Early Stages Of Stabilization: Houston Office Vacancy Decreases For First Time Since 2014
For the first time since the price of oil plummeted in 2014, total vacancy decreased in the Houston office market. The 30-basis-point decline suggests a momentum shift past the energy downturn.
"The Houston office market is in the early stages of stabilizing," JLL Executive Vice President Bruce Rutherford said. "The decrease in vacancy represents progress, but there is still a long way to go before we reach a more balanced office market."
Houston clocked 24.2% office vacancy in Q3 2018. That is nearly double the 13.4% vacancy in Q4 2014, according to a report by JLL.
The relocation of energy tenant ConocoPhillips Co. into its new 600K SF Houston headquarters at Energy Center 4 secured the positive absorption of the market at 435K SF.
Even without the relocation, the market showed signs of revitalization as net absorption for the third quarter would have been negative 160K SF, JLL reports. That is an improvement over negative 1.3M SF in Q1 and negative 1.1M SF in Q2.
"The market is climbing out of a hole," Lee & Associates principal Rob Johnson said. "We do see the light at the end of the tunnel, but we have so much space to digest on the sublease market."
The energy downturn caused companies to lay off employees and send millions of square footage to the sublease market — as much as 12M SF was available at one point, Lee & Associates Director Chris Nash said.
Sublease space decreased by 10% to 8.7M SF in the third quarter, JLL reports, bringing it closer to the average of between 3M and 5M SF before the price of oil tanked. Half of the current sublease space will expire in 2020, Johnson noted.
Market Hot For Tenants
Thanks to the vast amount of open office space, Houston is a tenant-friendly market. Landlords are willing to provide concessions such as free rent and tenant improvement allowances for build-out of space while maintaining rental rates, Johnson said.
"Landlords don't want to lose any tenants, now more than usual," Johnson said. "Along with the costs to re-lease the space, there is also uncertainty as to how soon they will be able to backfill a vacancy."
Companies have become more conservative in their future expansion and hiring. Even if the price of oil increased to $100 a barrel by year-end, it won't trigger immediate expansion, Nash said.
"They are asking their employees to do more because they realize when times were lean: 'I can get by and still function with less,'" Johnson said.
In the face of evolving workplace trends, companies are also getting more creative and functional with their office space.
"Companies are using real estate more effectively, so improvements in the energy sector and the economy have not necessarily translated to significant new demand for office space," Rutherford said.
Some companies are shrinking the size of their offices for higher-ups and allocating the same amount of space regardless of position. Other firms are redistributing space designed for law or design libraries into entertainment or meeting space. As energy-related companies renew, Nash expects them to also take less square footage.
Several big-name players have announced reduced office sizes. Bank of America, moving from its namesake tower downtown, will occupy 28% less space at Skanska's Capitol Tower. Vinson & Elkins and United Airlines will also slim their offices by more than 35% in their relocations.
Interest in smaller offices collides with another emerging trend, flight to quality, especially among the large corporate users and multi-floor tenants.
Users are taking advantage of the tenant-friendly market and opting to move from Class-B product into an older Class-A product or older Class-A product to new Class-A product. In some cases, it is possible for users to pay the same or little more than their current rent, Johnson said.
One reason companies are opting for better office space is for employee retention and recruitment, Johnson and Nash said. Companies are requiring more of their reduced rosters and justify it by improving the workplace.
Companies are looking for amenity-filled office space with a fitness center, a high-end deli, conference rooms and open meeting spaces. It is also attractive to be close to retail centers or be part of a mixed-use environment.
"Property owners will continue to focus on significant capital improvements to enhance their asset to remain competitive with both new office development as well as existing building within their direct competitive set," PMRG wrote in its Q3 office report.
New construction has dropped to a six-year low with 673K SF delivered since the start of the new year, according to PMRG. Developers delivered 51K SF in the last quarter with an additional 548K SF slated by year-end.
Over 3.5M SF of office space is under construction with 44.1% of the space pre-leased. However, significant pre-leasing will be required for any new development in the near future, PMRG reports.
Two projects make up the bulk of office under construction. This summer, Hines and Ivanhoé Cambridge announced a 47-story, 1M SF luxury office tower at 801 Texas. So far, tenants include Hines, which will relocate its global headquarters, and law firm Vinson & Elkins. New York-based Skanska will deliver its 35-story, 750K SF skyscraper next year. The towers are both luxury with the latest in design and amenities, which should draw tenants' eyes, experts say.
"Tenants across a wide set of industries continue to carefully assess the amply array of options available to them in this market," Savills Studley Research Director Brad Hauser said. "But with oil and gas prices rising steadily, there is a sense that the local economy has turned the corner. In turn, the recent flight to quality is likely to continue in the coming quarters."
CORRECTION, OCT. 31, 4:58 P.M. CT: An earlier version of this story misattributed quotes between Lee & Associates' Chase Cribbs, Chris Nash and Rob Johnson. The story has been updated.