Houston’s office market posts negative absorption in Q3 2020, pushing the year-to-date total to over -2.8M SF
Commentary by Patrick Duffy, MCR | President | Houston
The Houston Office Market continued to contract during the third quarter as the COVID-driven, government-mandated lockdowns continued. After experiencing negative absorption of 1.14 million square feet in the 2nd quarter, the 3rd quarter followed posting 1.33 million in negative absorption. We track absorption as the change in physically occupied space between the current quarter and the previous quarter. Negative absorption literally means that less office space was occupied vs. discussing an increase in vacant space, including new space delivery. In the 3rd quarter, Houston delivered 490,000 square feet of new product, pushing the year-to-date total of new inventory to 1.2 million square feet. Including the new product, vacancy, therefore, increased by 1.8 million square feet. The net result was to drive the vacancy rate up to 21.3% of the inventory we track. Obviously, not a positive trend for the Houston office market.
Despite the increase in vacancy, asking lease rates stayed steady. However, the concession packages became slightly more aggressive in the last quarter, especially free rent and tenant improvement allowances. The landlord’s theory seems to be “accelerate occupancy, but hold the line on the long-term rental income,” which has historically been a sound strategy during perceived short-term economic downturns. Given the bounce back in GDP (up 35%) and employment (unemployment fell to 7.9% nationally and low 7’s in Texas) during a still COVID restrained 3rd quarter, this strategy seems sound. As the COVID slowdown subsides and the global economy slowly restarts, expectations are that GDP will continue to recover at a relatively high rate in the next several quarters and that employment will continue to improve. All of this bodes well for the office market in the mid-term.
The move toward remote work, a clear threat to office occupancy, seems to have lost the shine we felt in the early parts of the lockdowns. Most corporate leadership consensus seems to have shifted from “it’s working surprisingly well” to “we do not see our normal productivity, collaboration and innovation that we had when we were all working in the same space.” Every seasoned office advisor knows that office space is not just a place to work – if that is all it is, then remote work would quickly replace it. Office environments are designed to attract talent, enhance collaboration and productivity, act as a cultural leverage point, and create environments where our employees’ intellectual capital is best deployed. If this is true, while remote work might get the in-box emptied, it does not provide for the rest of the package required to truly leverage our workforce’s talents.
We expect that the Houston office market will continue to show weakness well into 2021 and will not recover to a balanced (12-15%) vacancy for many years. There are almost 4 million square feet of new office product in the near term pipeline that will add to our vacancy issues and keep the market landlord soft and tenant-friendly for quite some time. The new product has performed very well and has approximately 10% less vacancy than the overall market. This move toward quality and new, more efficient buildings will likely continue at the expense of older A and B office product. Unfortunately, it also encourages new development when the new buildings have superior leasing volume and can command higher rents.
As you will see from our submarket analysis in this report, Houston is a vast market and the submarket matters. The Houston MCA is physically larger than 9 states. From a population perspective, we are larger than over 30 states. This summary includes all of Houston as if it is a single, homogenous market – it is not. Even within submarkets, some office buildings have significant competitive advantages to others. Colliers believes that these quarterly reports, with the submarket data tables included, can give the reader a reasonable understanding of the market’s health and trends, but will never replace a specific requirement analysis for granular understanding by a specific occupier/user. We hope you find this information helpful and welcome the opportunity to dive deeper with our clients.
Historical Available Sublease Space
Of the 1,683 existing office buildings in our survey, 93 buildings have 100,000 SF or more contiguous space available for lease or sublease. There are 28 options with 200,000 SF available for lease or sublease. Citywide, 5.7 million SF of sublease space is listed as available and 2.8 million SF of the space is vacant.
Absorption & Demand
Houston’s office market posted negative net absorption of 1.3M SF in the third quarter, pushing the year-to-date 2020 total net absorption to negative 2.8M SF. CBD Class A space recorded the only gain in Q3, posting 31,018 SF of positive net absorption, while suburban Class A space reported the largest loss, posting 701,731 SF of negative net absorption. Since tenants typically do not move into lease space immediately after signing a lease, absorption lags and can occur at anytime after. We believe absorption numbers will trail even longer than usual in the short-term due to the “stay-at-home” orders amid COVID-19, so absorption will more than likely remain negative moving into Q4 2020.
Houston’s average asking rental rate decreased over the quarter from $30.00 per SF to $29.85 per SF and Houston’s average suburban rental rate fell to $27.39 per SF from $27.58 per SF. In contrast, the average CBD asking rate increased from $39.35 per SF to $39.41 per SF. As stated in the commentary, rental rates have remained relative flat; however, landlords have been more generous with concessions.
Houston’s office leasing activity fell 42% over the quarter from 3.2M SF to 1.8M SF primarily due to the Covid-19 “stay-at-home” orders in the greater Houston area. Leasing activity includes new/direct, sublet, renewals, expansions in existing buildings and pre-leasing in proposed buildings. Some of the more notable transactions that did occur in Q3 2020 are listed in the PDF download below.
Houston’s office investment sales volume increased over the quarter from $110 million in Q2 2020 to $207 million in Q3 2020. The average sales price per square foot trended up from $197 to $276 per SF annually and Houston’s average office cap rate remained steady at 6.7%.
Office Development Pipeline
3.9 million SF of office space is under construction, and approximately 67% is pre-leased. 2.2 million SF is spec development, of which 34% is pre-leased. Below is a summary of the office buildings under construction with a GBA of 150,000 SF or greater.