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25% Availability, Historic Highs In Concessions: Tenants Have The Power In Houston Office Now

Houston's office sector saw direct vacancies, availability and sublease space grow throughout the third quarter, as the uncertainty of the pandemic continued to weigh on the local economy.

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Houston office direct vacancies rose to 19.2%, up from 18.6% during the second quarter, according to Avison Young’s latest office market report. Total vacancy, including sublease space, rose from 19.5% in Q2 to 20.4%.

Citywide, direct availability increased to 23%, while total availability, including sublease space, increased to 25.3%. Those figures account for all space being marketed that could be leased, but may or may not be vacant.

The fundamentals weighing on the office market have caused sublease space to reappear after falling for the last three quarters. Sublease space rose to 5.7M SF, an increase of 18% from the second quarter. Sublease space represents about 10% of the total 59.2M SF of office space available across the city.

“I think that when COVID first hit, there was probably more of a 'let's see if we can weather it [attitude],' groups trying to procure PPP [loans], and, you know, survive short term,” Avison Young Vice President Dustin Devine told Bisnow. “But as times went on, and the situation hadn't seemed to necessarily remedy immediately, people have just had to continue to give back space, to put it on the market.”

Amid rising vacancy and supply outpacing demand, overall asking rents didn't change much during the third quarter. The average asking rent increased marginally to $30.31 per SF, compared with $30.29 per SF during the second quarter, according to Avison Young.

Rents have not come down significantly because maintaining space rates is how landlords derive the value of their building, Devine said. Instead, it is likely landlords will continue to offer larger and more attractive concession packages to prospective tenants.

“In an effort to help blend down the effective rate, they are offering very large concession packages. And that's just the theme we've seen across all of our clients,” Devine said.

Devine said that the industry is seeing historic highs in terms of tenant improvement allowances, free rent packages, and abated reserved and unreserved parking charges.

Tenants have also been taking advantage of the situation by making the flight to quality.

“The quality and condition of the office environment may never have been more important for employers and employee retention than it is today,” NAI Partners partner Jason Whittington wrote in a broker perspective essay.

“Tenants are focusing on newer Class-A buildings while older buildings are being renovated in order to compete. For tenants, there may not be a better time to be in the market.”

As the public health crisis and economic disruption continues to cloud the future, landlords are facing a particularly difficult time, CBRE Executive Vice President Kevin Kushner told Bisnow.

“Landlords throughout the entire city remain very vulnerable — no office submarket or building asset class can avoid the realities of this Houston market. We have not yet seen indication of relief coming in the near or intermediate term,” Kushner said.

“Moving forward, we expect the tenant-friendly nature of the Houston market to continue and for landlords to become increasingly aggressive in their efforts to attract and retain occupancy rates, especially as competition increases from additional sublease space in the market.”

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Some CRE execs are considering adjusting compensation structures to account for remote work.

Leasing activity is slowly returning, but not fast enough to absorb the large amounts of office space available and returning to the market. During the third quarter, there was a total of 1.1M SF of negative net absorption across Houston, the report said.

The uncertainty of the business climate is causing some employers to hold off making major leasing decisions until more clarity around a vaccine comes to light. As a result, many people are continuing to work from home and looking further out at a return date to the office.

But light is starting to emerge at the end of the tunnel. Kushner said tenants are more focused on office space needs now than they were during the spring and summer months.

“Many tenants have surveyed employees to understand their desire in returning to the office on a regular basis and are adjusting office layouts to accommodate for COVID-related safety concerns,” Kushner said.

“There is more discussion than ever about creating a hybrid occupancy model — one that allows employees to utilize the office at regular intervals but does not require attendance five days per week from 9 a.m. to 5 p.m.”

Major global companies like Microsoft, Target, Ford Motor Co. and The New York Times have delayed return to the office until July next year. And with the Thanksgiving and Christmas holidays approaching, some tenants in Houston are looking further out to coordinating a larger return to the office.

“I feel like more often than not, I hear 2021, whether that is Q1, Q2, being [a] more realistic time frame. And [employers are] giving people the autonomy to say, if you are comfortable coming in now, then there could be a phased re-entry in the office [in] 2020. But as a whole, I think people are banking on next year,” Devine said.

Despite the overall negative absorption figure, eight submarkets actually posted positive gains, led by the Northwest market at 58K SF of positive net absorption, followed by Bellaire with 41.1K SF and NASA/Clear Lake with 38.1K SF, according to Avison Young.

Devine said some of the outer Houston submarkets like Sugar Land and The Woodlands have been more insulated from the economic disruption than their inner-city counterparts, because those markets have less product available and local decision-makers have more involvement with businesses in those areas.

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West Texas pumpjack

Though the pandemic has been the biggest headline in 2020, Houston’s office market faces a slow recovery for another reason: low crude oil prices. Oil plays a significant role in the health of Houston’s economy, and this year has been a particularly tumultuous time for the energy sector

The pandemic saw global demand for petroleum-related products fall, causing oil prices to plummet during the first quarter of 2020. With prices hovering around $41 per barrel, many energy companies are struggling to break even, let alone grow, which will weigh on Houston’s office market in the short-to-mid-term future.

“I think now, people are in hunker down and 'let's get through it' mode. And that's why many conversations are being had in terms of restructuring leases,” Devine said. 

“Whether that's subleasing space, whether that's being able to terminate a portion or reduce and extend our lease — whatever we can do to help with cost savings here in the short term such that, hopefully, at some point in 2021 or 2022, when pricing ticks back up, they can focus on growth again.”

CORRECTION, OCT. 15, 2:31 P.M. CT: The statistic on Q2 office vacancy has been updated.

CORRECTION, OCT. 15, 5:20 P.M. CT: A quote from Dustin Devine in a previous version of this article contained errors. The story has been updated.

CORRECTION, OCT. 16, 12:10 P.M. CT: A comment from Dustin Devine has been updated for clarity.