Like most major cities, Houston has had its fair share of market cycles. However, this most recent decline in the local economy’s growth rate that was caused by a steep drop of oil prices put a heightened level of stress on the Houston office market.
Fortunately, the energy sector has turned the corner, and, paired with the ever-diversifying economic base, the Houston economy is buzzing again. As such, Houston’s population and job growth have translated into early signs of improvement in office market fundamentals.
The metro’s employment base, which is currently seeing some of the highest employment numbers in history, is growing at more than twice the national rate. This rapid rate of expansion has provided the office market with much-needed positive momentum as we look toward the new year.
Improving Fundamentals
The much-anticipated turnaround in the office market is here. Asking rents, occupancy rates and absorption are all increasing across the metro area and across all building classifications.
In the third quarter of 2018, the office market posted approximately 1.1 million square feet of positive net absorption. This is a significant improvement compared to the negative net absorption of roughly 1.1 million square feet in the first quarter of 2018 and the positive net absorption of 125,648 square feet in the second quarter of 2018.
Bryan Strode, HFF
Total year-to-date positive absorption is 145,568 square feet. This number may seem small for a city that has 328 million square feet of rentable office space, but ending the year with a positive absorption number represents a tremendous step forward for Houston.
For the past 40 years, Houston has never had more than two consecutive years of negative net absorption. Keeping this trend intact is achievable so long as the pace of positive absorption continues through the fourth quarter.
The recent shift in absorption has been seen all over Houston, not just in individual submarkets. However, deals such as ConocoPhillips leasing more than 1 million square feet at Energy Center III and IV, McDermott consolidating into Energy Center V and Occidental purchasing the 1.2 million-square-foot former ConocoPhillips campus certainly help. These leases and purchases, while signed, will provide positive net absorption in future quarters.
More submarkets are seeing positive absorption than negative absorption, something Houston has not experienced since the third quarter of 2016. Consequently, Houston’s overall vacancy rate decreased 30 basis points in the third quarter of 2018 to 16.4 percent.
The office construction pipeline has significantly decreased in 2018 as well. Only 82,882 square feet was delivered in the third quarter of 2018, down significantly from 579,115 square feet delivered in the first quarter of 2018. Houston is expecting 638,000 square feet to be delivered in the fourth quarter of 2018 and around 2.1 million square feet in all of 2019.
Asking rental rates for available office space — across all classes — increased 2 percent to a gross rate of $28.44 per square foot. Much of this improvement comes from Houston’s employment growth along with the absence of major tenant move-outs.
A Growing Economy
Houston’s economy is currently on pace to make 2018 another year to remember. In the 12 months ending September 2018, Houston created 128,700 jobs for 4.3 percent year-over-year growth, outpacing the overall state in year-over-year job creation by over 90 basis points.
Houston saw payrolls in its business and professional services, a sector highly associated with office-using jobs, expand by 33,200.
Business and professional services has consistently served as the top performer in overall job growth for Houston, and this figure brings Houston’s year-to-date job growth to 62,500 — more than many other MSAs across the country have added throughout an entire year. The last time Houston added this many jobs through September was in 2012, when the metro added 118,800 new positions.
The Greater Houston Partnership forecasts that by 2045, Houston’s gross regional product is expected to exceed $2.45 trillion, a 400 percent increase over the current level of $490.1 billion. Houston is also expected to have more than 10 million residents and 5 million employees by 2045. With more than 3 million employees at present, Houston already has more jobs than the lowest 35 states combined.
More than 6.8 million people call the Houston metro area home, making it the fifth-most populous metro area in America. With the job growth Houston is experiencing, expect to see more rapid absorption and the return of new construction to the office market going forward. Growth in the Houston office market is already beginning to mirror the growth in the local economy as we enter the fourth quarter.
Closing Thoughts
As Houston continues to create jobs, improved health of its real estate markets will follow. The office sector is on the mend, and property fundamentals across Houston are improving. Thanks to an ever-evolving economy and an stabilized oil and gas industry, these upward trends should continue for the foreseeable future.
— By Bryan Strode, research analyst, HFF. This article originally appeared in the November 2018 issue of Texas Real Estate Business magazine.