Houston Office Market Still Battling Depressed Energy Prices
As we enter the fourth quarter, Houston’s office market remains sluggish due primarily to uncertainty in the energy industry.
With the price of West Texas Intermediate crude fluctuating between $45 and $60 per barrel, the market has seen minimal oil company expansions. With the pricing outlook remaining on a bleak to flat trajectory, little growth in office occupancy is expected in the next 18 to 24 months.
The cycle favors tenants, now and for the foreseeable future. Should energy pricing return to higher levels, there will undoubtedly be higher occupancy through positive absorption, making the next six months an ideal time to lock in rental rates and construction/build-out costs for the next five to seven years.
Through the third quarter of 2019, Houston has seen 217,000 square feet of overall net absorption, including sublease space returning to the direct market. The bright spots are new Class A downtown properties like Bank of America Tower, 609 Main and Texas Tower, whose current and future tenants have demonstrated their willingness to pay the higher base rates and operating expenses associated with new development.
Companies are using office space more efficiently due to technological advances and transformations in mobility and are demanding more high-class amenities for their employees. Owners of older Class A and B buildings are recognizing that heavy investment in upgrades and amenities is a must to stay competitive. This healthy competition among traditional Class A and new Class A product puts tenants in the driver’s seat.
Class A downtown properties have generated more than 329,000 square feet of direct positive absorption. Add that to newly occupied sublease space, along with Class A space in the CBD, and absorption totals more than 420,000 square feet.
“All-in” rates in the downtown submarket top $55 per square foot and are even higher for coworking space. Desirable amenities and efficient floor plates with less square footage per employee continue to be trends. Large employers have led the way in leasing both newly developed and newly renovated buildings as recruiting and retention strategies.
However, this flight-to-quality drift has had a negative, citywide impact on the demand for Class B space. Houston’s Class B properties suffered more than 1.3 million square feet of negative net absorption in the third quarter, contributing to a market-wide vacancy rate of 16.4 percent.
These trends will likely spill into 2020 and could worsen as increased global pressures — tariffs, unstable trade, the presidential election — cast a shadow on the Houston market. Tariff battles due to immigration concerns and trade wars will stifle hiring and nullify the positive energy influences in Houston.
The Highway 290 and Energy Corridor areas will be important to watch. As road construction nears completion along 290, tenants will start to capitalize on lower rents. This area’s occupancy rate was 82 percent in the third quarter, and the average gross rental rate was $20.29 per square foot.
Several commercial developments have broken ground and others have announced plans to do so. As retailers and restaurants continue to emerge, office development will likely follow. Jersey Village and new developments further out 290 continue to offer attractive places to live for millennials with young families. Signs suggest that development in this area will rival the boom that occurred along the Katy Freeway after its expansion was completed.
Leasing activity should increase in the Energy Corridor since landlords have begun to lower rates and offer concessions to fill up available square footage. The current overall occupancy rate of 83 percent and the average rental rate of $31.05 per square foot suggest that the Energy Corridor still requires increased leasing activity to attain stabilization, but 2020 should see this market rebound.
Although the office market has more vacant space than can be readily filled, investors should not underestimate the Bayou City. Houston is resilient and has the remarkable ability to overcome challenging economic conditions. Yes, the road to recovery will be slower than anticipated and will likely involve more than just the stabilization of energy pricing. But rest assured, the Houston office market will be back on track.
— By Charlie Neuhaus, principal, Avison Young. This article first appeared in the November 2019 issue of Texas Real Estate Business magazine.