“The Greater Houston MSA industrial market is in excellent shape. Southeast Texas ports continue to break records for incoming (and exporting) goods as distribution shifts more to the Gulf and Southeast U.S. ports from the highly constrained West Coast ports. We expect this trend to continue after the severe backlogs and potential upcoming labor issues on the West Coast.”
Patrick Duffy | President of Colliers in Houston
- Leasing activity remains steady
- Positive net absorption
- Vacancy up slightly as 9M SF delivers
- Rental rates continue to increase
- Construction starts up
Houston’s industrial market continued to gain momentum as leasing velocity reached over 11 million square feet in the third quarter. The increase in demand for space continued to spur new development with over 27 million square feet under construction and an additional 64 million square feet proposed or in the final planning stage. Houston’s industrial market recorded 5.6 million square feet of positive net absorption in the third quarter, pushing the year-to-date total to more than 21 million square feet. The vacancy rate increased 40 basis points quarterly, but was down annually by 150 basis points.
The forecast in the above graph is based on a trailing 4-quarter historical average.
Commentary by Patrick Duffy
The industrial market continues to outperform the balance of the commercial real estate market both nationally and here in Southeast Texas. Industrial absorption has slowed slightly from the very robust pace seen in all of 2021 and the first half of 2022, but remains steady, with just under 21 million SF absorbed year-to-date in the Greater Houston MSA.
The demand for industrial facilities, from manufacturing and assembly to distribution, especially east of the Rocky Mountains, is expected to remain strong despite a global economic slowdown and a push by central bankers to cool the world’s major economies. As inflation continues to burn hot and consumer spending shifts more to essential items such as food, transportation and shelter, the demand for other goods has cooled. The impact of this reality was most clearly demonstrated by Amazon significantly reducing their projected growth and placing over 60 of their facilities into the sublease or sale market globally. Amazon had been on a historic growth path prior to this significant shift in strategy. Interestingly, while Amazon has clearly slowed its growth in the Southeast Texas market, they have moved forward with occupying the new newly acquired facilities here.
The debt markets have moved to a much more cautious position in the past 90 days, increasing borrowing costs, reducing loan-to-value ratios and generally being much tighter with new issuances. Simultaneously, the investor/ buyer market has adjusted expectations and raised Capitalization / Yield requirements to help cover the higher debt constants and achieve higher positive yields relative to inflation. As a result, the 10-year Treasury yield has increased significantly with only a partial adjustment on Capitalization/ Yield expectations. While CAP rates have increased, the spread between current CAP rates and the 10-year treasury compressed in the first part of this year to an average of 3.7% down from 4.15% in 2021.
Construction costs have leveled off in the past 90 days, with most construction materials slowing their price increases and, in many cases, costs have come down. However, labor cost and borrowing costs (as previously mentioned) have continued to increase while exit CAP rates have risen (reducing the price per $ of rent). This combination has made speculative development much riskier, and as a result, we expect a significant slowdown in new development in the near term. In addition, many industrial users (like Amazon) have moved to a more defensive posture as the calls for a “hard landing” recession get louder. As a result, we expect most build-to-suit projects to move forward, but even this portion of the development pipeline will slow.
The Greater Houston MSA industrial market is in excellent shape. Southeast Texas ports continue to break records for incoming (and exporting) goods as distribution shifts more to the Gulf and Southeast U.S. ports from the highly constrained West Coast ports. We expect this trend to continue after the severe backlogs and potential upcoming labor issues on the West Coast.
Other than those already under construction, most speculative activity has been put on hold or canceled by the major developers, especially the national institutional players. As a result, we expect build-to-suit activity to remain solid, but speculative deliveries to drop dramatically by the end of 2023.
With a slowdown in new development, we expect rents to increase by 3-5% in the next twelve months and for competition for lease space to remain strong, albeit down from the pace we saw in the past 18 months.
Industrial Cap to Interest Spread
Institutional Inventory - 500,000 SF or Greater
Houston Industrial Construction