum back in the Landlord’s direction. While I don’t consider it a bold prediction, “it is not going to be 2010”.

However, it appears the office market in Houston may have bottomed out and will end the year somewhere around1.5 million square feet of negative absorption. Given the size of the Houston office market (approximately 195 million square feet), that is a significant  bruise, but not the deep flesh wound that many office markets around the country have experienced. I expect more downward pressure on rental rates at least through the first half of 2010 and that landlords will continue to offer aggressive concession packages to attract and retain tenants.

The important point here is that 2010 is  probably the time frame for Houston tenant’s to take advantage of attractive deals. While everyone seems to be predicting a slow economic recovery, as soon as we experience any significant and sustainable job growth in Houston, those attractive lease deals will begin to disappear very quickly. The fundamentals are in place for the Houston office market to have a fairly quick recovery once it actually begins.

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