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Navigating Through the Market Fallout of COVID-19

by In Market Reports, Tenant Representation, Tenant Tips Tagged , , , , , , , , ,

We have made some interesting observations during the last several market downturns. In
our current state of uncertainty, these observations may be helpful for commercial tenants
to navigate through the unexpected changes we are all experiencing.

1) Some businesses find that whatever real estate they had before a crisis will not be the real estate they need after it.

2) Rates drop partly due to the long-term nature of leases (5 years +/-) so rate adjustments often lag the “real” economy by 12-18 months.

3) “Blend and extend” arrangements that reduce space or monthly rental, but increase the overall obligation with a longer term may be beneficial to both landlords and tenants.

4) If you need to sublet excess space, don’t wait until the market is flooded with competition. Do it early, price it right, and get it off the books.

5) If a firm needs to raise capital for operations, a “sale-leaseback” may be a great option if its real estate is owned.

6) Construction will be impacted by both labor and supply issues. Planned projects may need to hold over or do short term extensions to manage through expected delays.

The current situation brings up several specific points to consider:

1) Outside the pending stimulus proposals and SBA loan programs, some governments may stop commercial evictions.

2) Force Majeure (“Act of God”) clauses may provide grounds for some tenants to temporarily suspend rent obligations but many Force Majeure clauses are too generalized to cover this kind of unprecedented event. Typically, rent will only abate if there is a fire or other casualty like a storm that results in the physical space no longer being usable for a period of time.

3) Business Interruption Insurance, which is called for in many commercial leases, may cover losses and pay for rent. Some even have a Civil Authority clause that could apply to government-imposed closures like those we have seen recently. The only certain remedy is to have “rent interruption insurance”.

4) There has been some talk in the commercial real estate world for an agreed-upon moratorium. This could mean a 30-60-day freeze on rent and mortgage payments.

Luckily, if you are in a difficult situation and need to free up cash, there may be some hope to get rent relief. Likewise, if you are in a good situation, a few months from now could be an ideal time to renegotiate. let’s allow landlords to focus on those tenants who need immediate help first. Keep in mind that the fallout from this and the oil markets could result in a tenant’s market later this year.

Each case will be addressed on an individual basis because every tenant, landlord, and lender situation is different. Here are the primary potential solutions:

1) Renegotiate and extend the lease term in exchange for a lower rental rate, reduced square footage, or both.

2) Abate or reduce your monthly rental without an extension, but pay it back at a later date.

3) Sublease or assign a portion of your space to a new company, almost certainly at a loss.

4) Negotiate a buy-out equal to a percentage of the remaining rental obligation.

5) Default on your lease.

 

Best wishes for you, your families, and your business teams during this interesting time.

 

Looking to move or expand your space? Contact Ryan Hartsell with questions or assistance to purchase
or lease commercial real estate in and around the Houston, Texas area.

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Houston Office Market Report: Mid-Year 2018

by In Market Reports, Office Tagged , , , , ,
Houston Office Market Report: Mid-Year 2018
Economic Indicators are Strong and Oil Market Continues Upward Trend.
Houston Office Market Update

As the 2017 calendar year came to a close, I noted the first glimpses of optimism within the Houston business community in a long time. The oil market was beginning to stabilize, and OPEC had recently announced an extension of its output restrictions through the end of 2018. Now, with half of 2018 in the rear-view mirror, we can safely agree on the fact that Houston’s office market has reached bottom. Growth is expected to occur slowly, and most in the commercial real estate industry admit that it may take 18+ months to backfill all the occupancy losses. Sublease space has continued to saturate the office market, especially in Q1 2018. In the 2nd quarter the available sublease space decreased by 700k sf and could mark a turning point. Tenant concessions are still quite strong across the leasing market, and it’s anticipated to remain a tenant-favorable environment through 2019.

The Strength of Oil & Gas

Today oil is trading consistently in the $65-70 per barrel price range, which is considered a comfortable price point for most in the industry. U.S. crude production has set new records on several occasions this year, most recently just a week ago reaching 11 million bpd. The U.S. rig count has consistently risen through H1 2018, and finally eclipsed the 1,000 mark for the first time since April 2015. There is certainly a feeling in the city that the oil market is back, and with it, the Houston economy. Of course this stabilizing market does not guarantee an immediate influx of hiring and job growth. Energy firms are beginning to hire, yet it is clear that new positions will be posted and filled cautiously on an as-needed basis. The trend prior to the most recent oil downturn was for energy firms to sign “large and long” lease agreements, and their hiring tended to follow suit. This time around we are noting a more measured approach to both hiring and leasing decisions.

Houston Office Market Report - By The Numbers

In the second quarter of 2018 the vacancy rate in the Houston office market decreased mildly from 16.7% to 16.5%. This equated to a net increase in occupancy of 202,720 sf for the quarter. With a total office market exceeding 325 million square feet, this rate yields upwards of 53-55 million square feet of vacant space citywide. When considering available space which is still occupied, but will soon be vacant, the rate exceeds 20%, or 65 million square feet. Despite a weak first quarter for Houston’s office market I do believe the bottom has been reached. Leasing activity seems to be trending upward, and there are a number of new start-ups and firms securing equity funding rounds at this time. Time will tell if this upward trend can continue, and if we will see any substantive reductions in the sublease market for H2 2018.

Rental rates decreased slightly in the 2nd quarter but are practically flat for the year. Across all building classes in Houston the average asking rental rate was $27.60 per square foot. Building owners have continued the strategy of providing more generous concession packages in the form of rental abatement, tenant improvement allowances, free parking, and other inducements as a means of avoiding rental rate reductions. We expect this to continue through the remainder of 2018.

The Houston office market now consists of over 326 million square feet of space and totals more than 9,000 properties. Class A buildings account for a staggering 45% of the total office market. Another 42% of the market is considered Class B, with the remaining 13% falling into Class C.

Houston Construction Activity

Commercial office construction activity remains light at this time, with only 2.6 million square feet in the works. Seven properties remain under construction in The Woodlands, accounting for 35% of the UC inventory in Houston. Overall, this construction space is 52% pre-leased at this time. Over half the properties currently underway will not deliver to the market until 2019. The construction activity for 2017 lagged behind the historical average of ~ 5 million square feet and 2018 will fall short of this number as well. As the market fundamentals begin to re-balance we expect to see an uptick in construction starts. The recent announcement by Hines that they will develop a new 47-story building on the former site of the Houston Chronicle is the first sign of this.

Best and Worst Performers

In the first half of 2018 three submarkets stood out for improved performance: Galleria/Uptown, The Woodlands, and the Katy/Grand Parkway area. Together these three submarkets accounted for over 700k sf of positive absorption. Overall, the South Main/Medical Center remains the strongest office submarket with a 4.1% vacancy rate, under-scoring the healthy performance of Houston’s medical industries. The Woodlands remains the strongest of the large markets at 9.1% vacant – well below the average. Sugar Land is a close second at 9.8% vacancy, and the FM1960/249 area is doing well at 10.4%, reflecting the fact that many Class B and C properties are managing to remain well-occupied.

On the other end of the spectrum we have Greenspoint/N Beltway, Houston CBD, the West Beltway, and Westchase submarkets rounding out the worst performers. Together these four submarkets accounted for over 1.3 million square feet of vacancy increases. Another 1 million square feet of vacancy was lost across 19 other submarkets in Q2 2018. Greenspoint/N Beltway is now 47% vacant, followed by Post Oak Park at 27%.

Summary

IAs you’ve read in this Houston Office Market Report, the local economy has been improving of late, due in large part to the oil & gas market rebounding. There are some economic headwinds on the horizon globally and nationally for the United States which could affect demand for the oil & gas market. Most predictions are considering a 24-36 month time period for that slowdown to materialize. The flattening yield curve, tumultuous stock market, rising interest rates, and the threat of inflation are certainly on investors minds. Here in Houston locally, there is renewed optimism about the coming recovery for our economy. With that recovery will come stabilization of the office market, though we expect this to be a long, drawn out climb back to reasonable occupancy levels.

Click here to view the full Oxford Partners Q2 2018 report.

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Houston Office Market Report: Year-End 2017

by In Market Reports, Office Tagged
Houston Office Market Report: Year-End 2017
Houston Office 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.

Summary

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.

 

View and download the full report here.