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Houston's Office Market Weakens Over the Quarter and Braces Itself Moving Research & Forecast Report HOUSTON | OFFICE Q1 2020 Houston’s office market weakens over the quarter and braces itself moving forward amid $20 oil Lisa Bridges Director of Market Research | Houston Commentary by Patrick Duffy MCR Market Indicators Annual Quarterly Quarterly Colliers generally uses this space to discuss the trends we see Relative to prior period Change Change Forecast* in market data and in conversations we have with our clients, prospects and friendly competitors. We take that data and attempt VACANCY to project activity going forward. The bulk of the first quarter was, NET ABSORPTION for all practical purposes, pre-COVID. Net “move-in” data, as well as new leases signed, were likely unimpacted for Q1 based on the DELIVERIES virus or only marginally impacted. Our industry has a lead time of UNDER CONSTRUCTION at least 4-6 months before a lease is signed or space made ready for occupancy. The real impact of this COVID crisis will not present *Projected in the data until later in Q2. Inertia will carry us for a few more weeks. The world is focused on the COVID driven economic slowdown. Houston has two issues to watch – COVID and a collapse in oil prices. The oil issue is driven by Saudi Arabia and Russia failing to reach an agreement on production and by the severe decline of oil and gas demand driven by the COVID shutdown. Oil has been Summary Statistics Houston Office Market Q1 2019 Q4 2019 Q1 2020 in the low 20’s since the collision of these two events. The Energy Information Administration is projecting that supply will continue to Vacancy Rate 19.4% 19.8% 20.0% outpace demand for the balance of this year by approximately 10MM barrels per day. If that projection holds, all land-based storage (3.3B Net Absorption 417,937 837,872 -177,916 barrels) will be full by mid-May. We will likely not see much relief in oil prices for at least 18-24 months, which means the upstream and Deliveries 73,773 0 251,672 midstream companies and the companies that support them will be under a great deal of pressure to trim costs. Under Construction 2,779,924 3,898,804 4,343,232 Houston has diversified its economy and is far less reliant on just Class A Vacancy Rate oil and gas to drive its economy. However, when it comes to the CBD 19.5% 19.3% 20.2% office market, we are still very dependent on oil and gas companies, Suburban 20.8% 21.3% 20.4% both directly in the space or businesses that are dependent on Asking Rents oil and gas companies as clients. These are the big space user Per Square Foot Per Year companies historically. Houston Class A $35.26 $35.60 $35.08 If we optimistically assume that the virus-driven economic CBD Class A $45.89 $46.04 $44.09 shutdown recovers quickly once the all-clear is given, Houston will still have a significant oil slow down to cope with. Most of the Suburban Class A $32.11 $32.45 $32.21 energy companies had already leaned up their workforces since the 2014 price crash. There is not a great deal of fat left in these Share or view online at colliers.com/houston Commentary - continued Job Growth & Unemployment (not seasonally adjusted) players to trim. The ultimate impact on the office market will likely be a factor of a lack of new space acquisition vs. a significant increase in sublease space, UNEMPLOYMENT 2/19 2/20 which we saw after the 2014 price crash. We hope that overall occupancy will not substantially decline on a net basis by year-end. We are currently projecting HOUSTON 4.2% 3.9% less than a 2-5% decline in occupancy by year-end from Q1 2020 levels based on TEXAS 3.7% 3.6% these assumptions. This marginal move would increase the overall vacancy rate by about 250 – 400 bps. U.S. 4.1% 3.8% Another issue to watch is the tenants unable to make rent payments or to make reduced rent payments if possible and the impact on the owners of office Annual # of Jobs JOB GROWTH Change Added buildings. There is a potential domino scenario where rent payments are delayed or lost altogether. Owners are then unable to cover their debt, and a loss of HOUSTON 2.2% 68.9K liquidity is created that could easily translate into owners being unable to fund TEXAS 2.4% 306.5K tenant improvements and commissions for new leases. It is a little too early to tell how significant an impact this scenario will have. U.S. 1.6% 2.4M If the US economy, followed by the global economy, recovers relatively quickly, Houston will get back to work. The energy sector will lag this recovery and will not help the Houston real estate market much in the next two years. CBD vs. Suburban HISTORICAL AVAILABLE SUBLEASE SPACE CLASS A OFFICE VACANCY 25.0% 12,000,000 10,000,000 20.0% 8,000,000 6,000,000 15.0% 4,000,000 2,000,000 10.0% 0 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 2015 2015 2016 2016 2017 2017 2018 2018 2019 2019 2020 Class A Class B Houston Total 5.0% Of the 1,662 existing office buildings in our survey, 79 buildings have 100,000 SF 0.0% or more contiguous space available for lease or sublease. There are 23 options with 200,000 SF available for lease or sublease. Citywide, 5.5 million SF of sublease space is listed as available and 2.6 million SF of the space is vacant. CBD Vacancy Suburban Vacancy AVAILABLE SUBLEASE SPACE - 100,000 SF OR GREATER CLASS A OFFICE RENTS $50.00 (Total available in building and/or complex) Large Sublease Availabilities $45.00 BUILDING TENANT SUBMARKET SF $40.00 Noble Energy Center II Noble Energy FM 1960 437,793 $35.00 Energy Tower II KTI Corporation (Technip) Katy Freeway 297,919 $30.00 Twelve Greenway Plaza CPL Energy Greenway Plaza 201,554 $25.00 GreenStreet Tower Reliant Energy Retail CBD 194,768 $20.00 Westway Plaza GE Oil & Gas West Belt 171,016 $15.00 One Shell Plaza Shell Oil CBD 191,043 $10.00 1100 Louisiana Enbridge CBD 179,694 $5.00 919 Milam St SNC-Lavalin Group Inc CBD 154,863 $0.00 10000 Richmond Ave National Oilwell Varco Westchase 118,215 1500 Post Oak Blvd BHP Billiton Petroleum West Loop 113,565 Source: CoStar CBD Rents Suburban Rents 2 Houston Research & Forecast Report | Q1 2020 | Office | Colliers International Absorption & Demand Houston’s office market posted negative net absorption of 177,916 SF in the first quarter, a huge decrease from the 837,872 SF of positive net absorption posted in the fourth quarter of 2019. Suburban Class A space recorded the largest gain, posting 463,878 SF of positive net absorption, while suburban Class B space reported the largest loss, posting 330,799 SF of negative net absorption. Since tenants typically do not move into lease space immediately after signing a lease, absorption lags and can occur at anytime after. We believe absorption numbers will trail even longer than usual in the short-term due to the “stay-at-home” orders amid COVID-19, so absorption will more than likely remain negative moving into Q2 2020. Rental Rates Houston’s average asking rental rate decreased over the quarter from $29.78 per SF to $29.62 per SF, primarily due to the average CBD asking rate dropping from $40.52 per SF to $39.57 per SF. Houston’s average suburban rental rate remained relatively flat, dropping only $0.04 to $27.00 per SF. Overall, rental rates only decreased by 0.5% on a quarterly basis and by 0.3% on an annual basis. CBD Class A rates posted the largest quarterly percentage decrease of 4.2%. Leasing Activity Houston’s office leasing activity increased slightly over the quarter from 3.4M SF to 3.6M SF, and decreased 31% on an annual basis. Leasing activity includes new/direct, sublet, renewals, expansions in existing buildings and pre-leasing in proposed buildings. Some of the more notable transactions are listed in the table below. Q1 2020 Select Office Lease Transactions BUILDING NAME/ADDRESS SUBMARKET SF TENANT LEASE DATE The Woodlands Tower at Waterway The Woodlands 133,948 Western Midstream Partners1 Mar-20 10451 Clay Rd Katy Freeway 97,293 TGS-Nopec Geophysical Co.3 Feb-20 1501 McKinney St CBD 92,523 EDP Renewables2 Jan-20 BHP Petroleum-1500 Post Oak Blvd West Loop/Galleria 68,139 SEMPRA LNG2 Jan-20 5555 San Felipe West Loop/Galleria 28,331 Serendipity Labs1 Jan-20 Westway Plaza West Belt 27,900 EXP2 Feb-20 1New/Direct 2Sublease 3Renewal or Expansion Sales Activity Houston’s office investment sales volume decreased over the year from $704 million in Q1 2019 to $414 million in Q1 2020. The average sales price per square foot trended up from $189 to $279 per SF annually and Houston’s average office cap rate moved from 7.6% to 6.8%.. AVERAGE OFFICE SALES PRICE PER SF AVERAGE OFFICE CAP RATE United States Houston United States Houston $350 8.0% $300 7.5% $250 7.0% $200 6.5% $150 6.0% $100 5.5% $50 $0 5.0% Sources: CoStar and Real Capital Analytics 3 Houston Research & Forecast Report | Q1 2020 | Office | Colliers International Houston Office Market Summary (CBD, Suburban, & Overall) SUBLEASE NET ABSORPTION RENTAL INVENTORY DIRECT VACANCY VACANCY VACANCY RATE (%) VACANCY (SF) RATE # OF RATE RATE TOTAL AVG CLASS TOTAL (SF) (SF) (SF) Q1-2020 Q4-2019 Q1-2020 Q4-2019 BLDGS.
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