‘Just Go Away’ – Houston’s Office Woes Mean Some Buildings Could Be More Profitable As Parking Lots
High interest rates, an inflationary environment and a looming potential recession will make this a difficult year for commercial real estate.
According to speakers at Colliers' 2023 Houston Trends event, that means it is time to accept some unpleasant truths about the state of the market, including what's in store for older office properties in the city's central core.
Colliers Houston President Patrick Duffy told a crowd of about 350 people at the Tuesday event a few things they likely already knew, like industrial is a top-performing asset class. But he also shared a few hot takes, including his opinion that some downtown office buildings could be more profitable as parking lots.
“There are buildings that get barely over operating expenses," Duffy said. "If you get $2 or $3 in net rent [per SF], you probably can tear it down, turn it into a parking lot if you're downtown, and make more money as a parking lot with a lot less headaches."
Houston has one of the nation’s highest return-to-office rates, with Kastle Systems data indicating properties it monitors were 66% occupied on the most densely populated day of the week last month.
But according to Colliers data, Houston’s office vacancy rate was 23.2% in Q4 2022, well above the national average of 16.5%.
It can be appropriate to bring some flagging buildings down and “sit on the dirt” until it is a better time to do something vertical, Duffy said.
Some older Houston office properties are being converted to new uses. The iconic 45-story building at 800 Bell St. that formerly served as the headquarters of ExxonMobil is being transformed into apartments.
But “some of these buildings need to be lots,” Duffy said.
“They need to just go away. That will be part of our solution. We've got a lot of very old product out there that just doesn't need to exist anymore.”
Newer buildings have better amenities and floor plates, which is what people want, he said.
The news isn't much better for residential real estate, Duffy said, noting “the drop-off is real” in the single-family housing market.
Considering the circumstances, it makes sense that people can’t afford to buy houses right now.
“People can't afford the down payment, the prices of housing got out of control, and when you take interest rates from 3% to 6%, the debt coverage on that just kills you,” Duffy said.
With its focus on commercial real estate, Colliers doesn’t deal with individual home sales, but it sells large tracts of land for subdivision development.
“Sometime around late Q3 … I think we had five or six large tracts of land under contract to national homebuilders, who universally dropped the contracts all almost within a week or two of each other,” Duffy said, adding some of those tracts got picked up by smaller offices.
On the other side of the equation, there are historically low lot inventories, Duffy said.
“Lot supply is going to have a major lag because we've taken a year off from what has been a fairly steady flow of lots," he said. "That's going to hold prices up or drive them up.”
While the supply of housing lots may be behind, Duffy said the Houston market may be getting ahead of itself when it comes to healthcare construction.
It is a more popular, seemingly safer option than office construction, he said. Medical care absorbed 867K SF in Houston last year compared to 196K SF for office. There is an additional 2.7M SF of healthcare space under construction.
However, “if we're building three times … what we absorb this year, we might be getting out over our skis a little bit,” Duffy said.
Duffy said the Houston office market’s struggle is tied directly to the oil and gas industry consolidating and its major players vacating large spaces in favor of smaller leases at newer buildings.
“But for the most part, we're healthy,” Duffy said of the overall outlook. “We're in that expansion. Markets are working for retail, multifamily, industrial and healthcare. Office is our big black eye, and that's the energy companies, if you want to take it down to one sentence.”