Real Estate Indicators by HFF Research Analyst Bryan Strode in HFF's Houston office.
Like most major cities, Houston has had its fair share of market cycles; however, this most recent decline in the local economy’s growth rate that was caused by a steep drop of oil prices had put a heightened level of stress on the Houston office market. Fortunately, the energy sector turned the corner, and, paired with the ever-diversifying economic base, the Houston economy is buzzing again. With some of the highest employment numbers in Houston history, Houston’s employment base is growing at more than twice the national rate, which provides the office market with much needed positive momentum as we look toward the new year. Houston’s population and job growth have translated into early signs of improvement in office market fundamentals.
Houston’s economy is currently on pace to make 2018 another year to remember. In the 12 months ending September 2018, Houston created 128,700 jobs for 4.3 percent year-over-year growth, outpacing the overall state in year-over-year job creation by over 90 basis-points. By industry, Houston saw that Business and Professional Services, a sector most highly associated with “office-using jobs,” added 33,200 jobs. Business and Professional Services has consistently served as the top performer in overall job growth for Houston, and this brings Houston’s year-to-date job growth to 62,500, which is more than many other MSAs across the country have added throughout an entire year. The last time Houston added this many jobs through September was in 2012, when Houston added 118,800 total jobs.
Looking ahead, The Greater Houston Partnership forecasts that by 2045, Houston’s Gross Regional Product is expected to exceed $2.45 trillion, which is a 400 percent increase over Houston’s current Gross Regional Product of $490.1 billion. That same year, Houston is expected to have more than 10 million residents and five million employees. Currently, with more than three million employees, Houston already has more jobs than the lowest 35 states combined.
More than 6.8 million people call the Houston metro area home, making it the fifth most populous metro area in America. Houston’s economy is currently performing better than most other metro areas around the United States. With the job growth Houston is experiencing, expect to see improvements in the office market going forward. Fortunately, as Houston enters the fourth quarter of 2018, growth in the office market is beginning to mirror the growth in the Houston economy.
The much-anticipated turnaround in the office market is here. Asking rents, occupancy and absorption are each increasing across the metro area and across all building classifications. In the third quarter of 2018, Houston posted 1.138 million square feet of positive net absorption. This is a significant improvement compared to the negative net absorption of 1.118 million square feet in the first quarter of 2018 and the positive net absorption of 125,648 square feet in the second quarter of 2018. That brings Houston to positive 145,568 square feet year-to-date. This number may seem small for a city that has 328 million square feet of rentable office space but ending the year with a positive absorption number would be a tremendous step forward for Houston.
For the past 40 years, Houston has never had more than two consecutive years of negative net absorption. Keeping this trend in tact is achievable so long as absorption continues through the fourth quarter. These most recent absorption statistics signal that Houston has emerged from the 2014 downturn and a fundamental shift in the office market has occurred. This major shift in absorption has been seen all over Houston and not just an individual submarket; however, events such as ConocoPhillips taking occupancy of over one million square feet in Energy Center III and IV, McDermott consolidating into Energy Center V and Occidental purchasing the 1.2 million square foot former ConocoPhillips campus certainly help as these leases and purchases, while signed, will provide positive net absorption in future quarters.
The Houston office market is seeing more submarkets with positive absorption than negative absorption, something Houston has not experienced since the third quarter of 2016. Vacancy across Houston decreased 30 basis points in the third quarter of 2018 to 16.4 percent. The office construction pipeline has significantly decreased in 2018 as well. Only 82,882 square feet was delivered in the third quarter of 2018, down significantly from 579,115 square feet delivered in the first quarter of 2018. Houston is expecting 638,000 square feet to be delivered in the fourth quarter of 2018 and around 2.1 million square feet in all of 2019. Asking rental rates for available office space, across all classes, increased two percent to a gross rate of $28.44 per square foot. Much of this improvement comes from Houston’s employment growth along with the absence of major tenant move-outs.
As Houston continues to create jobs, the health of its real estate market will follow. The office market is on the mend, and property fundamentals across Houston are improving. Thanks to an ever-evolving economy and an improving oil and gas industry, Houston will continue this upward trend for the foreseeable future.
Bryan Strode is a research analyst in HFF’s Houston office where he is primarily responsible for providing extensive market reports, client presentations and deal-specific analysis for the debt placement and investment advisory groups.
Mr. Strode joined the firm in June 2018. Prior to joining HFF, he interned with Stream Realty Partners and Congressman John Culberson (TX-7) while pursuing his degree at Texas A&M University. He majored in agricultural economics and was awarded a faculty-nominated merit scholarship by the College of Agriculture Development Council.
Originally appeared in Texas Real Estate Business Magazine.