Houston’s industrial market is much healthier than other CRE sectors amid $20 oil and COVID-19
Commentary by Walker Barnett and Patrick Duffy
Colliers generally uses this space to discuss the trends we see in market data and in conversations we have with our clients, prospects and friendly competitors. We take that data and attempt to project activity going forward. The bulk of the first quarter was, for all practical purposes, pre-COVID. Net “move in” data, as well as new leases signed were likely unimpacted for Q1 based on the virus or only marginally impacted. Our industry has a lead time of at least 4-6 months prior to a lease being signed or space made ready for occupancy. The real impact of this COVID crisis will not present in the data until later in Q2. Inertia will carry us for a few 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 was driven by Saudi Arabia and Russia failing to reach an agreement on production and to a greater extent by the severe decline in oil and gas demand driven by the COVID shutdown. Oil has been in the low 20’s since the collision of these two events. The Energy Information Administration is projecting that supply will continue to outpace demand for the balance of this year by nearly 20MM barrels per day. If a recent agreement between OPEC and Non-OPEC countries brokered by the US holds, that gap may fall to 5-10MM barrels. Most experts predict that our land-based storage globally will be full by early June. We will likely not see much relief in oil prices for at least 18-24 months, which means the upstream and midstream companies and the companies that support them will be under a great deal of pressure to trim costs. Many will be filing for bankruptcy protection in the near term.
Industrial CRE will outperform and recover faster than the other major sectors (office, retail, multifamily) as we are released from the shutdown. Bright spots in the recovery for industrial space will be a growing reliance on third-party logistics companies to help customers with increasing supply chain efficiency. E-commerce growth and resultant warehouse leasing will accelerate. The need for national stockpiles for public health supplies and readiness will drive warehouse demand. Also, the emerging change from “just in time” to “just in case” will increase inventory requirements and lead to additional demand for warehouse storage. Many firms will be on-shoring after years of offshoring. The increase in inventory and on-shoring alone may require as much as 1 billion square feet of industrial product in the US (according to Duke Realty Corporation). The crippling of the airline industry will have a profound impact on air cargo, especially to smaller markets. The major multi-modal cities will benefit from this issue. As a global port city and a super regional economic powerhouse, Houston stands to benefit from the re-ordering of the global economy.
On the positive side locally, Houston was heading towards an “overbuilt” bulk industrial market with multiple industrial projects under construction and recently delivered. Many additional speculative (not pre-leased) projects were in the planning and preconstruction phase. The economic destruction wrought by the pandemic will substantially curtail any additional speculative inventory – and allow the demand side to catch up with the supply of available buildings. We do expect new construction, but it will be limited primarily to
build-to-suit projects with a tenant secured preconstruction. In discussions with landlords, April rent collections were better than expected, and the infusion of cash from the CARES act helped some tenants stay current. Tenant demand, in general, has dropped substantially with most renewals, relocations and new leases on hold for 60-90 days while companies stand on the sidelines to better gauge business decisions in the “new abnormal.” The most immediately impacted tenants are the smaller regional and local small businesses, while the larger national companies have more staying power.
Vacancy & Availability
On an annual basis, Houston’s average industrial vacancy rate increased 180 basis points from 6.1% in Q1 2019 to 7.9% in Q1 2020 and by 100 basis points quarterly from 6.9% in Q4 2019. At the end of the first quarter, Houston had 45.6M SF of vacant industrial space for direct lease and an additional 2.2.M SF of vacant space for sublease. Among the major industrial corridors, the Inner Loop Corridor has the lowest vacancy rate at 5.3%, followed by Liberty County at 5.4%. The submarket with the largest percentage of vacant space is the North Corridor, which has a 10.0% vacancy rate.
Absorption & Demand
Houston’s industrial market posted 3.2M SF of positive net absorption in the first quarter, an increase of 39.1% over the quarter. Some of the tenants that relocated or expanded in Q1 2020 include Home Depot, moving into 770,640 SF in the Hwy 290/Tomball Pky Corridor, Sunbelt moving into 191,175 SF in the North Inner Loop Corridor and Starplast USA moving into 168,850 SF in the North Hardy Toll Rd Corridor.
The majority of first quarter positive net absorption occurred in the Northwest Corridor, recording 1.9M SF. All of the major industrial corridors recorded positive net absorption in the first quarter, with the exception of the Inner Loop Corridor. 9.8M SF of new inventory delivered during the first quarter. The Northwest Corridor had the most significant amount of new inventory, 3.2M SF, delivered during the first quarter.
According to our data service provider (CoStar Property), Houston’s citywide average quoted industrial rental rate for all product types increased from $7.52 per SF NNN to $7.83 per SF NNN over the quarter. According to Colliers’ internal data, actual lease transactions are in the $4.68 – $5.28 per SF NNN range for newer bulk industrial spaces, while flex rates range from $7.20 to $10.80 per SF NNN depending on the existing improvements or the allowance provided for tenant improvements and the age and location of the property.
Based on data from our data service provider, the average quoted NNN rental rates by property type are as follows: $6.89 per SF for Warehouse Distribution space, $10.16 per SF for Flex/Service space, Tech/R&D space averaging $9.75 per SF and $5.47 per SF for Big Box.
According to our data service provider (CoStar Property), Houston’s industrial leasing activity decreased over the quarter from 6.7M SF in Q4 2019 to 5.5M SF in Q1 2020. Most of the Q1 2020 transactions consisted of leases for 50,000 SF or less; however, there were several larger deals that occurred. The table below highlights some of the larger transactions that closed in Q1 2020.
Currently, 17.8M SF of industrial space is under construction in Houston with 50.4% of this space pre-leased. The largest project under construction is a 2,165,000-SF distribution warehouse for Ross Stores Inc., located in Brookshire, TX. The majority of projects under construction are located in the Southwest, Northwest and Southeast Corridor submarkets. Below is a partial list of the largest buildings currently under construction.