Recovery of Houston Office Market Still Distant, Say InterFace Panelists

HOUSTON — If patience is a virtue, then developers and brokers in Houston’s office market are poised to become a bit more saintly.

For the past three years, the story of the market has been a painful coinciding of sluggish oil prices hurting Houston’s largest tenants, while deliveries of new office spaces are at a peak. According to CoStar Group, more than 5 million square feet of office space has been delivered in Houston during each of the past three years.

The nosedive that oil prices took beginning in early 2015 set rising vacancy in motion, leading to an 11-quarter streak of negative absorption. And while the price of oil has risen substantially to start the new year — increasing by roughly $10 to its current price of $65 per barrel over the last two months — that won’t force an overnight recovery in this struggling niche.

This one-two punch has players in the space wondering when the market might finally begin to display sound fundamentals. According to panelists at the InterFace Houston Office Forecast, that’s not likely to happen before 2020.

The event was held Thursday, Feb. 1 at the Royal Sonesta hotel in Houston. Approximately 150 industry professionals attended the event, which was incidentally located in the Galleria, one of the metro’s few submarkets with a strong office sector.

How It Began

Moderator Stuart Showers, Transwestern’s director of research, kicked off the discussion by winding the clocks back to 2013, when energy prices were on a tear. Many firms in the sector accelerated their hiring and expanded their office spaces during this run-up.

“We saw a lot of defensive leasing in 2013,” said Showers. “We saw energy and engineering companies take down space before they needed it. That was combined with millions of square feet of new product being added to the market and a large overhang of sublease supply.”

Oil prices began dropping in early 2015, eventually falling from approximately $100 per barrel to $40 per barrel.

With leasing activity throughout Houston being very slow, owners of office properties are aiming to hold their properties as long as possible. Outside a few sales of trophy assets such as the former ExxonMobil campus at Greenway Plaza, there has been little investment in Houston’s office market during the downturn. CoStar notes that just 4 percent of the office inventory has been traded during this stretch, the lowest level since 2008.

Though Houston continues to create jobs in professional services like healthcare, aerospace engineering and biomedical research, these fields do not typically require large blocks of office space. In addition, the growth of the petrochemicals business that has coincided with the oil slump has been largely concentrated in manufacturing jobs, while the expansion of Houston’s retail market has been precisely that — retail jobs.

Panelist Patrick Jankowski, a regional economist at the Greater Houston Partnership, noted that as of the third quarter of 2017, roughly half of the major energy firms in Houston were still losing money. As such, the industry overall is not poised to help the office market much in 2018.

“Don’t expect to see any significant hiring in the oil and gas business this year,” said Jankowski. “If a firm is losing money, it’s not going to be taking on additional staff; if anything it will be letting staff go. One downtown company has already announced 300 layoffs forthcoming this year.”

Jankowski stated that office users that service global clients or represent population-driven industries — like multifamily or retail management firms — may expand in 2018 and absorb some of the excess space. But oil and gas firms will need to post several consecutive quarters of profitability before they will feel comfortable enough to ramp up their hiring and expand their office spaces, he said.

Bright Spots

While the panelists agreed that healthy absorption, rent growth, cap rate compression and other fundamentals are unattainable in 2018, they were quick to point out some bright spots in the market.

Deniese Palmer-Huggins, a senior advisor for the University of Texas Center for Energy Economics, said that global economic growth and softening restrictions on the production of American crude oil could make the price of oil sustainable at its current level. She also noted that many oil companies have pledged to increase their capital budgets in 2018, pumping additional money into the local economy.

Ariel Guerrero, senior vice president and director of research and market analysis at PMRG, reminded the crowd that the office sector tends to lag behind the overall economy by 10 to 12 months, meaning a delayed recovery is to be expected.

In addition, he drew attention to the fact that the pace of new construction is lower than it’s been at any point in six years, and the volume of sublease space is also on the decline. Yet before the tide can really turn, office users will need to re-absorb their “shadow space” — space that’s leased but not in use. Shadow space figures are not generally included in research on vacancy numbers.

“We’re not necessarily going to see it in the numbers in the office sector, but there are some positive indicators right now,” said Guerrero. “We’re moving in the right direction, but it’s going to be a very slow, gradual recovery.”

— Taylor Williams

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