Houston’s industrial market expansion continues with the addition of 13M SF of new inventory in 2019
Commentary by Kent Willis | Vice President | Houston
The month of January gets its name from the Latin language and the Roman god Janus, the god of beginnings, transition, gates, passages and endings. So, I guess it makes sense that it is the first month (in the Gregorian calendar anyway) of the year and that it causes many of us to reflect on the past year and look forward to the beginning of a new one.
The commercial real estate world is no different as we look back on what the market told us by way of transactions, absorption, deliveries of new product and overall user sentiment about the future. The length of the term a tenant is willing to sign on a lease, the price a user is willing to pay for a building and the price a developer pays for land are all examples of the market “speaking”. The beauty of markets and the law of supply and demand is that they don’t lie. Yet, there is always more to the story.
What did the markets say?
The Houston Industrial market has not traditionally been classified as a “Big Box” (buildings over 250,000 SF) market in the past and that hasn’t completely changed. However, the last few years have seen more and more spec development and build-to-suits of these buildings. Nowhere is this more evident than the West and Far West submarkets with tenants and users like Igloo, Rooms To Go, Amazon and Academy, all of whom occupy what are termed “mega-distribution centers” (1,000,000 SF plus). Ross Stores Inc. broke ground in Q4 2019 on what is expected to be a 2M SF distribution facility. This is a new trend in Houston that is likely to continue, albeit at a slower pace as the availability for developable land slowed down land transactions somewhat in 2019.
The demand to purchase rather than lease a building by an owner/user has increased due to lower interest rates and a desire to relocate closer to the city’s inner core. As a result, sellers are getting reasonable prices and that segment remains strong. Cap rates are also extremely low, resulting in a higher than average price per foot trades on investment sales.
As everyone knows, oil is king in Texas and Houston is known around the globe as the Energy Capital of the World. And nowhere in the world has more oilfield service companies than Houston. 2019 will be known as a year of consolidation in the industry. The price of oil in 2019 rose from $45.15 per barrel (12/2018) to $61.66 per barrel (12/2019). In November of 2019, the US became a net exporter of all oil products, including both refined petroleum products and crude oil and the resulting effect has been a stable oil price hovering around $60 per barrel. Capital expenditures in the oilfield have tightened, meaning layoffs. Consolidations that occurred resulted in companies eliminating redundancies in their operations, which for the industrial real estate market meant downsizing and merging of facilities.
The main thing you will hear almost unanimously across town is that spec development of bulk distribution space has outpaced demand and that is cause for some worry among real estate professionals. As of January 2020, there is about 21M SF under construction in Houston. While many brokers noticed a slowdown in deal volume over the summer and the early fall of 2019, most agree that Q4 2019 saw an increase in tenants actively searching for space, which is thankfully carrying over into 2020. The Far East and Baytown submarkets (and other submarkets where large spec developments have occurred) will force Landlords to “get creative”, which means readjusting their proformas or getting very aggressive on lease rates and incentives- essentially becoming a Tenants market as they say.
Here is a quick way to “put the pieces together” and summarize the state of the Houston Industrial market:
According to NAIOP, 60% of the total U.S. demand for industrial space is coming from just five industries: logistics and distribution, food and beverage, e-commerce distribution, third party logistics (or 3PL’s), and traditional retailers.* Hence, the emergence of Katy/Brookshire area as a Big Box market, as discussed above.
Now couple that with the continued low cost of feedstocks for the petrochemical industry that has driven demand on the Port of Houston and East side markets and the need for plastics and packaging materials. Once products are produced and packaged, they need to be shipped. But the 3PL’s cannot do all the work, which has led to an “explosive 84% year-over-year growth” of “in-house and distribution demand” according to the NAIOP report. *This bodes well for Houston’s Industrial market in the coming months, albeit with some caution. The good news is that recent history tells us that Houston seems to have been less affected by the past recessions than the rest of the country and likely could do so in the face of another one.
The mythical god Janus was often depicted in statues and drawings as having two faces, looking to the past, but also to the future. The general sentiment from other brokers around Houston is that 2019 was a “healthy” and overall solid year with a decent amount of active requirements in the market today.
Vacancy & Availability
On an annual basis, Houston’s average industrial vacancy rate increased 150 basis points from 5.4% in Q4 2018 to 6.9% in Q4 2019 and by 40 basis points quarterly from 6.5% in Q3 2019. At the end of the fourth quarter, Houston had 38.8M SF of vacant industrial space for direct lease and an additional 2.2.M SF of vacant space for sublease. Among the major industrial corridors, the Inner Loop Corridor had the lowest vacancy rate at 4.5%, followed by the South Corridor at 5.3%. The submarket with the largest percentage of vacant space is the North Corridor, which had a 8.4% vacancy rate.
Absorption & Demand
Houston’s industrial market posted 2.4M SF of positive net absorption in the fourth quarter, pushing the year-end total absorption to 8.7M SF. Some of the tenants that relocated or expanded in Q4 2019 include COE Distributing, moving into 238,000 SF in the Northwest Corridor, Daxwell Distribution moving into 171,700 SF in the Northwest Corridor and Exclusive Furniture moving into 156,000 SF in the Southwest Corridor.
The majority of fourth-quarter positive net absorption occurred in the Northwest Corridor, recording 2.2M SF. The North, Northeast and South Corridors also reported positive net absorption in the fourth quarter of 2019. The Inner Loop, Southeast and Southwest Corridors recorded negative net absorption. 4.9M SF of new inventory delivered during the quarter. The North Corridor had the most significant amount of new inventory, 1.7M SF, delivered during the fourth quarter.
According to our data service provider (CoStar Property), Houston’s citywide average quoted industrial rental rate for all product types decreased from $7.76 per SF NNN to $7.52 per SF NNN over the quarter. According to Colliers’ internal data, actual lease transactions are in the $4.68 – $5.28 per SF NNN range for newer bulk industrial spaces, while flex rates range from $7.20 to $10.80 per SF NNN depending on the existing improvements or the allowance provided for tenant improvements and the age and location of the property.
Based on data from our data service provider, the average quoted NNN rental rates by property type are as follows: $7.09 per SF for Warehouse Distribution space, $9.34 per SF for Flex/Service space, Tech/R&D space averaging $10.22 per SF and $5.15 per SF for Big Box.
According to our data service provider (CoStar Property), Houston’s industrial leasing activity decreased over the quarter from 7.2M SF in Q3 2019 to 5.7M SF in Q4 2019. The decrease in leasing activity can be attributed to more owner/users in the market. Most of the Q4 2019 transactions consisted of leases for 50,000 SF or less; however, there were several larger deals that occurred. The table below highlights some of the larger transactions that closed in Q4 2019.
Currently, 18.3M SF of industrial space is under construction in Houston with 38.9% of this space pre-leased. The largest project under construction is a 1,300,000-SF distribution warehouse for Medline Industries which is being developed by Clay Development & Construction. The majority of projects under construction are located in the Southeast, Southwest and North Corridor submarkets and are between 25,000-150,000 SF. Below is a partial list of the largest buildings currently under construction.