Houston’s office market recovery hits a speed bump in Q2

 Over the last two quarters, Houston’s office market has shown signs of a slow recovery from the energy downturn, but it hit a speed bump in Q2. During the quarter, the market posted negative net absorption of 842,200 SF, a substantial reversal from the positive absorption of 492,000 SF recorded in Q1. The newest trend of vacating older spaces for modern/creative, efficient interior designs has tenants effectively leasing less space without reducing head count. Unless the tenant is in an expansion mode, this trend will lead to a reduction in the amount of office space leased. Leasing activity has trended down in the first half of 2019. The majority of the leasing activity is a result of horizontal movement (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 the most optimistic scenario, it will take six to seven years of steady absorption to reach a pre-recession vacancy rate.

Houston’s overall vacancy rate rose from 19.1% to 19.8% over the quarter, and construction activity declined as several buildings delivered during Q2. With only 2.1M SF under construction, developers continue to show constraint by holding off on proposed projects.

Houston’s job growth increased by 2.6% over the year, according to recent data released by the U.S. Bureau of Labor Statistics. The Houston MSA created 79,800 jobs (not seasonally adjusted) between May 2018 and May 2019, growing faster than the U.S. during the same time period. Employment sectors with the most substantial growth include architectural, engineering and related services which grew by 12.8%, support activities for mining which grew by 12.1% over the year and durable goods manufacturing up by 9.3%.

Vacancy & Availability

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 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.

The average Class A vacancy rate in the CBD rose 90 basis points. The increase was primarily due to vacancy in the newly delivered Bank of America Tower. 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 increased 100 basis points from 17.8% to 18.8%.

Of the 1,657 existing office buildings in our survey, 75 buildings have 100,000 SF or more contiguous space available for lease or sublease. Of these, 26 buildings have contiguous space of 200,000 SF or more available. Citywide, available 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. 

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. *

*For a table of select office lease transactions click here to download the complete report. 

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%.

Office Development Pipeline

2.0 million SF of office space is under construction, all but one being spec development. Approximately 32.4% of the spec development is pre-leased. Below is a summary of some of the office buildings under construction.* 

*For a table of the buildings under construction click here to download the complete report. 

Q2 2019 Houston Office Highlights