Houston’s Office Market Rides Out Oil Downturn, Poised For Stability
Capitol Tower, a 35-story office project in downtown Houston, reflects the return of investor confidence to the metro's office market.
Over the past few years, Houston’s diverse economy has proven resilient. This diversity helped the city weather a major drop in oil and gas prices that, during previous downturns, severely affected the office market. While Houston has taken its share of recent hits, it appears poised to move forward into a period of stability and steady growth.
While most of Houston seems to be in recovery mode, the local office market historically trails the oil and gas industry and usually takes additional time to reflect the current economic recovery. Houston’s office market was hit hard by the downturn when oil prices plummeted at the end of 2014.
Submarkets like the Central Business District and the Energy Corridor — where roughly half of the workforce belongs to
the energy sector — were hardest hit. Firms in these submarkets suffered big layoffs and created large swaths of available sublease and direct office space. However, according to CoStar, tenants still spent more than $7 billion (larger than the GDP of 55 sovereign nations) on office space during the past year.
What does this all mean for the office market? At the end of the first quarter of 2017, Houston’s direct vacancy rate was 15.2 percent. Sublease space rose from 5 million square feet at the end of 2014 to 12 million square feet during the third quarter of 2016. However, some of this sublease space was short-term in nature, created by corporate relocations to new spaces in 2014 and 2015. This helps explain why total sublease space has decreased by 7 percent over the last two quarters to 11.2 million square feet.
Additionally, new office construction, which had a frenzied pace in 2013 and 2014, subsided beginning in the first quarter of 2015. New projects had met demand, and growth slowed due to the drop in oil prices.
At the office market peak in mid-2014, Houston had 19.4 million square feet under construction, with about 10 million square feet built on a speculative basis. In the first quarter of 2017, that number fell by 89 percent to just 2.2 million square feet – a reasonable response to Houston’s supply/demand imbalance.
That doesn’t mean investment capital for new construction has been scared away. Development companies continue to build speculative office projects to provide newer and innovative spaces.
Thor Properties’ Kirby Collection, a 200,000-square foot office/retail project in Greenway Plaza, is scheduled to be delivered in late 2017. Skanska is pushing forward with its long-delayed 780,000-square-foot downtown project, Capitol Tower, after signing a 210,000-square-foot lease with Bank of America. The building is expected to be delivered in mid-2019.
Two other speculative projects were completed during the first quarter of 2017: Hines’ 609 Main, which delivered 1.1 million square feet of new office space to the downtown market; and MetroNational’s 10100 Katy Freeway, which delivered 274,000 square feet to the Katy Freeway East submarket. Together, the buildings are 51 percent leased. These deals suggest that tenants still desire amenity-rich buildings, regardless of where the market is in the rent cycle.
Houston has also inked some major leases in the past year. United Airlines and Bank of America are consolidating the office space they’ve occupied for decades in the CBD and starting fresh at 609 Main and Capitol Tower, respectively.
In North Houston, Hewlett Packard (HP) and American Bureau of Shipping (ABS) are relocating to the booming Springwoods Village complex just south of The Woodlands. HP will occupy a two-building campus totaling 378,000 square feet while ABS is building a 327,000-square-foot building for its new headquarters, which will include 20,000 square feet of ground-floor retail.
Although direct rental rates for Class A properties have dropped 6.8 percent from their historic highs at the end of 2014, CoStar still ranks Houston’s office rents near the top 10 percent of national markets, with Class A asking rents averaging $34.90 per square foot. Some suburban areas, like the Northwest Houston, 1960 Corridor and Woodlands submarkets, saw slight increases in their rental rates over the same period. Additionally, Class B and C rental rates have remained relatively steady.
While Houston’s economy has certainly slowed in recent years, there are clear signs recovery is happening and stability is on the horizon.
Houston remains a destination city. Recent population estimates from the U.S. Census Bureau rank Houston the second fastest-growing metropolitan area in the U.S., adding over 125,000 residents for the year ending July 2016. These positive population gains occurred during the height of the oil and gas downturn, suggesting Houston will continue to grow even with volatility in the energy sector.
Other signs of recovery in oil and gas suggest the worst is behind us. The Houston Purchase Managers Index has been above 50 for six consecutive months, signaling short-term future economic growth; rig counts have more than doubled from 415 in the first week of May 2016 to 877 in the first week of May 2017; and WTI Spot Prices are hovering around $50 per barrel, up from a low of $26.19 per barrel in February 2016. These hints of recovery are harbingers of revitalization in the local economy.
With continued population growth, steady oil prices and an ever-growing global presence (bringing more foreign investment and expansion), there are tremendous opportunities to lease current vacant spaces. Given those factors and a diminishing construction pipeline, the Houston office market should see positive progress in 2017 and 2018.
— By Mary Caldwell, SIOR, senior vice president of brokerage services, Caldwell Cos. This article first appeared in the July 2017 issue of Texas Real Estate Business magazine.