More Vacancies, Shorter Leases And The Return To The Office: Houston’s Office Brokers Weigh In On 2021
It's an understatement to say 2020 was a difficult year for Houston's office market. Deals were placed on hold or dropped, office employees largely shifted to remote work and business leaders backed away from making long-term real estate decisions.
Brokers hope 2021 will be better as vaccine deployment and economic confidence returns. Houston office experts have voiced optimism that the second half of 2021 in particular will mark the beginning of a return to normalcy in the market once sublease and downsizing activity have bottomed out.
“I think the second half of the year will be busy from a transaction standpoint as companies start to get comfortable being back in the office and thinking about how to implement any necessary workplace changes,” tenant rep NAI Partners Senior Associate Joe Bright told Bisnow.
Houston will go into the new year with lots of space on the market. The city’s office vacancy increased to 23.4% in November, up from 21% a year ago, according to NAI Partners’ most recent market snapshot report. Availability rates rose to 27.9%, up from 25.9% a year ago.
Office brokers expect Houston’s vacancy and availability rates to increase further in 2021, driven by more sublease space hitting the market and some firms opting to downsize.
“Given there are still some large subleases that are on the market that will roll from the last big oil boom, I believe the vacancy in 2021 will get a little higher before it gets better,” said Stream Realty Partners Managing Director Ryan Barbles, a landlord rep. “I believe the vacancy will bottom by mid-summer, and then we should see some pent-up demand on the tail end of 2021.”
It is widely anticipated that 2021 will yield more office deals in Houston than 2020 did. Barbles and Bright said they are hopeful the effect on availability rates will be minimized by pent-up demand in the second half of the year from companies who have been delaying office transactions in the wake of the pandemic. Many are also expected to take advantage of a tenant’s market and move to higher-quality space.
But there are still doubts that the volume of new office deals will be able to offset the anticipated increase in both sublease and direct lease space.
“I believe there will be more gross leasing activity next year, but with the expected ‘give back’ space, it may have little impact on creating a significant positive net absorption for the office market,” landlord rep Transwestern Executive Vice President Michelle Wogan said.
Still, she said she thinks that will pick up eventually.
“By end of 2021, I think we will see a more normal commercial real estate environment with net absorption in the positive,” Wogan said.
The economic uncertainty of the pandemic has also eroded certain predictable market trends. Savills Corporate Managing Director Lesa Nickelson French, a tenant rep, said that typically in a down market, she would expect to see tenants sign long-term lease deals to take advantage of market conditions.
“However, that is currently not the case, as tenants are looking to do shorter-term deals to allow them flexibility as they discover how COVID will affect the long-term workplace footprint and model,” Nickelson French said.
Wogan said more tenants are likely to make long-term decisions in 2021 about the size and length of their leases, especially since the COVID-19 vaccination is now in play. She expects average new leases to be around five years in length but to range anywhere between three and 10 years.
Bright said short-term renewals and Band-Aids were “the name of the game” in 2020 as people shifted to working from home without a sense of what the future looked like. Longer lease terms are more likely in 2021, though some companies may continue to hold off and opt for flexibility in the short term.
“I do expect many companies will pursue shorter terms than the historical norm until there is more consensus around how office use and design might change in the post-pandemic world,” Bright said.
Tenant rep Cushman & Wakefield Executive Vice Chairman Tim Relyea said he expects downsizing activity to continue next year and eventually bottom out before starting to improve in the second half of 2021.
“We will continue to deal with consolidations, redesigns and downsizing in 2021, but I expect these trends will bottom out by the third quarter of next year,” Relyea said.
The strength of Houston’s office market performance in 2021 will hinge on when workers start coming back in larger numbers. Relyea said that depending on the success and distribution rate of vaccines, workers could be back in the office by summer 2021.
Wogan said she also thinks the majority of companies will be back in the office by the summer, while Nickelson French said the third quarter is her guess. Barbles and Bright said that while summer is most likely, many could start coming back in the second quarter.
“It will probably be July before we see what amounts to a mostly full return to the office, but I expect that a majority will start coming back in April or May,” Bright said.
While vacancy and availability rates are expected to increase, office brokers remain confident that demand for Class-A office space will continue, though landlords will need to continue to offer attractive packages to secure tenants. JLL Senior Vice President Jessica Ochoa, a landlord rep, said that demand for premium office product remains strong, and that segment is proving to be more resilient during the current downturn than the overall Class-A market.
“This lends tentative support to an expectation of continued flight to quality as office workplace requirements adjust to the ‘new normal,’” Ochoa said.
Flight to quality is often a driver of new development, but many brokers say it is unlikely Houston will see many new speculative office projects break ground in 2021, as there is still so much space that needs to be absorbed.
“You are very brave to build a spec office project now,” Barbles said. “I do believe you might see one or two if they have a pre-lease tenant in tow. Most institutional money is not going to get approval to build an office spec project in Houston in 2021.”
Wogan said that office build-to-suit projects might happen next year, as tenants have continued to show interest in controlling their own environment in the wake of the pandemic. She also noted that more office users have been buying existing office properties versus leasing in 2020 while they can take advantage of the tax benefits and low interest rates.
Nickelson French and Bright said that some projects will move forward in 2021, but it will likely be a much smaller volume than in prior years.
“I think we will see one new building in Downtown Houston commence construction in 2021, and several new buildings will commence construction in various parts of the city, especially in the Texas Medical Center,” Relyea said.
On the whole, office brokers who spoke to Bisnow said they are optimistic about the sector’s prospects in 2021, particularly in the second half of the year. There are growing expectations that the damage to the sector will bottom out, followed by a slow return to normalcy.
“We will hit bottom and we will start the process over to get back to normal vacancy in town,” Barbles said. “I think a lot has changed fundamentally since the oil crash at the end of 2014 and now with COVID. We are entering a new era on how companies value their office space, and I think this will only help long term [with] people’s willingness to get back to work.”
Relyea said that from an office standpoint, he sees Houston benefiting from more corporate relocations, following the announcement of HPE moving its headquarters to Houston and other firms around the country eyeing Texas as an attractive alternative to the coasts.
The life sciences development activity underway will also attract more medical, life sciences and biotechnology companies to Houston, which will only benefit the sector.
“I am confident the Texas Medical Center will continue to expand at a far greater pace than we have seen in the past,” Relyea said.