Energy Recovery, Economic Diversification Could Bring Global Capital Back To Houston
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Houston is rebuilding its reputation as an international hub that attracts foreign capital. Coastal strongholds such as New York City, Los Angeles and Boston typically dominate foreign investors’ wish lists, but as the Bayou City recovers from an oil downturn, it may have the opportunity to get back on the radar.
“We want to be on that list,” Avison Young principal Darrell Betts said. “We are on the doorsteps of becoming a gateway city in investors’ eyes.”
Investors expect a quantifiable discount to invest in Houston compared to other global cities as a risk adjustment, CBRE Senior Director Brandon McMenomy said. A return premium is necessary for a Houston deal to beat out opportunities in other cities.
A Rise And A Fall
Foreign investment in Houston was on the rise between 2010 and 2012 — peaking at $913M in acquisitions during that period, according to data from Real Capital Analytics. Canada has been the biggest foreign buyer of office product in Houston since 2010, totaling more than $4B in acquisitions.
Investment sharply declined to $546M in 2013. South Korea dominated with nearly 90% of the office acquisition volume. Canadian players invested $66M that year.
Despite the investment dip, investors planned on spending money in a big way in Houston in 2014. A survey by the Association of Foreign Investors in Real Estate ranked Houston as the fourth global city international players were considering. The other top five metros were gateway cities: London, New York, San Francisco and Los Angeles.
Houston dropped from the global list the following year but ranked third among the U.S. markets.
“No sooner were we on the list, we hit a bump in the road,” JLL Executive Managing Director Tom Fish said.
The price of oil began plummeting in June 2014, and Houston real estate’s attractiveness to foreign players proceeded down the drain as well. International investment totaled $422M in 2013, followed by $475M in 2015 and only $8M in 2016, an eight-year low, RCA reports.
Slumped oil prices led to industrywide job loss and cutbacks. Nearly one in every four oil jobs in Houston was lost, according to the Greater Houston Partnership. More than 100 oil and gas companies filed bankruptcy between 2014 and 2016, CNBC reported. Oil prices went from $115 per barrel in June 2014 to under $35 at the end of February 2016.
Overall office vacancy nearly doubled from 13.4% in Q4 2014 to 24.3% in Q3 2018, according to a market report by JLL. Vacancy rose for 16 straight quarters, finally breaking the trend in October.
With the oil bust of the 1980s never fully off their minds and with the recent flashbacks, foreign real estate capital has been wary of Houston and some investors have considered the city persona non grata.
“It took us a long time to regain the confidence of the real estate capital markets,” Fish said. “Memories are long, and a lot of money was lost.”
But in a few short years, Houston has shown the world an enormous amount of resilience, Fish said. The market’s recovery from the energy downtown, and how quickly it shook off Hurricane Harvey, has capital reconsidering the city.
“We are no longer a one-horse oil town,” Fish said.
Houston lost more than 86,000 jobs due to the energy downturn and has only regained about 24,400 since then, per the GHP. But even with that, Houston is exceptionally strong in a long-term view. GHP predicts the Bayou City will end 2019 with 3.2 million payroll jobs, a net increase of more than 600,000 over the past 10 years. It said only New York, Los Angeles and Dallas have created more jobs over the same period.
And we’ve rebounded hard and fast. Houston added the country’s largest number of jobs from November 2017 to November 2018 — 114,400 — followed by New York-Newark-Jersey City, with 113,000 jobs, the Bureau of Labor Statistics reports.
“Houston is one of the most diverse cities in the country and offers the largest, most sophisticated STEM [workforce] in America,” Transwestern Executive Vice President David Baker said. “The oil and gas business is now dominated by technology advancements and Houston has many world leaders in medical and space explorations sciences.”
Space City is estimated to create 71,000 new jobs in 2019, according to the 2019 GHP Employment Forecast. More than a third are projected to come from healthcare, construction, administrative support and waste management sectors. The report estimates only about 2,000 new jobs in 2019 will come from the oil and gas industry.
Recent Activity — Bouncing Back Globally?
With this improvement, foreign money is starting to trickle back in. In 2017, Canada Pension Plan Investment Board purchased Parkway Inc., a Houston-based real estate investment trust, for $1.2B. Parkway owned 19 properties totaling 8.7M SF across four campuses in Houston, one of the city’s largest office portfolios.
Canadian investors spent a total of $2.6B in Houston that year, and China followed with $59M. No other countries completed acquisitions in 2017.
More international players got into the action last year but on a smaller scale. Mexican firms dished out $109M, while Canadian spending dropped to $63M. Puerto Rico-based companies spent $16M and Sweden spent $1M.
Mexico-based private equity firm Aztec Fund Inc. acquired Westway Plaza, a 313K SF office building in West Belt Corridor. The five-story property represented the firm's first deal in Houston, but it planned to expand its footprint in the future.
“This will definitely not be our only purchase in this amazing city,” Aztec President and CEO Charles Haddad said at the time.
The majority of the global appetite in Houston’s short term will come for smaller, single-tenant assets with long-term leases, corporate credit and at an attractive price point, McMenomy said.
"That is where we are in the cycle," he said. "From a macro standpoint, as the cycle becomes more mature, international investors tend to feel more comfortable with small investment sizes."
The Next Step To Gateway Status
Like any market, Houston has had to work through its cycles from time to time, McMenomy said. Houston becoming a gateway city will depend on the strengthening of non-oil sectors such as technology, education, research, aerospace and energy exploration and manufacturing.
While the Houston economy has diversified, it is not as much as foreign investors would like, McMenomy said. The expansion of the technology scene will play a critical role if Houston wants to maintain its momentum, he said. It is a message Houston has heard before, when Amazon omitted Houston as its next global headquarters. That spurred a citywide effort to revamp the innovation and entrepreneurial profile. City officials, higher education institutions and private partners introduced the Innovation District, a 4-mile stretch from Downtown to the Texas Medical Center.
Some of the metro’s job and office improvements are due to the rebound in oil, which foreign investors are wary of. Earlier this week, Texas crude oil production broke the 1970 production record, according to the Houston Chronicle. Texas produced 1.54 billion barrels of crude in 2018. Advances in oil drilling technology have improved efficiencies, allowing companies to produce gas around $50 per barrel and still turn a profit, Betts said. Others argue the range is closer to $60.
The volatility of oil prices remains a consideration, McMenomy said. West Texas Intermediate Crude closed Wednesday at $54.11. Prices had tipped to above $70 last year.
But overall, McMenomy said Houston is maintaining its appeal.
"The oil industry provides a solid foundation and strengthens the underlying Houston economy," he said. "Other industries have grown in the aggregate. It is a more diversified economy as a whole, and that is attractive."