Houston’s office market vacancy rate continues to struggle amid $50 crude prices

Houston’s office market continues to struggle as U.S. crude prices waiver around $50 per barrel. According to the U.S. Energy Information Administration (EIA), they are expected to stay in this range through 2018. With no indication that prices will rise substantially over the next few years, vacant office space placed on the market by firms in the energy industry will take longer to absorb. Recent news articles indicate that some of the large energy giants reported profits in the second quarter. However, profits were largely driven by lean budgets and staff reductions.

Fortunately, most of the proposed projects that were in the construction pipeline when the oil slump hit were put on hold. Companies such as Bank of America, American Bureau of Shipping and HP, have signed leases in proposed buildings that have either recently begun construction or will begin in the very near future. Once these projects deliver, those companies will vacate their existing space, leaving more than 1.0 million square feet for landlords to backfill.

During the third quarter of 2017, Houston faced one of the worst natural disasters in history. Hurricane Harvey, a Category 4 hurricane, slammed the Texas coast and dumped over 50 inches of rain in parts of Houston. The event caused widespread flooding, destroying homes, businesses and infrastructure. Several large refineries were shut down due to the flooding and off-shore drilling was stopped once the storm entered the Gulf of Mexico. This event stalled business for several weeks, but Houston was resilient and quickly went back to work. This was a temporary set-back for many, but has had permanent ramifications for others. A joint industry survey confirmed that less than 7% of Houston’s office inventory suffered damage. Of that amount, approximately 45% were repaired and back on-line within the first month. Another 30% reported repairs to be completed by the end of the year and the remaining properties were so severely damaged they could not report a time frame for repairs.

According to the U.S. Bureau of Labor Statistics, the Houston MSA created 53,500 jobs (not seasonally adjusted) between August 2016 and August 2017, an annual growth rate of 1.8%.

Historical Available Sublease Space

  

Large Sublease Availabilities 

BUILDING 
TENANT SUBMARKET  SF
Four WestLake Park
BP Katy Freeway 504,327
Two Allen Center
Chevron CBD 396,309
One Shell Plaza
Shell Oil CBD 320,796
Four Oaks Place
BHP West Loop/Galleria 320,349
1100 Louisiana
Enbridge CBD 294,580
Three Greenspoint Place
ExxonMobil North Belt 253,562
Three WestLake Park
Phillips 66 Katy Freeway 221,723
8 Greenspoint
ExxonMobil North Belt 198,256
CityWestPlace 2
Statoil Westchase 190,214
10777 Clay Rd
AMEC Foster Wheeler Katy Freeway 189,285
Energy Center I
Foster Wheeler Katy Freeway 182,966
West Memorial Place II
IHI E&C Katy Freeway 158,317
Three Northborough
FMC Technologies North Belt 151,372

Source: CoStar

Vacancy & Availability

Houston’s citywide vacancy rate rose 30 basis points from 18.8% to 19.1% over the quarter, and rose 200 basis points from 17.1% in Q3 2016. Over the quarter, the average suburban vacancy rate increased 30 basis points from 18.5% to 18.8%, and the average CBD vacancy rate increased 60 basis points from 19.8% to 20.4%.

The average CBD Class A vacancy rate increased 100 basis points from 17.3% to 18.3% over the quarter, while the average CBD Class B vacancy rate fell 50 basis points from 28.7% to 28.2%. The average suburban Class A vacancy rate remained steady at 21.4% between quarters, while the average suburban Class B vacancy rate rose 50 basis from 16.4% to 16.9%.
Of the 1,709 existing office buildings in our survey, 91 buildings have 100,000 SF or more of contiguous space available for lease or sublease. Further, 28 buildings have 200,000 SF or more of contiguous space available. Citywide, available sublease space totals 10.0 million SF or 4.3% of Houston’s total office inventory, and 18.2% of the total available space. Available space differs from vacant space, in that it includes space that is currently being marketed for lease, and may be occupied with a future availability date. Whereas vacant space is truly vacant and is and may still be immediately available.
 

Absorption & Demand

Houston’s office market posted 669,517 SF of negative net absorption in Q3 2017. Suburban Class B space recorded the largest loss, with 406,747 SF of negative net absorption, while Suburban Class A posted the largest gain with 61,218 SF of positive net absorption. Some of the tenants that moved during the quarter include Kirkland & Ellis (104,025 SF) in the CBD submarket, ABM Industries Incorporated (62,457 SF) in the E Fort Bend Co/Sugar Land submarket, and Apache Industrial Services Inc. (33,128 SF) in the Northeast Near submarket. Over the last two years, Houston’s office market has suffered due to downsizing by large energy companies, and some of these firms moved from leases in third-party buildings into owned property, thus creating a glut of vacant sublease space. However, available sublease space has decreased over the last four quarters, primarily due to lease expirations and space going back to the landlord. There were a few instances where the sublease space was withdrawn by the sublessor. The majority of the sublease space in the market now has three years of term or less remaining.

Rental Rates

Houston’s average Class A asking rental rate increased over the quarter from $35.50 per SF to $35.31 per SF. The average Class A rental rate in the CBD remained steady over the quarter at $44.36 per SF, while the average Suburban Class A rental rate decreased from $33.16 to $32.74 per SF. The current average rental rate, which includes all property classes, for Houston office space is $29.34 per SF gross.

Leasing Activity

Houston’s office leasing activity decreased 18.7% between quarters, dropping from 3.4 million SF in Q2 2017 to 2.7 million SF in Q3 2017.

Q3 2017 Select Office Lease Transactions

BUILDING NAME/ADDRESS
SUBMARKET SF TENANT LEASE DATE
910 Louisiana CBD 431,000 NRG1 Aug-17
1000 Main CBD 105,026 Porter Hedges LLP2 Apr-17
601 Travis CBD 60,000 EDF Trading NA1 Jul-17
811 Main St CBD 50,000 Gibson Dunn4 Sep-17
Heritage Plaza CBD 28,560 S&P GLobal Platts2 Sep-17
Three Hughes Landing The Woodlands 27,390 Sabinal Energy1,3 Sep-17
1New/Direct
2Renewal
3Colliers International Transaction   
4Sublease
  

Sales Activity 

Houston’s office investment sales activity increased substantially over the year, increasing by 3.4% since Q3 2016. With most of the investor community believing the downturn in the energy industry has reached the bottom and has begun to rebound, they now see Houston as offering limited downside and the potential for healthy returns. The average sales price per square foot increased over the quarter, but is still below the historical average.

Q3 2017 Change in Sales (Year Over Year)

  

Q3 2017 Office Sales Price Per SF

  

Source: CoStar and Real Capital Analytics

  

Quoted Gross Rental Rates for Existing Top Performing Office Buildings

BUILDING NAME
ADDRESS
SUBMARKET

RBA (SF)

YEAR BUILT

LEASED

AVAIL. SF

RENT ($/SF)

OWNER

BG Group Place
811 Main St
CBD

972,474 2011 93.0% 107,504 $52.41 BG Holdco LLC
Heritage Plaza
1111 Bagby St
CBD

1,212,895 1986 98.5% 44,143 $51.06 Brookfield Office Properties, Inc

Kirby Grove
2925 Richmond Ave
Greenway Plaza

248,275 2015 85.5% 35,989 $47.31 Midway Companies
CityCentre Two
818 Town & Country Blvd
Katy Freeway

149,827 2009 99.1% 8,790 $50.04 Midway Cc15 Partners

Town Centre One
750 Town & Country Blvd
Katy Freeway

253,714 2015 65.6% 87,278 $42.04 Moody Rambin

Williams Tower
2800 Post Oak Blvd
West Loop/Galleria

1,476,973 1983 90.0% 187,088 $47.81 Invesco Real Estate

3009 Post Oak Blvd
3009 Post Oak Blvd
West Loop/Galleria

304,419 2003 90.1% 39,764 $45.48 Post Oak Building LLC 

CityWestPlaza 4
2103 CityWest Blvd
Westchase

518,293 2001 85.5% 128,303 $45.83 Parkway Properties, Inc
One BriarLake Plaza
2000 W Sam Houston Pky
Westchase

502,410 2000 89.5% 208,682 $42.63 TIER REIT, Inc
Two Hughes Landing
1790 Hughes Landing Blvd
The Woodlands

197,696 2014 94.0% 8,899 $42.60-
$48.60
The Woodlands Development Company, L.P.

Note: Available SF includes direct and sublet space as well as any future available space listed.

Source: CoStar Property