Houston’s office market continues to see expansion in the co-working niche
Commentary by Taylor Wright | Vice President | Houston
“Co-working” and, more specifically, WeWork continue to dominate the CRE news cycle. With billion-dollar annual losses, the recent withdrawal of their initial stock offering, the removal of the founder as CEO and seemingly a different executive vacating every day, both your average newsreader and our commercial real estate colleagues are questioning the viability of WeWork specifically and co-working in general. After meeting with different well-known flex space operators and talking to landlord’s who lease space to various co-working companies (not necessarily WeWork), our view is a little more positive. The concept of co-working is nothing new, but the way people and companies today are viewing their workspace occupancy has definitely changed.
The total co-working footprint is minuscule in Houston’s overall office occupancy (an estimated 1.3 million square feet out of 230.7 million total square feet). We believe co-working has a place in occupancy solutions, albeit a relatively small one.
When discussing flex space operators with landlords, we hear that they serve as a valuable building amenity. For example, in the instances where tenants face a time crunch between vacating their previous space and when a new space will be ready, co-working space can serve as an effective stop-gap solution. When a company has to staff up quickly for a short-term project, but does not want to commit to long term space, co-working can meet those requirements. Co-working space is also an effective solution for employees who cannot justify a commute to the corporate office 5 days a week. These are just three examples of how co-working space may be utilized. The concern and focus on WeWork may be more of financial viability versus the core underlying offering. In a booming economy, this niche should be enjoying financial success. The concern has historically been what happens to these operators in a downturn where “flex” space is the first to go. Every co-working operator has filed bankruptcy at some point in their history. WeWork made a huge splash entering the world market; let’s hope that after the splash – they float.
With regards to the more traditional office market in Houston, we see leasing activity concentrated in “pockets.” The Central Business District reported minor positive absorption again in Q3, with 18,544 square feet absorbed. Q2 recorded a much healthier 229,836 square feet absorbed Downtown.
Suburban Office (everything outside of Downtown) posted negative absorption for the second straight quarter with -153,671 square feet following Q2’s negative absorption of -1,148,877 square feet. The citywide vacancy has increased slightly to 20.2%, as opposed to 19.9% in Q2. Asking rental rates for all classes has remained relatively unchanged. Landlords continue to offer attractive tenant improvement allowances and other concessions to maintain face rates.
The strategy that most of the Class A landlords have embraced is to upgrade the older Class A product in order to slow the “flight to quality” that has tenants embracing new construction and moving to the newer assets. This massive capital investment should result in better occupancy, but we believe that there will be very little upward pressure on lease rates in most submarkets. The Woodlands and Sugar Land are the outliers in terms of market occupancy with vacancy rates in the low teens. Tenants in those markets will see slightly less aggressive positions from the landlord community, but in all markets, the tenant has the near-term leverage.
Of the 1,672 existing office buildings in our survey, 80 buildings have 100,000 SF or more contiguous space available for lease or sublease. Citywide, 6.8 million SF of sublease space is listed and 3.6 million SF of the space is vacant. The largest available sublease space currently occupied by Occidental Petroleum Corporation may be withdrawn soon as their previous plans to relocate to the Energy Corridor have changed according to a statement by CFO Cedric Burgher. Available space differs from vacant space in that it includes space that is currently being marketed for lease, but may be occupied with a future availability date.
Historical Available Sublease Space
Absorption & Demand
Houston’s office market posted negative net absorption of 135,127 SF in the third quarter, a huge improvement from the 919,041 SF of negative net absorption posted in the second quarter. Year-to-date net absorption stands at negative 549,519 SF. Suburban Class A space recorded the largest loss, posting 213,110 SF of negative net absorption, while CBD Class A space reported the largest gain posting 76,454 SF of positive net absorption. The majority of negative absorption was caused by Southwestern Energy placing the South Tower of it’s corporate offices located in Springwoods Village in The Woodlands submarket on the market. Looking forward, our forecast shows positive absorption in the fourth quarter as tenants take possession of spaces leased earlier in the year.
Houston’s average asking rental rate decreased over the quarter from $29.64 per SF to $29.55 per SF. The average asking rental rate for Class A space decreased over the quarter from $35.36 per SF to $35.07 per SF, and the average CBD Class A rental rate fell from $46.01 to $45.64 per SF. The Suburban average asking rental rate for Class A dropped from $31.99 to $31.83 per SF.
Houston’s office leasing activity decreased over the quarter from 4.2M SF to 3.3M SF. Leasing activity includes new/direct, sublet, renewals, expansions in existing buildings and pre-leasing in proposed buildings. Some of the more notable transactions are listed in the table below.
Houston’s office investment sales volume decreased over the quarter from $730.9M in Q2 2019 to $274.1M in Q3 2019. The average sales price per square foot trended up from $147 to $162 per SF over the quarter. Houston’s average cap rate of 7.8% lags the average U.S. cap rate of 6.7%.