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Houston's Office Market Recovery Hits a Speed Bump in Q2

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Houston's Office Market Recovery Hits a Speed Bump in Q2 Research & Forecast Report HOUSTON | OFFICE Q2 2019 Houston’s office market recovery hits a speed bump in Q2 Lisa Bridges Director of Market Research | Houston Over the last two quarters, Houston’s office market has shown signs of a slow recovery from the energy downturn, but it hit a Market Indicators Annual Quarterly Quarterly speed bump in Q2. During the quarter, the market posted negative Relative to prior period Change Change Forecast* net absorption of 842,200 SF, a substantial reversal from the positive absorption of 492,000 SF recorded in Q1. The newest VACANCY trend of vacating older spaces for modern/creative, efficient interior NET ABSORPTION designs has tenants effectively leasing less space without reducing NEW INVENTORY head count. Unless the tenant is in an expansion mode, this trend will lead to a reduction in the amount of office space leased. UNDER CONSTRUCTION Leasing activity has trended down in the first half of 2019. The majority of the leasing activity is a result of horizontal movement *Projected (existing tenants in the market relocating). Houston’s overall vacancy rate rose from 19.1% to 19.8% over the quarter and is still well above Houston’s pre-downturn average vacancy rate in 2014 of 11.6%. An additional constraint to recovery is a very tight labor market, not just in Houston, but nationally. Companies wanting to increase head count and expand are finding it difficult to fill the available job openings. Given these conditions, Colliers estimates, in Summary Statistics the most optimistic scenario, it will take six to seven years of steady Houston Office Market Q2 2018 Q1 2019 Q2 2019 absorption to reach a pre-recession vacancy rate. Vacancy Rate 20.1% 19.1% 19.8% Houston’s overall vacancy rate rose from 19.1% to 19.8% over the quarter, and construction activity declined as several buildings Net Absorption -299,400 492,600 -842,200 delivered during Q2. With only 2.1M SF under construction, developers continue to show constraint by holding off on proposed New Inventory 83,100 32,200 982,300 projects. Under Construction 1,839,300 2,531,100 2,093,900 Houston’s job growth increased by 2.6% over the year, according to recent data released by the U.S. Bureau of Labor Statistics. Class A Vacancy Rate The Houston MSA created 79,800 jobs (not seasonally adjusted) CBD 19.7% 19.1% 20.0% Suburban 22.2% 20.5% 20.7% between May 2018 and May 2019, growing faster than the U.S. during the same time period. Employment sectors with the most Asking Rents substantial growth include architectural, engineering and related Per Square Foot Per Year services which grew by 12.8%, support activities for mining which Houston Class A grew by 12.1% over the year and durable goods manufacturing up $34.96 $35.51 $35.36 by 9.3%. CBD Class A $44.18 $46.04 $46.01 Suburban Class A $32.29 $32.31 $31.99 Share or view online at colliers.com/houston Vacancy & Availability Job Growth & Unemployment (not seasonally adjusted) Houston’s citywide vacancy rate increased 70 basis points from 19.1% to 19.8% over the quarter. The average suburban vacancy rate also increased 70 basis UNEMPLOYMENT 5/18 5/19 points from 18.6% to 19.3% and the average CBD vacancy rate rose 90 basis points from 21.4% to 22.3% between quarters. HOUSTON 4.2% 3.2% The average Class A vacancy rate in the CBD rose 90 basis points. The increase TEXAS 3.6% 2.9% was primarily due to vacancy in the newly delivered Bank of America Tower. U.S. 3.6% 3.4% The average Class B vacancy rate in the CBD increased from 30.0% to 31.1%. The average suburban Class A vacancy rate rose 20 basis points from 20.5% to 20.7% between quarters, while the average suburban Class B vacancy rate Annual # of Jobs JOB GROWTH Change Added increased 100 basis points from 17.8% to 18.8%. HOUSTON 2.6% 79.8K Of the 1,657 existing office buildings in our survey, 75 buildings have 100,000 SF 2.4% 301.2K or more contiguous space available for lease or sublease. Of these, 26 buildings TEXAS have contiguous space of 200,000 SF or more available. Citywide, available U.S. 1.5.% 2.3M sublease space increased over the quarter from 6.7 million SF to 6.8 million SF. Available space differs from vacant space in that it includes space that is currently being marketed for lease, but may be occupied with a future availability date. In contrast, unoccupied is truly vacant and is available immediately. CBD vs. Suburban CLASS A OFFICE VACANCY HISTORICAL AVAILABLE SUBLEASE SPACE 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 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2014 2014 2014 2015 2015 2015 2015 2016 2016 2016 2016 2017 2017 2017 2017 2018 2018 2018 2018 2019 2019 5.0% Class A Class B Houston Total 0.0% AVAILABLE SUBLEASE SPACE - 100,000 SF OR GREATER CBD Vacancy Suburban Vacancy Large Sublease Availabilities (Total available in building and/or complex) BUILDING TENANT SUBMARKET SF CLASS A OFFICE RENTS 5 Greenway Plaza Oxy Greenway Plaza 746,070 $50.00 Four WestLake Park BP Katy Freeway 454,487 $45.00 Energy Tower II KTI Corporation (Technip) Katy Freeway 297,919 $40.00 1500 Post Oak Blvd BHP Billiton Petroleum West Loop 273,127 $35.00 One Shell Plaza Shell Oil CBD 266,990 $30.00 GreenStreet Tower Reliant Energy Retail CBD 194,768 $25.00 Three WestLake Park Phillips 66 Katy Freeway 221,723 $20.00 Hess Tower Hess Corporation CBD 215,887 $15.00 1100 Louisiana Enbridge CBD 179,694 $10.00 BHP Billiton Tower BHP Billiton Petroleum West Loop 162,943 $5.00 Westway Plaza GE Oil & Gas West Belt 131,663 $0.00 Kinder Morgan Building EP Energy Corporation CBD 124,600 10000 Richmond Ave National Oilwell Varco Westchase 118,215 Source: CoStar CBD Rents Suburban Rents 2 Houston Research & Forecast Report | Q2 2019 | Office | Colliers International Absorption & Demand Houston’s office market posted 842,200 SF of negative net absorption in Q2 2019, a dramatic reversal from the 492,600 SF of positive net absorption recorded in Q1 2019. Suburban Class B space recorded the largest loss, posting 742,500 SF of negative net absorption, while CBD Class A space reported the largest gain posting 332,900 SF of positive net absorption. The majority of negative absorption was caused by tenants relocating, vacating older properties and moving to smaller more efficien spaces in newly constructed office buildings with a larger variety of amenities which help employers attract top talent. Rental Rates Houston’s average asking rental rate increased over the quarter from $29.20 per SF to $29.64 per SF. The average asking rental rate for Class A space decreased over the quarter from $35.51 per SF to $35.36 per SF, and the average CBD Class A rental rate decreased marginally from $46.04 to $46.01 per SF. The Suburban average asking rental rate for Class A fell from $32.31 to $31.99 per SF. Leasing Activity Houston’s office leasing activity increased over the quarter from 3.1M SF to 3.8M SF. Leasing activity includes new/direct, sublet, renewals, expansions in existing buildings and pre-leasing in proposed buildings. Some of the more notable transactions are noted in the table below. Q2 2019 Select Office Lease Transactions BUILDING NAME/ADDRESS SUBMARKET SF TENANT LEASE DATE 8770 New Trails Drive The Woodlands 180,000 Alight Solutions1, 3 Apr-19 CityWestPlace 1 Westchase 114,200 Honeywell1 Apr-19 Pinnacle Westchase Westchase 107,000 Empyrean Benefit Solutions, Inc.2 Apr-19 1100 Louisiana CBD 91,300 King & Spalding2 May-19 America Tower Midtown 90,200 Marsh Wortham2 Apr-19 609 Main at Texas CBD 57,139 White & Case LLP1 Apr-19 609 Main at Texas CBD 56,351 WeWork1 Jun-19 Park Place | River Oaks West Loop 27,300 Compass Real Estate1 Apr-19 Northwest Crossing III Northwest Far 26,810 Harris County Engineering Department1 Apr-19 1New/Direct 2Renewal 3Colliers International Transaction Sales Activity Houston’s office investment sales volume increased over the quarter by 81.8% to 675.3M from 371.5M in Q2 2019. The average sales price per square foot trended up from $187 to $233 per SF over the quarter. Houston’s average cap rate of 7.2% lags the average U.S. cap rate of 6.6%. AVERAGE OFFICE SALES PRICE PER SF AVERAGE OFFICE CAP RATE Houston United States Houston United States 8.0% $300 7.8% $250 7.6% 7.4% $200 7.2% 7.0% $150 6.8% 6.6% $100 6.4% $50 6.2% 6.0% $0 5.8% Sources: CoStar and Real Capital Analytics 3 Houston Research & Forecast Report | Q2 2019 | Office | Colliers International Houston Office Market Summary (CBD, Suburban, & Overall) SUBLEASE NET ABSORPTION RENTAL INVENTORY DIRECT VACANCY VACANCY VACANCY RATE (%) VACANCY (SF) RATE # OF RATE RATE TOTAL AVG CLASS TOTAL (SF) (SF) (SF) Q2-2019 Q1-2019 Q2-2019 Q1-2019 BLDGS. (%) (%) (SF) ($/SF) CBD A 35 32,876,914 5,830,734 17.7% 758,170 0.0% 6,588,904 20.0% 19.1% 332,930 -11,007 $46.01 B 28 9,424,143 2,802,828 29.7% 125,451 0.0% 2,928,279 31.1% 30.0% -102,294 123,909 $30.81 C 11 798,903 76,500 9.6% 0 0.0% 76,500 9.6% 9.6% 0 0 $20.15 Total 74 43,099,960 8,710,062 20.2% 883,621 2.1% 9,593,683 22.3% 21.4% 230,636 112,902 $40.89 SUBURBAN A 398 99,057,725 18,447,423 18.6% 2,032,522 2.1% 20,479,945 20.7% 20.5% -92,015 731,773 $31.99 B 904 76,362,524 13,972,280 18.3% 389,341 0.5% 14,361,621 18.8% 17.8% -742,526 -335,377 $20.58 C 281 13,183,422 1,496,196 11.3% 31,165 0.2% 1,527,361 11.6% 9.8% -238,270 -16,654 $19.88 Total 1583 188,603,671 33,915,899 18.0% 2,453,028 1.3% 36,368,927 19.3% 18.6% -1,072,811 379,742 $26.75 OVERALL A 433 131,934,639 24,278,157 18.4% 2,790,692 2.1% 27,068,849 20.5% 20.1% 240,915 720,766 $35.36 B 932 85,786,667 16,775,108 19.6% 514,792 0.6% 17,289,900 20.2% 19.1% -844,820 -211,468 $22.29 C 292 13,982,325 1,572,696 11.2% 31,165 0.2% 1,603,861 11.5% 9.8% -238,270 -16,654 $19.89 Total 1657 231,703,631 42,625,961 18.4% 3,336,649 1.4% 45,962,610 19.8% 19.1% -842,175 492,644 $29.64 Houston Suburban Office Market Summary SUBLEASE NET ABSORPTION RENTAL INVENTORY DIRECT VACANCY VACANCY VACANCY RATE (%) VACANCY (SF) RATE # OF RATE RATE TOTAL AVG CLASS TOTAL (SF) (SF) (SF) Q2-2019 Q1-2019 Q2-2019 Q1-2019 BLDGS.
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