Leasing activity plunges, availability & sublease space balloon
Office leasing activity in Houston in the first quarter plunged 25% from the already beaten-down levels a year ago, to 1.56 million square feet (msf), worse even than during the Financial Crisis, according to commercial real estate services firm Savills Studley.
That’s down 59% from the 3.8 msf of signed deals in the fourth quarter 2014, back when the oil bust was still considered a blip and hadn’t yet impacted the office market.
The availability rate rose by 4 percentage points from a year ago to 24.5%, or 47.4 msf for Greater Houston. A horrendous office glut! The availability for Class A buildings jumped by 5.3 percentage points to 26.5%, the “highest mark in more than a decade as sublease space continues to hit the market.”
There were large variations: In Houston downtown, where “only” half of the office space is occupied by energy and engineering firms, the availability of Class A buildings soared 5.7 percentage points during the quarter to 21.5%; but in the Katy Freeway sub-market, where about 90% of the office space is occupied by energy firms, availability hit 33.6%. In the Greenspoint sub-market, it hit a stunning 48%!
These are the effects of the collapse of the energy sector timed impeccably with a majestic construction boom.
Now companies are trying to unload empty office space. During the oil boom, “warehousing” empty office space for future growth was all the rage, even as a building boom promised massive additions of new space.
But once the bust hit, companies started laying off people, and offices emptied out, and “warehoused” empty space became an albatross. Since they can’t get out of their leases but are under pressure to cut expenses, companies are dumping this space on the sublease market, where it pressures the 8 msf of new construction that remains unleased.
Just over the course of the first quarter, sublease space soared 19%, to 9.16 msf, “boosted by new sublease blocks from Shell, Marathon, BHP Billiton, and Apache.” It’s up 124% from Q3 2014:
And there’s more gloom coming down the pike, according to Savills Studley:
In the meantime, it is not a matter of “if” but “when” more sublease space hits the market. Significant amounts of leased, but unused, “shadow” space should continue to open up as tenants move or shed space through mergers and acquisitions, downsizing, or bankruptcy.
The good news is that non-energy companies are picking up some space downtown:
Kirkland & Ellis signed on to be the anchor tenant at 609 Main, the Hines development that will deliver at year-end 2016. The firm, which will relocate from 600 Travis, finalized a lease for 62,000 sf. According to the Houston Business Journal, United Airlines will reportedly take 235,000 sf in the same new development rather than renew at 1600 Smith and 600 Jefferson.
But they’re simply vacating one space and moving to another. On a net basis for the Houston office market, it is a non-event.
And yet, net asking rents didn’t budge “as landlords tried to anchor their starting position in any potential lease negotiation.” But brokers are reporting an increasing gap between asking rents and signed starting rents, with some lease deals showing starting rents of $5 to $8 per square foot below asking rents — huge discounts as rents in Greater Houston average $29.75. And that’s “in addition to increased improvement allowances and rent abatement.”
So when is this pain going to be over? Not anytime soon, according to Savills Studley:
Although the price of oil may have finally found a floor – oil prices hovered between $35 and $40 per barrel for much of the quarter – there is no recovery in sight for the energy industry. The North American rig count sank to 450 by the end of the first quarter; according to Baker Hughes, this was the lowest count since tracking began in 1949 and marked an ominous drop of 56.2% from a count of 1,028 just one year prior.
Maintaining an oil price floor is pivotal in order to avoid an acceleration of weakening in the office market. However, the floor will likely be tested as equity markets remain turbulent and investors implement varying long- and short-term strategies that can spur fluctuation.
Whatever happens to oil production in the US isn’t the only factor. Other major producing countries, such as Iran, are increasing output and are adding to the glut. Then there’s “the economic slowdown in China and other emerging markets” that are curtailing demand:
So long as the world continues to contribute to a growing supply glut, the price of oil cannot rebound, and Houston’s energy employment will not return to previous levels.
Unemployment has already risen in Houston from 4.6% in Q4 2015 to 4.8% in Q1, “as employment gains in non-energy sectors failed to keep pace relative to energy losses.” Alas, it takes lots of new employees and contractors to fill all this vacant office space. And that’s just not happening anytime soon.
So who is going to get hit?
Construction companies and their workers as the construction boom collapses, and secondary industries supporting them. Real estate is highly leveraged, so a meltdown in the office market hits banks and bondholders. It hits REITs that hold these office buildings. It hits commercial mortgage-backed securities. The consequences of real-estate busts spread far and wide, but they take their time.
But a broadening commercial real estate bust is the last thing the US economy needs. Read… US Manufacturing Sinks Deeper into Mire, Sep. 2009 evoked
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– Yep. That’s what we Always will have. A credit boom “lifts all boats” and (office) construction is one of those boats. But the inevitable bust is now underway. It’s the same in the canadian oilpatch.
One of these days CEOs will realize that, as technology becomes more sophisticated, they can drastically shrink their administrative bureaucracies, and shrink the amount of necessary office space as well.
I think the next full-fledged recession is going to bring even more economic pain than 2008-2009…
You got that right Robert! Let alone CEO’s, one would imagine that the normal J6P out there with a laptop on his kitchen table could see the days of Meat Puppets, those of them fortunate enough to actually have a job of course, commuting to and from office parks in endless fuel guzzling traffic jams, concentrated into dedicated office buildings had reached its sell by date at least 2 years ago!
Davebee: I agree that many people could work from home, or really anywhere. I was told that was the direction we could expect when I started in the oil patch in the late 70s. I retired in 2010, still tethered to the central office. Maybe the paradigm will change this time.
It is happening but not because of any real foresight on the part of CEOs. Its due to the need to reduce overhead costs.
VB, how many CEOs are really doing their job running the company, looking through their workforce, operations, – and its layers of management – for efficiencies and so forth.
Those things don’t happen as much in expansionary environments as the incentives are cloudy at best. I think the focus is on getting a bigger piece of pie (i.e. growth). It is also really hard damn work making an organization run better – I bet few of todays CEOs are cut from a cloth that could even make that happen – it is much easier lying to the customers/clients, getting some friendly legislation past, or legislate your competition off the farm, and generally robber barroning – which is the cloth too many of our CEOs these days are cut from.
But, there will come a time when the expansion becomes contraction, and oh my is there layers and layers of waste to be mined. This is where I think CB’s really screwed the pooch – we need the downturns to have motivation to muck the system so to speak. And has the muck been piling up with all this mana from heaven, so they are guaranteeing the first real downturn to come along that they can not game will be significantly compounded and subsequently more extreme/amplified.
To be clear, when genuine contraction starts to happen – someone, somewhere will figure out there are many fat layers of administration/bureaucracy/infotech/etc and it will get streamlined – and it will get quickly emulated once it is shown to provide results.
I expected it by now to be honest, so perhaps there is consolation for those who disagree in the fact that, to date, I have been wrong on this point. This has been very long overdue in the info tech space, at corp offices and such, for a long time – I have seen some very poorly managed teams and organizations – but perhaps my experience was an outlier.
Without a doubt Bob the next collapse is going to be biblical in nature Got gold?
My work office is in Santa Clara, CA. The commercial contruction is stupid and off the chart. Older single or two story office buildings are being torn down for multi story buildings. In the meantime there are plenty available signs. What could possibly go wrong.
Oh and I am an AM radio listener. Supposedly the Houston Housing market is “on fire” (per the housing shills). I suspect if commerical real estate in houston is fading, private real estate is not far behind. But what do I know.
Maybe they’re doing re-runs on the radio – because Houston housing WAS on fire. Friend of mine and commenter here sold his house in one day after putting it on the market. But that was a little while ago. From what I heard, the market is decidedly no longer on fire.
The Houston construction industry may get a slight boost from the recent massive floods in the city. Last week they got over 10 inches of rain in a day and the water seem to cover the entire city. The said it was a once in 500 year flood. And it keeps raining every few days. When it rains it pours.
You must have been reading the puff sheet reports. The rain levels were around 17 inches. Usually we get about one major storm with over 15 inches max about every 3 years. Once in 500 years is a joke.
But still it was a “minor” storm. Not like the 42 inches a while back that hit a suburb (Alvin) where the weather bureau is located. And all this on a community that slopes one foot per mile. Those underpasses that were dug out to move traffic are death traps when it rains.
That said, for the first time we ended up filling the Barker and Addicks dams that were created in West Harris county after the big 1939 flood that swamped Buffalo Bayou and downtown Houston.
Maybe Texas would benefit from effective public investment in flood control and water impoundment systems. Ramp down those repair and cleanup costs and convert all that destructive waste into a productive resource. The catch is that you’d have to tax the rich to do it, and besides, it would smell like socialism.
Forget I said anything.
Retention ponds – that was why Addicks and Barker were built in 1939 and never filled until this year.
We are drained by 5 major bayous. Usually when it rains only one bayou is the target of the downpour. And there is no way in the world that you can drain off a city of several thousand square miles of flat land in a system of what could be considered a couple small creeks that have a slope of less than 1 foot per mile.
Our problem is that we were inundated with Yankees looking for jobs when the Rust Belt went belly up and converted all our valuable rice field into housing tracts. As we joked , my high school classmate’s families grew rich raising the best crop they ever had, Houstonians.
The truly wealthy did build those retention facilities that you talk about. Those were the dams I mentioned that protected Buffalo Bayou. It is the new comers who do not want to pay to fix the problem with Cypress, Spring , White Oak and Braes bayous. Not that there is a realistic solution, other than requiring that each house be built 3 feet above the surrounding land.
Houston is FLAT.
My old man has a saying when folks ask him how old he is – he usually replies “three hundred and seventy X” (where X is his actual age).
When they ask why, he says he has lived through a hundred year ice storm, a hundred year flood, and a hundred year snow storm. Notice how this term is thrown around all the time now – implying it won’t happen again.
My sister was living in Houston back in the late 90s, but it could have been the early 00s. Anyway, exact same thing happened then. She was working for SeaRiver at the time I think and sent out a slide show of the mess. One of the pictures looked like a LA bayou with overpasses coming out of the water (and not much of the overpasses at that).
They can call this a X year flood if they want, but the reality is people are building in living in areas that do not have sufficient drainage.
The drainage plan for metro Houston is those things called “streets” and those little bayous that swing though the area. If you try to fill a 20 foot depth of bayou with the water from several square miles of homes you will have a little bit of wetness left over. And rare is the home that is more than 12 inches higher than the curb.
At 70 I have seen all sorts of water foolishness. From Dan Rather trying to be the brave reporter by standing up to hurricane Carla on the seawall at Galveston (the hurricane landed over a hundred miles to the south)(but devils advocate time — after traveling 150 miles the storm had enough energy to take out the anemometer that we had just installed on the roof of my high school at 130 mph). And then we had the rush hour storm that flooded about 10 miles of a major freeway that was way below the surrounding land thus serving as a “drainage” path to the shock of hundreds of motorists.
Texas weather is legendary. Consider that the Texas Revolution was fought through 2 months of almost continuous rain (and most of our 40 some odd inches of rain occurs in February and March.) The 186 men who lost at Alamo were able to take out a quarter of Santa Anna’s army. Tactical loss / Strategic Victory. Most of the losses at San Jacinto were due to the Mexicans drowning in the swollen bayous. (And the less said about the West Point “hero” at Goliad who set up his defense at a point with no drinkable water, the better.) Just the exciting difference between rain every day and the occasional 15+ inch down pours in the other months.
Of course nothing was more fun that seeing everybody in southeast Texas try to flee hurricane Ike. The traffic jams lasted days and the number of cars out of gas was a logistical nightmare. And the only people who really had to move were those living EAST of the 610 loop. (ie the places that were less that 10 feet above sea level). But the vast majority of Houstonians are Yankees and have no idea what a hurricane is like and take the weatherman’s word for head to high ground (which is several counties to the West)
I don’t want to be a copy editor, at least not for free, but in the eighth paragraph, it’s up 124 percent from Q3 2014, not 2015.
While i should be paying more rigorous attention to the errors of my own ways, i thought I’d share this time.
Otherwise, an interesting article about a specific local market. I wonder if and how it will reverberate in the country.
Thanks, Steve. I always appreciate a free copy editor – because I need won :-]
In response to your final musing, I’m looking into the office market in San Francisco … first signs of cracks in the foundations.
Would love to see that lefty-mayor get taken down in it!
Houston tycoons have enjoyed their bubble, but now it’s time to pay for it. By non-tycoons.
Maybe they can get Ireland to bail them out. It’s the richest country in the world.
Houston’s tycoons built the Addicks and Barker dam retention ponds after the 1939 floods along Buffalo Bayou. Thus protecting River Oaks and The Memorial areas as well as protecting the under class who lived in the First, Second, Third, Fourth, and Fifth Wards. This protection was built into the price of their homes.
But then Houston was a small town of only 100,000 pre WW2.
In the 50s and onward the town grew out into the boondocks where our rice production used to be. So now Greater Houston is around 4 million.
The builders were those big national construction firms that buy a plat of land develop it while it is dry weather and sell the homes to suckers who want low cost housing. Definitely not the Tycoons.. So after a few years the rich Yankee builders are sitting with their profits and the Yankees that came down here are sitting with a foot of water in their living room.
Why in all fairness should the wealthy owners along Buffalo Bayou have to pay for the new drainage improvements. They already paid for their own plus those of the inner city. In a fair world we should tax the rich Yankee builders who built substandard facilities. Or at a minimum tax the owners of the houses built in the flood plains.
“Why in all fairness should the wealthy owners along Buffalo Bayou have to pay for the new drainage improvements.”
Glad you asked. It’s because they derived the most benefit from the boom and will derive the most benefit from the infrastructure improvements. Besides, it’s pretty useless to tax people who don’t have any money. Don’t worry. The rich seem to get richer no matter how much you tax them.
While you’re deciding, take a look at the Netherlands, which is half under sea level and still manages to stay dry. Are you prepared to admit that your much-vaunted capitalism is unable to match the achievements of modern socialism? Or do you prefer to stay underwater and try to compare favorably with Bangladesh? If recurring cleanup costs and lost resource opportunity really are preferable then simply accept destructive flooding as a part of the non-solution.
Oh for the love of God! The Netherlands are among the INVENTORS of capitalism! And serious practitioners today. They were developers of modern banking going back to the 14 hundreds and as an early sea faring trading nation (butting heads with the Brits) co-developers of futures and the corporation itself. Royal Dutch Shell is today the largest but they have many.
Their dikes were built by companies, paid with taxes. The fact that a country has roads, etc. doesn’t make it ANY political stripe.
Re: the New Orleans flood. I can’t believe that more attention hasn’t focused on the incredibly chintzy levees- crappy earth dams about 12 wide with a steel topper stuck into them.
They’re like something a prosperous farmer would build for a water retention pond.
Built by any regime they were a joke.
“The builders were those big national construction firms that buy a plat of land develop it while it is dry weather and sell the homes to suckers who want low cost housing.”
Just a guess, but maybe you should have taxed those firms to pay for infrastructure and set restrictions on them, instead of letting them go hog wild and leaving you with a mess down the road.
Regulation is your friend. It can help you make sure good things happen and bad things don’t.
At this point, I have to say something nice about Florida. The water management system in south Florida is excellent. Every development has a retention pond and they are all connected somehow. Most Floridians consider it a super highway for the alligators, but it works. It is very expensive and everybody pays for it. I survived at least 5 hurricanes without getting my floors wet.
With all this talk about floods, I see why pickup trucks are a practical choice.
Central Florida eventually caught on. I had a period of about 7 years where I averaged site work on about 550 houses a year. This was part of my business. I obtained & kept this business due to giving a guarantee to the builders I worked with that if they set their finish floor elevations to achieve a minimum of 1% fall, I would guarantee/warranty drainage issues. Throughout that entire period I spent 0$ on marketing. My work sold itself.
This worked like a charm as most builders & their supers really didn’t have a clue regarding setting up proper finish floor elevations. They relied on the garbage engineering provided to them by clueless civil engineering firms or used 50 year old techniques that didn’t work.
Towards the end of this period, the various counties & cities in the area eventually found religion & made 1% or 1 1/4% drainage for residential sites part of the local codes. Some cities (Winter Park) went further & you had to have X amount of water retention on every lot which was always a challenge on the normally small lots. Then 2008 came. I miss those years of making serious coin. Gotta go busk on the street corner with my guitar now :-)
The CEO of UBS bank was on Bloomberg last night to speak about the 60% drop in profit. The outfit has a big wealth management unit.
He said there was so much uncertainty out there that the clients weren’t trading- they were ‘paralyzed’
I am in HOU. I have been doing some early investigative work around a possible move and new lease for my company – non-energy and relatively small space at 10k to 12k feet. I came across an ad for class A space sublet at $0 base rent for the remainder of the term – that’s right: $0 base rent. OPEX only.
A broker told me that a couple of years ago during the peak of the boom he saw tenants doing crazy deals – 20 year terms, no outs, etc. There was a euphoria coupled with paranoia that had big companies (energy mostly) locking up unreasonable amounts of space. That is where the huge chunks of sublease are coming from.
Maybe you can take a look at the office building binge in Silicon valley. In Santa Clara and north San Jose is ridiculous.
If you take central express way from Palo Alto to San Jose Airport all along the way you see brand new construction on both sides. Also if you detour towards North 1st SJ…. construction is crazy… they’re knocking down all the 70s 1 or 2 stories and building 7 story towers…
SF is first … coming in a day or two.
Good idea about Silicon Valley. I’ll check into it.
“low rates stimulate”
at some point, a rest is necessary.
I don’t remember the exact number, but something like one sixth of the entire nations new commercial property was built in Houston last year (or so). Just think of that.
How could it not go bad?
Lance Roberts has all of these statistics. He can fill you in.