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With Oil Recovering, Houston Industrial Market Turns to Distribution

Clay 99 Building 5, a 433,200-square-foot speculative industrial project in northwest Houston by Indianapolis-based Duke Realty, will be marketed to Houston's growing base of logistics users.

For many years, companies seeking to establish major distribution operations for the southwestern United States flocked to one market: Dallas-Fort Worth (DFW). Any deal that required a warehouse or logistics space of several hundred thousand square feet or more headed to the metroplex, and Houston received what was left — deals falling anywhere from 20,000 to 100,000 square feet.

That began to change in 2010, when oil was consistently trading at close to $100 per barrel. Subsequent innovations in hydraulic fracturing that lowered the threshold at which offshore drilling companies could turn a profit, combined with escalated tensions among Middle Eastern producers, kept prices for American crude at high levels until December 2014. At the time of this writing, oil futures traded at about $58 per barrel, suggesting that any hopes of a recovery by mid-2019 had been premature.

But between 2010 and 2014, when the party was in full swing, Houston experienced tremendous job growth that attracted tens of thousands of new residents to the city. More housing was built, and significant amounts of industrial absorption began to stem from the need to store and distribute consumer goods, from food to furniture to household appliances.

Jon Farris, CBRE

Today, Houston’s population is still growing. Retailers looking to bolster their e-commerce platforms increasingly view Houston as a viable last-mile market, with the likes of Amazon, Best Buy and Conn’s HomePlus all opening large-format distribution centers in the Houston area over the last few years. Absorption by third-party logistics users (3PLs) has also been more pronounced in recent years, particularly in submarkets across the north side of the city.

Market Imbalances

The growth of these user bases has facilitated the development of an unprecedented amount of pure-play distribution space. Rising land and construction costs have dictated that these facilities span several hundred thousand square feet; updated city codes call for advanced utility systems; and the requirements of e-commerce and logistics users translate to higher clear heights and larger floor plates.

These are the projects that are getting the most attention, but they don’t tell the entire story. With oil prices still vacillating, Houston is seeing a delayed return to the market from a key user base: oilfield service companies.

These users typically require manufacturing or warehouse spaces between 25,000 and 100,000 square feet. Their absence from the market has created a surplus supply of vacant, grade-level machine-shops in the 15,000- to 30,000-square-foot range. At the same time, because new projects have to be big enough to make the numbers dance, the market is seeing a shortage of dock-high distribution spaces that could service the smaller e-commerce or logistics users requiring 50,000 to 100,000 square feet.

Construction Challenges

Any industrial developer will tell you that dividing a 500,000-square-foot distribution center into eight or more spaces just isn’t economically feasible. The costs of running demising walls, as well as splitting utilities to each space, add up very quickly. Consequently, developers wait for the larger users and factor the timing of those deals into their pro formas and income projection statements.

Yet smaller buildings that can be split are often older construction featuring clear heights between 18 and 24 feet and outdated sprinkler systems. Raising the heights in a tilt-wall building would require taking down the panels and re-pouring columns, which isn’t exactly cheap. Likewise, many of these properties simply don’t have the curbside water pressure needed to implement ESFR sprinkler systems. Some landlords opt to install pumps or storage tanks, but they sacrifice land for these improvements.

Regardless of their size and occupant, virtually all distribution centers today need expanded truck courts to accommodate the ever-increasing size of tractor trailers, some of which now run as long as 60 feet.

As a result of these conditions,, Houston has a shortage of modernized distribution facilities that can be marketed to users looking for spaces under 100,000 square feet.

Examples in Action

An approximately 50,000-square-foot, grade-level facility located in North Houston has been listed for lease for two years, despite being crane-served and having 28-foot clear heights. Another property located in North Houston that is roughly 100,000 square feet and has unusually high bridge cranes has also been on the sublease market for more than a year. These properties are very specialized, and the user base that could occupy them simply doesn’t have the economic incentive to be leasing space right now.

There are some smaller projects under construction that could shore up Houston’s supply of small-yet-modern industrial space. Several freestanding buildings measuring about 40,000-square-foot are under development in Sugar Land Business Park, and a 33,000-square-foot warehouse project is underway at 1031 Bammel Road that will be marketed to smaller distribution users. But by and large, vacancy remains high in small machine-shop spaces, while demand for modern, small-format distribution space continues to outstrip supply.

Until oil prices make a full recovery, the primary means by which these market inefficiencies will be corrected lies in Houston’s sustained growth as a last-mile market. This form of growth will not only bring more users to the area and spur development of underserved product, but also fuel additional demand that could turn some of these older, vacant facilities into more sensible and profitable uses.

— By Jon Farris, executive vice president, CBRE. This article first appeared in the July 2019 issue of Texas Real Estate Business magazine. 

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