Office Market in Houston Gets Hit

Watch the banks.

Commercial real estate is highly leveraged. Debt is everything. The entire math is based on high rental rates and low vacancy rates. Without them, the debts cannot be serviced. But now in Houston, both are shooting in the wrong direction.

OK, Houston’s economy is diversified, they say. The oil bust hurts, and there have been waves of layoffs of highly paid engineers, but it won’t hit the city as bad as the last big oil bust did, they say.

And yet, the amount of office space vacated by companies that are trying to slash their operating expenses and that is now on the market as sublease space has spiked 69% by the end of 2015, to 7.6 million square feet (msf), according to real-estate services firm Savills Studley. And they “continue to sit on the market.”

It’s going to get worse:

New sublease blocks are expected to hit the market in 2016, particularly in the CBD [Central Business District]. Shell is projected to vacate 250,000 sf in One Shell Plaza and EP Energy, likewise, is anticipated to leave 100,000 sf in the Kinder Morgan Building. Shell would likely also shed space at BG Group Place should its pending $70-billion acquisition of BG Group clear governmental hurdles and finalize.

Many large tenants who paid at the very top of the market in the last few years warehoused space in anticipation of continued headcount growth. As a result, many firms had surplus space even prior to the implementation of layoffs in the last year. In 2016, the office market should see more shadow space listings….

Occupancy, after five years in a row of increases, fell by 1.4 msf (“negative absorption”), the biggest decrease in occupancy since 2009. Going forward, M&A and bankruptcies “will contribute to additional negative absorption” and will hit the vacancy rate. It already spiked to 23.2%.

And it’s going to get even worse:

After a tremendous building boom in 2013 and 2014, a total of 17 msf is expected to hit the market over the next few years, with 7.9 msf scheduled for completion in 2016. Only about two-thirds have been pre-leased. Some of these pre-leased properties will enter the shadow inventory as soon as they’re completed. But 5.5 msf have not been leased.

These new buildings will hit the market at the worst possible time, competing with 7.9 msf of sublease space and large amounts of shadow inventory, during a period of negative absorption.

Already the first “see-through buildings” in this cycle are appearing — that infamous phenomenon of vacant and transparent buildings dotting Houston’s business district during the oil bust of the 1980s.

Piedmont Office Realty Trust last year “opened a glassy 11-story building in the heart of the Energy Corridor district without any tenants,” the Wall Street Journal reported. The company’s CEO Don Miller lamented in November during the earnings call that “there’s no real genuine activity in the marketplace.”

And “several notable mistimed projects to be completed this will be under immense pressure,” Savills Studley reported, including:

609 Main. Of its 1,000,000 sf, only 62,000 sf have been leased so far. “Only time will tell whether that space continues to remain vacant after delivery or if the landlord successfully cannibalizes other CBD Class A buildings through new relocation deals.”

And Energy Center Five, scheduled to deliver in April, “remains completely unleased with 524,328 sf available.”

Leasing activity in 2015 plunged 42% to 8.4 msf, the weakest since Financial-Crisis year 2009. While there were some large deals in the fourth quarter, they were “bearish moves”:

Apache Corporation, for example, extended its 524,000-sf lease in Post Oak Central for just one year, pushing back its expiration from December 2018 to December 2019. It executed this extension instead of moving forward on a new development with 6.4 acres of land that it purchased in BLVD Place in 2012.

The quarter’s second largest lease, finalized by Bracewell & Giuliani at Pennzoil Place, was a renewal that saw the law firm downsize by an entire floor to 189,061 sf.

Now the market is in a holding pattern, without real demand, and lots of supply. Savills Studley’s report:

Landlords are feeling the marked reduction in tours, requests for proposals, and ultimately deal volume. Rents appear to be adjusting in spots, but the gap between tenant and landlord expectations has widened.

Many landlords still want to hit or come close to their pro forma financials. In contrast, some area businesses expect rents to adjust on a level that matches the sharp slide in energy pricing.

So overall asking rent edged down 1.6% to $28.99 per square foot, the second quarter in a row of declines. Class A asking rent fell 2.5% to $34.70. But the oncoming flood of sublet supply and new space, while demand is actually declining, will likely lead to “sharper rental rate erosion in future quarters.”

And this is where it gets tricky for banks. Commercial real estate is highly leveraged. Without high rental rates and low vacancy rates, the math won’t work and the debts cannot be serviced. Now both are shooting in the wrong direction.

Last time this happened, it turned into a gigantic mess that helped tear up over 400 Texas banks between 1980 and 1989, including nine of the state’s 10 largest.

So now everyone is hoping for a miraculous turnaround in the price of oil, in addition to healthy growth in the overall US economy, and everything else will follow. They’re hoping for another oil boom, and all that comes with it. But if their wishes come true even modestly, it would very quickly lead to a boom in production and thus an extension of the glut that would destroy the price of oil all over again before it ever gets back to a survivable level. And the shakeout in the real estate bust will simply get worse.

And how are banks that lent to the oil & gas sector dealing with? “All of it is in the gutter.” Read… Banks Much Deeper in the Hole on Oil & Gas Collateral than they Pretend

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  33 comments for “Office Market in Houston Gets Hit

  1. Merlin says:

    Deja vu all over again, triple wammy from the 80s: banking, real estate, oil and gas. There is no alternate scenario in my crystal ball.

    • LG says:

      Totally agree! Classic car prices went nuts in the eighties as well then dove 50%!
      With it real estate and banking!
      Hedge accordingly!

      • Toddy says:

        I’m rather interested in various reader’s personal opinions on how to hedge.

        Anyone care to offer some ideas for our collective inspiration and entertainment?

        I like the idea of classic cars but would never do it myself. Physical gold sounds prudent. I’m also looking at German real estate because I expect a residential asset bubble like we saw in the USA.

  2. Jonas says:

    Everything’s better with Hopium ..

    Thanks Wolf for the update on Texas banking / commercial real estate btw, I really appreciate the broad range of topics you cover on your website. Keep up the good work!

  3. CrazyCooter says:

    I don’t think this oil bust is particularly unique. Folks who are in the market or looking for a reasonable benchmark only need to go back to the 80s oil bust. Let’s stop off at Wiki for a moment (lots of quotable stuff):

    The FIRST sentence: “The 1980s oil glut was a serious surplus of crude oil caused by falling demand following the 1970s energy crisis.”

    While I happen to have my horse in the “demand is collapsing”, let’s presume I am an idiot (or just perhaps, wrong) and everyone else is right – it is a glut. Either way, it is a supply/demand imbalance with a potential (in)elasticity – nothing too complicated despite what might be driving things.

    Oil went from $35 to $10 over a period of time (Wiki provides real numbers), which at a glance is not unlike the $100 to $30 collapse we are seeing today. Note that also gives us a bit lower floor, but don’t expect things to match up so well. Feel free to check my math with your personally favorite oil index, peak/trough/etc. My point is we are in the same ball park.

    Of particular note, and this plays back into Cooter-is-right-and-pundits-are-wrong, is the massive increases in supply that drove the collapse in price in the 80s – demand is driving it now in the aught-teens. Global production has been net flat-ish for years now. It isn’t “increasing exponentially” unless one has a very, very modest exponent. That leaves …

    But, this is still instructional.

    Most importantly, what happened in the 80s is … CASH FLOW problems … and that kicked the legs out from under quite a few stools (I do adore my wordplay – I hope readers are just as sharp) … and again, this is exactly what we are seeing today.

    What is different is where we were (are) in the larger debt cycle. I think this is the key.

    If you are an investor, or looking for how this is going to unwind, I think the charts of the 80s of similar companies/exposures might be quite instructive.

    But do not discount where we are today in the debt cycle.

    That said, my long is moving to Alaska, getting out of debt, and well I don’t have a pile of cash yet so I am not worrying about what to do with it – just thinking, reading, and getting ready for what I might do.

    I am quite aware we are screwed (as a state) with lack of oil revenue, but I can roll with that. If I was doing what everyone else was doing, I would be certainly wrong – the fact I am contrary and still have a plan puts me where I want to be – or at least have fair odds.

    I won’t be posting much for a while – but I will be back eventually!

    Best of luck!



    • Dan Romig says:

      All the best to you Cooter. I enjoy(ed) reading your comments.

    • Spencer says:

      Well the word play is well, sharp indeed. Is that why you are crazy in your handle, no?

      And the word …”screwed”…, is that like in intercourse? If it is, I was well screwed eons ago and was glad to be reminded of that event.

      Cheers, CC.

    • MC says:

      I think you hit the nail squarely on the head with declining demand.
      One of the backbone of the modern refining industry is ULSD (ultra low sulfur diesel), which also gives a decent measure of economic activity because it’s used in lorries, escavators, large power generators, combine harvesters, feller bunchers etc.
      The price of ULSD throughout all of Europe has completely collapsed. This has probably little do with supply: since 2008, refining capacity in Europe has considerably declined, as older refineries became simply too expensive to run in face of deterioration and tighter environmental legislation. Decommissioning them just made more economic sense.
      Just to give a few numbers off the top of my head, since 2008 France has lost 345,000bbl/d refinining capacity, Germany 300,000 and Italy a massive 400,000. In short the three main eurozone economies lost between them over a million bbl/d in refining capacity since 2008.

      Now, during past “oil gluts” (let’s call them this way) the price of gasoline and ULSD has always fallen in step. This time, if gasoline fell off a cliff, ULSD is tumbling down through a bottomless pit.
      I haven’t got the latest numbers for industrial vehicles sales but if prices at the local CNH dealership are anything to go by, they aren’t anything to write home about, if not downright worrying.
      There may be a car boom (although I am firmly convinced it owes a lot to channel stuffing and other accounting tricks), but it isn’t accompanied by the usual boom in industrial vehicles that happens at the same time.
      As the sci-fi story ended “The stars were going out one by one”.

      Now, I know Gulf Coast refineries have a similar problem: Exxon and Marathon have attempted shipping ULSD to Amsterdam over the past two months, only to change idea after seeing spot prices being so low as not to make any economic sense. Tanker prices may be low, but they aren’t free. Storage facilities are literally bursting at the seams both sides of the Atlantic.

      What does this tell us? That industrial activity has slowed down, a lot. We are not in recession and may not even be in a depression, but I’ve been taught that if the industry doesn’t use diesel fuel there’s something wrong and you should pay attention to it.

      We have come to rightly criticize the “fanciful and completely made up” economic numbers originating from China, but given what I am seeing I am starting having lot of second thoughts about our own as well.

      • chris Hauser says:


      • CENTURION says:

        I and my family have everything we need. We do. Now, “wants” are infinite, but we are tired of “wanting”. In a way, my family and those who work with me, etc. all express the same feelings: We are tired of all our stuff (Thank you, George Carlin)

        We really don’t buy anything because we don’t want to. We watch TV, rent cheap DVDs and go out to dinner as a family every Saturday night. We are happy.

        We are satiated. Why buy anything? Today’s big-box stores are depressing in the vastness of….stuff……5,000 T-Shirts, 2,000 different towels. Who cares?

        The world now OVER PRODUCES.

  4. Jonathan says:

    “Commercial real estate is highly leveraged.”

    Is there anything not “highly leveraged” these days?

    • Vespa P200E says:

      For those old enough to remember – RTC from the late 80’s anyone?

      RTC was created to mop up the savings & loans debacle and bailout the ill bets made on ahem commercial real estate.

      Yep we learn history so as not to repeat it

      DEFINITION of ‘Resolution Trust Corporation – RTC’
      A temporary federal agency established under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), enacted on Aug. 9, 1989, to resolve the savings and loan (S&L) crisis of the 1980s.

      The Resolution Trust Corporation (RTC) had a mission to resolve all thrifts placed under conservatorship or receivership between Jan. 1, 1989, and Aug. 8, 1992. The S&L or thrift industry crisis had resulted in the biggest collapse of U.S. financial institutions since the 1930s. The RTC accomplished its mission by closing, selling or merging troubled thrifts and disposing of assets in an expeditious manner.

      • Sgt Milstar says:

        RTC – Father of sub-prime loans sold to investors. They packaged loans in excess of 90 days NON PERFORMING and sold them.

      • TheDona says:

        The expeditious manner of disposing of assets you speak of was anything but. As far as homes go, RTC had a laborious bidding process to finish up half built homes or make sure foreclosed homes were up to snuff (lighting and appliances were always stolen). By the time you won the bid and went back over…the houses had been stripped of something else (AC and commodes). Local RTC would not go over and look and say OK just add that to your winning bid. Had to start new bidding process. Not to mention they did not winterize the properties, so much unseen pipe damage once utilities turned back on….then back to bidding process. Some of these homes lingered for years stuck in rounds of bidding process due to continued deterioration. The ones we did get and finish were slow pay from RTC. But at least we got paid….unlike my precious stent as a Commercial RE Broker.

        Commercial Brokers beware: I got stiffed on sub-leasing some of the “see throughs” back in the day. If they don’t pay you on time as per contract, you most likely are not getting that commission.

      • Petunia says:

        I remember entire new developments being bulldozed because the areas were over built and the houses would never be sold. I think those developments/lending were connected to a certain dynastic family. We have the govt we deserve.

      • OutLookingIn says:


        The S&L debacle resulted in vigorous prosecution.
        According to Prof. Wm. Black who investigated and brought down criminal proceedings against those who were at the center of wrong doing, their resources were outstanding. Thousands of FBI agents specifically assigned to this, along with hundreds of prosecutors, sent well over a thousand S&L individuals to lengthy prison terms.

        So how many have gone to prison, that were responsible for the sub-prime crash? ZERO! Corruption is endemic and systemic. Stemming from the pits to the very top. The entire rotten edifice is riddled with systemic corruption, which includes ALL THREE branches of government.

  5. Mick says:

    This won’t be like 08, the 80’s, or any other bust. For the simple fact that the game has changed dramatically.
    Shale is nothing like conventional, we all know the spinning plates will drop with a crash and take the entire shale debt complex with it.
    This will all happen alongside a tech bust, bond bubble bust, stock bust, China explosion, EU disintegration, and housing crash.

    No, this will not be like any other time. We’re about to witness the greatest collapse in man’s history.

    • CENTURION says:

      There is also going to be a “societal” collapse. Europe will blow first since “they” are all forced to live so close together. It is going to be more ugly. (Don’t ask me to explain any more than this)

  6. night-train says:

    It is like Wolf has said before, when drilling for oil is what you do, when people give you money, you drill oil wells. Same with commercial real estate firms, residential builders and so on. Even in a diversified economy, when any major sector hits the economic skids, all other sectors feel some pain. And I think in the long run we are going to find out Houston isn’t nearly as diversified as we are led to believe. I know it is different this time. It always is. And it’s not. Lower for longer is going to underscore the unsustainable debt driven Houston economy.

  7. Kevin Beck says:

    When talking about prices and commodities, the main rule to remember (courtesy of Rick Rule) is, “The cure for low prices is low prices, and the cure for high prices is high prices.” First, there will be a wash-out, where those with the least cash flow and/or most leverage (usually the same entities) will stop producing. This will help set a floor for price, slightly lower than the average marginal cost of production. Then the grinding-out process will happen, as producers are financially restructured, often with the assistance of the bankruptcy courts. Then, and only then, will prices begin to move back up. This will happen first with oil and gas, before it can happen with local real estate in Houston.

  8. Kreditanstalt says:

    No entity, corporation or individual can ever be SEEN to go overtly, undeniably and for-all-to-see BANKRUPT.

    The government and Fed WILL prop up, extend-and-pretend, manipulate, falsify and lie to see that that never happens and they will do it endlessly.

    That’s the essence of “the recovery”. All about “confidence”.

  9. Vancouver Guy says:

    …and you should see the related office market in Canada: Calgary. The commercial market there is getting ravaged. Of note – and not really being reported on, is the carnage going on in the Vancouver office market. Here leases are being renegotiated as more supply comes on just as many resources companies are laying off people, closing the Vancouver location, or, in many cases, simply going bust and vacating the space. This has been going on here since 2014.

  10. chris Hauser says:

    i’m optimistic, but not about texas real estate.

    on the other hand, i am thinking of a term for balance sheet deflation.

    “asset inversion”?


    i live north of houston. in montgomery county. north of xom’s new multi-billion dollar campus.

    high rise office buildings are going up on speculation. both in montgomery county and in harris county.

    and then there is the home building. and the multi-family construction. every day i ask, where are these occupants coming from?

    i have watched the houses and the apartments being built. extraordinarily short-sheeted construction. throw-away buildings? and the rents for a two bedroom in these new apartments are high.

    i was at the mays clinic at mdanderson on monday and i have never seen so many auslanders in the waiting rooms. many of them coming without any appointments. i have been going here for 5 years and i have never seen anything like this.

    i have lived in this area for 50 years. never have i seen a construction craze as this last two years.

    and it will not end well. state of texas has now acknowledged that the low price of gasoline is not boosting the state economy. if my analysis is accurate, in 2015 into january 2016, i figure about a quarter million hydrocarbon industry jobs have disappeared. this has real cascading effects in the overall texas economy. and it will show up in oklahoma and louisiana as well.

    the southern alberta province.

    • CENTURION says:

      When the “auslanders” hit 51% of your State, they will take “orders” from South of the Border to exercise the Republic of Texas right to either divide into 5 States…..or leave the Union.

      You need to learn to speak “auslander”….and I don’t mean German, Herr.

  12. Tim B says:

    Oh the 80’s in Oklahoma. Banks were giving properties away. You couldn’t finance anything. You had to pay cash. I sold a 12-plex for $30,000, a nice 4-plex for $10,000, and a 20,000 sf office building for $125,000. Investors from California with cash were buying them up and a few years later made a killing. It was nuts. I hope this isn’t going to be that bad.

  13. doug says:

    this is a time when you hunker down with no debt–yeah gold/silver will have its day but probably awhile aways…i really like Martin Armstrong’s blog–he calls it right-he says we are in a once in a 300 year cycle–my kids party on like there is no tomorrow–i feel for all the young people and old who will never get there retirement $$– its going to be ugly-moved to a small community and downsized my “look”-older house,older cars,etc.

  14. Barefoot Oil Hillbilly Gone Home says:

    I lived in Houston (not the icky suburbs) for 31 years. Yes, that’s right… IN Houston. I worked in the oil industry in a white-collar capacity for 31 years, so no I’m not a Pasa-Get-Down-Dena Redneck Billy Bob.

    That said, I’ve witnessed these up and down cycles all this time… and it’s the same ol’ same ol’ headlines, promises and predictions of big money and doom and gloom three and a half years up and three and a half years down.

    Having retired, I moved out of Houston in April 2015 and put my Tanglewood home of 18 years on the market. And there, it still sits, unsold. But I knew it probably would because fate had it that I chose the worst possible time to put a home for sale on the market. My neighbors don’t seem to digest the in financial pattern of this oil cycle because they are lost in the weeds. They question (demand) why oh why and harass me about selling my house on the cheap. I tell them, “I don’t need the money. I will wait until the price of oil goes back up.” And they look at me, aghast… “But it will NEVER go up. It will NEVER sell. The oil business is forever DOOMED!”

    It’s like listening to a broken record.

    “When there’s blood on the streets… BUY PROPERTY.”

    NOW is the time you should be dumping your seven-year money into real estate and other oil-related Houston investment options. Because in a short while, the headlines and attitude will read “But it will NEVER go down. It will ALWAYS sell. The oil business is forever WONDERFUL!”

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