Houston Office Market Update:Vacancy Flat, Oil Market Strengthening
With the second half of 2017 coming to a close there has been a renewed confidence in the Houston market. Disruptions to global oil supply including a leak in the Forties Pipeline system in the U.K., Iranian protests, economic uncertainty in Venezuela, and reduced output in the Keystone pipeline in North America contributed to higher oil prices. These supply disruptions, along with OPEC’s agreement to continue the 2% output restriction through the end of 2018 helped push Brent and WTI prices into a $60-70 trading range. At the same time, the global economy has been strengthening which has pushed the demand higher and helped draw on crude inventories. Crude inventory stockpiles have consistently dropped week over week for nearly a quarter, leading Goldman Sachs to forecast a balancing of the market by mid-2018.
As reported in the Houston Chronicle at the end of December, a survey of oil executives found that most believed a trading price of $60-65 per barrel would drive new drilling in 2018. At least half the executives surveyed believed the US rig count would continue to climb. US oil production is already approaching 10 million bpd and some are claiming production records could be set for the US and Texas in 2018.
There is certainly an excitement and optimism in Houston around the improvement of the oil & gas market, and by extension, the Houston economy as a whole. Economic indicators for the US look good, and the stock market rally continues. However, there still remains a potential for sharp price corrections in the short term. Some have questioned the level of speculation in trading recently, and if any negative indicators were to surface it could lead to a swift drop in price. Worse, if US production continues to climb and new well drilling picks up, OPEC and Russia may decide to halt the production freeze prior to year end. These risks are ever-present, but with strong global economic growth and demand leading the way, 2018 may be a strong rebounding year for the city of Houston.
What This Means For Houston Office Market
The citywide vacancy rate rose in Q3 by 0.3% but improved slightly by year end to 16.3%. This improvement in vacancy rate, a positive 769k square feet of office space being occupied, represents the only quarterly improvement of 2017. Though the economic indicators are strong it is clear that the office market will take awhile to re-balance. Developers have largely avoided new office construction projects over the last two years. This has helped to avoid adding too much new space to an already saturated market. If the Houston economy can continue to strengthen through 2018 we could see an influx of new oil & gas startups. Some sublease space may be removed from the market as firms adjust their staffing needs in the face of a potentially bullish market. The largest of the industry may even consider hiring in key roles to support growth initiatives. The office market would benefit greatly from these developments, and we could see the vacancy rate finally begin to fall.
For now though, let’s take a look back at the previous two quarters of 2017 and where things stand today.
Best & Worst Performers
The overall Houston office vacancy rate dropped slightly from 16.4% to 16.3% at the end of 2017. Some of the submarkets to reduce vacancy rates in the fourth quarter include: Downtown Houston CBD, Sugar Land, FM1960/Champions, Energy Corridor, The Woodlands, Westchase, and the Medical Center. It is interesting to point out that the largest oil & gas heavy office areas of Houston all improved in the final quarter of 2017.
Some of the under-performing submarkets which again increased in vacancy include: Greenway Plaza, Katy & Grand Parkway West, NASA / Clear Lake, West Loop, and San Felipe / Voss.
What About Rental Rates?
The average rental rate across all Houston office buildings increased slightly from $27.60 to $27.76. Though a very minor increase, these rates are aligned with a slight improvement in vacancy rates. The completion of several Class A properties joining the market likely also contributed to the increase. There are still many deals to be made out in the market today, but lease expirations toward the end of 2018 and into 2019 may face a shifting market from the tenant’s favor to the landlord’s. Vacancies are still high though, and it will take time to fill all that space.
Houston Construction Activity
The year 2015 was a busy time for commercial construction in Houston. The 12.6 million square feet of office space delivered that year represented the largest amount of space to hit the market in one year since 1984. Unfortunately that timing also coincided with the beginning of the oil & gas downturn. Predictably in 2016 construction decreased significantly to 6.1 million square feet. Still this number was higher than 4 out of the previous 6 years – due mainly to projects already in progress during the start of the downturn. In 2017 the number was halved again, down to 3.4 million square feet delivered. Just under 2.5 million square feet of office space remains under construction today. About half of this space is already pre-leased to tenants. Capitol Tower in downtown Houston CBD accounts for 700k of the space under construction, and another 6 buildings in The Woodlands account for 700k more. The rest is distributed across various other Houston submarkets.
The talk all throughout 2017 centered around when the market would hit bottom. Finally we are seeing some indication that it may have been reached toward the end of the year. Entering 2018 we see strong economic fundamentals here in Houston, in the United States, and globally as well. The oil & gas recovery is just beginning, and there are several risk factors to watch including recovery of supply from recent disruptions, retracting of the OPEC production freeze prior to year end, and speculative trading which could cause an imbalance in the financial markets. The rapid increase in U.S. shale production will need to be watched closely as well. As crude inventories continue to decline we will all be watching for market equilibrium to occur. If oil can continue trading in the $60-70 price range consistently we believe hiring will begin and new companies will start-up. The words today are “cautious optimism”, and that probably describes the feelings of the majority of Houstonians very well.
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