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Is Record Industrial Development In Houston Too Much?

A record-breaking 16M SF of industrial product is under construction in Houston. The number blows away the previous peak of 15.4M SF underway in Q2 2015, according to NAI Partners research. 

Developers are bullish on the industrial space because of the city's strong economic outlook, but industrial brokers disagree on whether there is enough demand to absorb the increasing supply in the Bayou City. 

"The amount of industrial construction going on is mind-blowing," Avison Young Vice President Grant Hortenstine said. "That is a massive amount of space. No one can say there are 15 Home Depots, Walmarts, Lowes, Conns or whoever looking for that much space because they just are not." 

A rendering of Bay Area Business Park

Houston's overall vacancy stands at 5.9% in the first quarter, up 30 basis points quarter over quarter and an increase of 80 basis points year over year, according to NAI Partners. The vast amount of spec industrial development in the pipeline has put a strain on the vacancy rate, which has been below 6% since Q4 2011. 

Absorption, primarily dependent on consumer goods and distribution tenants, slowed in the first quarter. The market recorded positive net absorption of 1.4M SF for Q1, a 44.2% decrease over the previous year at 3.1M SF, per NAI Partners.   

The rising vacancy is a key indicator to watch for the stability of the industrial market — it is in direct response to the stiffness in leasing activity, Hortenstine said.

"From a street perspective, talking with tenants and the deals we are working on, you wouldn't think this much space is starting to pile up," he said. "We are delivering new product, some of its pre-leased but most of it is not." 

Avison Young Vice President Grant Hortenstine

Hortenstine expects vacancy to continue to increase. Many tenants are expanding in the market and leaving behind old space. There is not a lot of absorption coming from new tenants looking to break into the Houston market.

On the flip side, CBRE First Vice President Faron Wiley can point to 10 to 12 companies seeking to lease 500K SF. Almost all of the prospective tenants are consumer products and will rely on Port Houston to bring in products, he said.  

Port Houston remains one of the driving forces behind the industrial market. According to preliminary results of the Houston Ship Channel Economic Impact Study, the port provides $339B in state economic value, up 28% from four years ago, and 1.35 million jobs statewide, a 15% increase from four years ago.

The uncertainty surrounding the U.S. and China trade wars has many near the Port taking a wait-and-see approach in regards to expansion, Wiley said. He noted a slowdown of new business in the East submarket. He said the numbers don't automatically show it and there is about a six-month delay for those to be reflected. 

One developer showing great confidence in the market is Clay Development & Construction, which has a total of 1.8M SF of spec industrial development in the pipeline in Houston.

"We try to stay ahead of our competitors on our start and get our buildings out of the ground faster," he said.

The massive projects cover four submarkets: Port Houston, West, Northeast and North. Each submarket poises its own strengthen, Director of Development Charlie Christ said. 

A rail-served and cross-dock facility near Port Houston is ideal for the plastic pellet-related industries and distribution companies that come through the port, Christ said. Following companies like Amazon and Rooms To Go, the west market has grown in popularity due to its access to several suburban hotbeds such as Katy and Cypress.

Christ noted a need for new distribution space in the North, which was overbuilt a few years ago but since then has absorbed that space, and in the Northeast, which he described as an underserved market.

Most potential tenants have distribution requirements and include industries such as homebuilding-related companies, e-commerce and consumer goods retailers.

Christ said the company has many active deals in the market and strong initial interest from prospects, but it will pause on starting new projects until it sees how this latest wave is being absorbed.

"This is enough for us for now. We will see how we do as far as lease-up." 

A rendering of the Kennedy Greens Distribution Center in North Houston

Why the confidence to break ground on 1.8M SF of spec space? Robust figures in employment and population growth are the largest drivers for industrial space, Christ said.    

Metro Houston created 72,600 jobs, a 2.4% increase, in the 12 months ending in February, compared to 56,400 jobs created in the 12 months leading up to February 2018, a 1.9% increase, according to NAI Partners and the Texas Workforce Commission. The unemployment rate was 4.2% in February.  

Durable goods manufacturing led employment growth at 15,200 jobs, followed by professional, scientific and technical services at 12,800 and healthcare at 10,300. 

More To Come

There are capitalized industrial projects that have yet to break ground, Wiley said. Building permits are taking twice as long as before due to new flood plain control regulations, which is causing the supply to take a little longer than anticipated. 

Wiley knows of at least two developers whose projects have been delayed due to permitting and neither of those projects is within the flood plains. One developer filed for a permit in September; a process that usually takes about 90 days is approaching the six-month mark and still hasn't received approval. The projects are in the north and northwest submarket, he said. 

Knowing the backlog of permits, developers are taking additional time to consider and anticipate the flood plain regulations. The amount of due diligence on each step of the process is dragging out the time frame to deliver a project, Wiley said.    

"You drive by the site, they haven't started construction," he said. "But, they are legitimate projects because they own the land and have capital. So, you know they are coming." 

Commercial real estate experts will discuss more industrial trends during the State of Houston Market event on May 1.