Q2 2018 | HOUSTON OFFICE MARKET Office Market Still Struggling as Signs of Recovery Emerge Office Using Job Growth on the Rise OVERVIEW TRENDLINES With Fatigue on the Rise, is Increased Activity on the Way? 5-YEAR TREND CURRENT QUARTER The office market displayed mixed results over the second quarter, as leasing activity increased and office-using job growth picked up mo- JOB GROWTH mentum; however, total availability and direct vacancy both continued to soften. The increase in vacancy and availability was due to a combi- 37k jobs Office-using* jobs nation of tenants leasing attractive sublease offerings, thereby increas- gained over the year ing direct vacancy upon move, as well as through an additional wave of sublease listings that increased total availability by 0.8%. Of note, Occidental Petroleum (Oxy) listed approximately 800,000 SF of sublease ABSORPTION space in 3 and 5 Greenway Plaza with term through 2026. Oxy is leaving -1.5M SF its longtime Greenway Plaza space and will relocate into its new build- YTD 2018 absorption ing in 2020, at which time the prime Greenway Plaza sublease will be for all classes of space available for occupancy. Absorption through mid-year continued in the red, recording negative DIRECT VACANCY 1.5 million SF year-to-date, and marking seven out of the past eight quarters in negative territory. Class A properties have posted negative 16.2% absorption for 6 of the past 8 quarters, leading to financial fatigue in the Increased 0.3% over the quarter market. This is especially pronounced in product built prior to 2000 as leasing activity has been markedly in favor of either new construction or heavily discounted, attractive sublease offerings. With over 9.0M SF TOTAL AVAILABILITY of sublease space currently available, spec construction on the rise and 23.7% proposed buildings anticipating landing lead tenants, the near-term Increased 0.8% over future for the leasing environment continues to be one of the most chal- the quarter lenging in Houston’s history. Despite these bumps in the road, office-related job growth is back on UNDER CONSTRUCTION the rise. Nearly 80,000 jobs were created over the 12 months ending in May, of which, 37,000 jobs were created in the office-using employment 1.8 msf sectors*. Additionally, oil prices remain elevated in the mid-upper $60s Under construction at mid-year 2018 to low $70s, which is likely to translate into further job growth. As such, the long-term outlook on the Houston market remains bright despite the challenges the market is currently experiencing. RENTAL RATE DEMAND $30.78 psf Sublease Expirations Drive Negative Absorption Rental rate for all classes of space Quarterly absorption for all classes of space totaled negative 515,000 SF, bringing year to date cumulative absorption to negative 1.5 million * Office-using employment sectors include: Professional and Business Services, Information, and Financial Activities. Q2 2018 | HOUSTON | OFFICE MARKET SF. Class A absorption totaled negative 66,000 SF while Class B absorp- tion recorded negative 477,000 SF for the second quarter. North Total Available Space Houston District drove the negative absorption with the submarket Houston Metro | Q2 2018 having cumulative space give backs totaling just under 400,000 SF SUBLEASE % OF % TOTAL SUBMARKET between Class A and B properties. This was due in part to the expiration SPACE (SF) SUPPLY AVAILABLE of ExxonMobil’s lease of 253,000 SF at 233 Benmar, Exterran vacating CBD 2,345,723 5.4% 28.4% 147,000 SF at 16666 Northchase, and the expiration of Insperity’s 87,000 Energy Corridor 2,269,839 6.3% 26.3% SF lease at 263 N Sam Houston Pky. Westchase 1,392,048 8.8% 29.0% Net direct absorption still faces headwinds as approximately 400,000 SF of sublease space is set to expire over the balance of the year and Greenway Plaza 927,042 6.3% 25.8% value-conscious tenants look to attractive sublease alternatives, vacating West Belt 603,961 11.3% 37.2% direct space in the process. That said, Q2 saw office-using employment All of Houston 9,141,135 3.8% 23.7% growth, and the first round of tenants in the market expanding their leases in lieu of renewing. As such, it is anticipated that absorption will begin to move into positive territory towards the end of the year as leasing velocity continues to improve and the availability of viable sublease alternatives wanes, pushing activity back to direct space. VACANCY Office Under Construction Sublease Space Exceeds 9.0 Million SF Houston Metro | Q2 2018 # OF % PRE- SUBMARKET SF The total availability rate for all classes of space rose to 23.7% over the BLDGS LEASED second quarter, a 0.8% increase from 22.9% recorded at the close of the CBD 1 778,344 27. 0% first quarter. The increase in availability can be attributed to several large FM 1960/Hwy 249 1 156,000 0.0% additions of sublease space. Oxy listed over 800,000 SF of sublease on Woodlands 4 854,800 82.5% the market in Greenway Plaza between two buildings as it looks to build a corporate campus. Additionally, GE listed 182,000 SF (Westway III, Total 6 1,789,144 54.1% Class A) for sublease through December 2022 in the West Belt market. The CBD was also in on the mix with EP Energy listing 124,000 SF (1001 Louisiana, Class A) through August 2025, while Vistra Energy listed 104,000 SF (601 Travis, Class B) through April 2022. Total sublease space for the market sits at 9.1 million SF, the majority of which is in the Class A market with 7.5 million SF available. AVERAGE OFFICE RENTS Direct vacancy increased to 16.2% for all classes of space over the Houston Metro Area quarter, up 0.3% from the first period. Class A vacancy remained Overall Class A Class B unchanged recording 15.7% at mid-year, while Class B increased to $40 17.7%, from 17.1% over the same period. The submarkets recording $35 the lowest vacancies are Kingwood Humble - 3.4%, South Main/Medical Center - 3.6% and Northeast - 5.0%. As over 1.0 million SF of sublease $30 space is set to expire over the next 18 months, expect to see further $25 increases in direct vacancy throughout the metro. $20 SUPPLY AND DEVELOPMENT Speculative Projects Break Ground $15 07 08 09 10 11 12 13 14 15 16 17 18* SOURCE: CoStar, Transwestern The development pipeline currently sits at 1.8 million SF across the metro *Through Q2 2018 following the groundbreaking of two speculative construction buildings in North Houston. CityPlace I in Springwoods Village broke ground late in the second quarter, a 150,000 SF Class A building anticipated to deliver Q2 2018 | HOUSTON | OFFICE MARKET | 2 Q2 2018 | HOUSTON | OFFICE MARKET in Q2 2019. Additionally, Chasewood Crossing broke ground Comparative Office Investment Sales Volume on its next phase, Chasewood Crossing Three, the third of Select Metro Areas six proposed Class A office buildings at the office park. The Atlanta Dallas Denver Houston 156,000 SF speculative building broke ground on June 28 $8 and will be located at 19350 State Hwy 249 with occupancy $7 in 14 months. $6 The largest developments under construction are Capitol $5 Tower (CBD, 778,000 SF - 36% leased to Bank of America $4 and Quantum Energy), CityPlace 2 (The Woodlands, 326,000 SF - 100% Leased to ABS) and HP’s build-to-suit campus (The $3 Sales Volume in Billions Woodlands, two 189,000 SF buildings). With strong tenant $2 demand for new construction, it is anticipated that several $1 additional buildings will break ground in the near term. $0 07 08 09 10 11 12 13 14 15 16 17 18* RENTAL RATES SOURCE: Real Capital Analytics, Transwestern ,*Through Q2 2018 Rental Rates Soften in Q2 Overall asking rates for all classes of space totaled $30.78 per SF gross over the second quarter, a 0.5% decrease from the first quarter, but up 0.3% over the same period last year. Landlords continue to maintain face rents as long as possible, Average Office Sale Price Houston Metro Area but concession packages remain hefty and prevalent with free rents and high TI allowances still being offered. Class A rental Average Sale Price Per SF $250 rates dropped 0.8% over the quarter and 0.6% year-over-year to $36.00 per SF gross. Class B rates were $22.25 per SF gross $200 at mid-year which is a 1.5% increase over the quarter and over the year. $150 INVESTMENT SALES Portfolio Activity Decreases $100 Sales in the second quarter slowed, recording $254.3 million, down from the $715.7 million in the first quarter. The $50 largest sale of the quarter was the longtime listed former Halliburton campus in Westchase. The campus is situated $0 07 08 09 10 11 12 13 14 15 16 17 18* on approximately 49 acres and consists of a 570,000 SF (NRA), three story office building. Garden Capital Partners, a SOURCE: Real Capital Analytics, Transwestern,*Through Q2 2018 group led by Lawrence Wong acquired the property for an undisclosed price. Plans for the former campus have yet to be announced, but it is anticipated that the campus will Notable Q2 Sales Transactions BUILDING SUBMARKET SF SELLER BUYER 10200 Bellaire Blvd Westchase 568,458 Halliburton Garden Capital Partners Cameron Management and TRC Capital Partners and 1001 McKinney CBD 375,440 Silverpeak Real Estate Partners Amstar America 950 & 952 Echo Ln Katy Freeway East 189,162 Velocis Fund I Metropolitan Custom Homes E Ft Bend Co/ Three Sugar Creek 154,263 Radler Enterprises WEDGE Group Sugar Land SOURCE: Real Capital Analytics, Transwestern Q2 2018 | HOUSTON | OFFICE MARKET | 3 Q2 2018 | HOUSTON | OFFICE MARKET be a redevelopment opportunity infusing mixed-use Office Absorption and Employment components.