OVERVIEW Sublease Space Spills Back Over 9.0 Million SF The Houston office sector is off to a slow start in 2018 as the market continues to find its footing following the energy downturn and recent construction cycle. Direct vacancy and availability rates both saw increases over the quarter. Vacancy rate increases were due to a combination of downsizing tenants, subleases expiring and tenants vacating direct space for sublease alternatives. Availability was pushed upwards by new sublease offerings on the market. After dropping to 8.7 million SF, sublease space spilled back over 9.0 million SF in the first quarter as Technip put up 375,000 SF (Energy Corridor) and Hess Energy added 123,000 SF (CBD) as the year ended. Additional energy related sublease offerings are anticipated to come online as the year progresses. The first quarter saw several large renewals, led by Apache's extension of 524,000 SF in Post Oak Central, further postponing any potential for their long-discussed build-to-suit project. Also of note, Williams renewed for 353,944 SF in Williams Tower (Galleria/Uptown). Market fundamentals are likely to soften further through the first half of the year as additional fallout continues to avail itself. However, an uptick in the second half of the year is anticipated as sustained oil prices begin to translate into job growth. Furthermore, the long-term outlook on Houston remains bright, underscored by the heightened level of investor activity in the market. HOUSTON OFFICE MARKET FIRST QUARTER 2018 REAL ESTATE OUTLOOK Office Market Off to a Slow Start in 2018 Direct Vacancy and Sublease Supply Rise NET ABSORPTION AND VACANCY RATE TRENDS HOUSTON METRO AREA CONTIGUOUS BLOCKS OF AVAILABLE SPACE HOUSTON METRO SOURCE CoStar, Transwestern *Through Q1 2018 SOURCE CoStar, Transwestern *At Q1 2018 Note: Delivery of preleased space counts as positive net absorption Notable Q1 Leases TENANT SF LEASE TYPE BUILDING SUBMARKET Apache Corporation 524,342 Lease Extension 1990 & 2000 Post Oak Blvd Galleria/Uptown Williams 353,944 Renewal Williams Tower Galleria/Uptown Dashiell Corporation 79,308 Renewal/Expansion 12301 Kurland Dr Gulf Freeway/Pasadena Hunting Energy Services 62,137 Renewal 16825 Northchase Dr Greenspoint/N Belt West PFS Group 54,891 Renewal 2600 N Loop Fwy W North Loop West NextEra Energy 50,283 Renewal 601 Travis CBD -4000 -3000 -2000 -1000 0 1000 2000 3000 4000 5000 6000 7000 8000 Net Absorption 18* 17 16 15 14 13 12 11 10 09 08 07 5% 10% 15% 20% 25% Total Availability Direct Vacancy In Thousands 0 50 100 150 200 Class A Sublet Class A Direct 200,000 SF 100,000 SF 50,000 SF 25,000 SF Class B Sublet Class B Direct
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REAL ESTATE OUTLOOK HOUSTON OFFICE MARKET Availability Continues to Decline as Co-Working Rises The Houston office market ended 2017 on a strong note, as total availability declined
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OVERVIEW
Sublease Space Spills Back Over 9.0 Million SF The Houston office sector is off to a slow start in 2018 as the market continues to find its footing following the energy downturn and recent construction cycle. Direct vacancy and availability rates both saw increases over the quarter. Vacancy rate increases were due to a combination of downsizing tenants, subleases expiring and tenants vacating direct space for sublease alternatives. Availability was pushed upwards by new sublease offerings on the market. After dropping to 8.7 million SF, sublease space spilled back over 9.0 million SF in the first quarter as Technip put up 375,000 SF (Energy Corridor) and Hess Energy added 123,000 SF (CBD) as the year ended. Additional energy related sublease offerings are anticipated to come online as the year progresses.
The first quarter saw several large renewals, led by Apache's extension of 524,000 SF in Post Oak Central, further postponing any potential for their long-discussed build-to-suit project. Also of note, Williams renewed for 353,944 SF in Williams Tower (Galleria/Uptown). Market fundamentals are likely to soften further through the first half of the year as additional fallout continues to avail itself. However, an uptick in the second half of the year is anticipated as sustained oil prices begin to translate into job growth. Furthermore, the long-term outlook on Houston remains bright, underscored by the heightened level of investor activity in the market.
HOUSTON OFFICE MARKETFIRST QUARTER 2018
REAL ESTATE OUTLOOK
Office Market Off to a Slow Start in 2018Direct Vacancy and Sublease Supply Rise
NET ABSORPTION AND VACANCY RATE TRENDS HOUSTON METRO AREA
CONTIGUOUS BLOCKS OF AVAILABLE SPACE HOUSTON METRO
SOURCE CoStar, Transwestern *Through Q1 2018
SOURCE CoStar, Transwestern *At Q1 2018
Note: Delivery of preleased space counts as positive net absorption
Notable Q1 LeasesTENANT SF LEASE TYPE BUILDING SUBMARKET
Apache Corporation 524,342 Lease Extension 1990 & 2000 Post Oak Blvd Galleria/Uptown
Williams 353,944 Renewal Williams Tower Galleria/Uptown
Dashiell Corporation 79,308 Renewal/Expansion 12301 Kurland Dr Gulf Freeway/Pasadena
Hunting Energy Services 62,137 Renewal 16825 Northchase Dr Greenspoint/N Belt West
PFS Group 54,891 Renewal 2600 N Loop Fwy W North Loop West
NextEra Energy 50,283 Renewal 601 Travis CBD
-4000-3000-2000-1000
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NET ABSORPTION
Absorption Stays in the RedThe office market continues to experience fallout from the energy downturn with negative absorption of 946,738 SF for all classes of space over the first quarter. Class A absorption was negative 343,853 SF and Class B space recorded negative 549,406 SF. There were several large move outs that occurred during the first quarter that drove negative absorption. United Airlines vacated 200,000 SF (1801 Smith, CBD) followed by NRG at 145,000 SF (1000 Main, CBD), Baker Hughes at 128,000 SF (America Tower, Midtown) and Cameron at 128,000 SF (Westway One, West Belt). The first half of 2018 is likely to experience additional negative absorption as 1.0 million SF of sublease space is set to expire over the balance of 2018. It is anticipated that absorption will start to see a rebound in the second half of the year as higher energy trading prices begin to result in office using job growth.
DIRECT VACANCY & TOTAL AVAIL ABILIT Y
Hess and Technip Push Availability UpwardsThe overall office availability rate (all space marketed as available for lease, both direct and sublet) increased 0.5% over the quarter, closing Q1 at 23.2%. After seeing a decrease in sublease space towards the end of the year, sublease space jumped back over 9.0 million SF at the close of the first quarter. This was driven by Technip listing 375,000 SF of space on the sublease market in Energy Tower II (Katy Freeway West, Class A) and Hess putting an additional 123,000 SF online in 1501 McKinney (CBD, Class A). Class A availability was 25.1%, up from 24.1% at the close of 2017 and Class B total availability was 21.7%, unchanged quarter-over-quarter.
Overall direct vacancy saw a 0.5% increase over the quarter ending at 15.9%. Class A direct vacancy closed the quarter at 15.8%, up 0.5% over the quarter. Class B direct vacancy increased by 0.6% over the same period, ending the first quarter at 16.9%. With 1.0 million SF of sublease space set to expire by the end of 2018, direct vacancy will continue to increase over the course of the year.
RENTAL R ATES
Rents Increase Over Q1Overall asking rates for the Houston metro area increased slightly over the quarter to $30.99 PSF full service as compared to $30.66 PSF full service at the end of 2017. Rental rates for both classes of space saw an increase in the first quarter. Class A rental rates increased 1.1% to $36.26 PSF full service and Class B rates increased 0.3% to $21.81 PSF full service. Despite the recent increases in rental rates, the market remains in the tenants favor as generous concession packages continue to be offered. The submarkets with the highest full service asking rents are the Central Business District (Class A - $44.64 PSF), Katy Fwy East (Class A, $40.77 PSF), and Greenway Plaza (Class A - $39.60 PSF). The most value friendly Class A submarkets include Northwest Far ($19.58 PSF), Southwest/Hillcroft ($19.89 PSF) and Southwest/Beltway 8 ($21.10 PSF).
Office Under ConstructionHouston Metro | Q1 2018
SUBMARKET NUMBER OF BLDGS SF % PRE-
LEASED
CBD 1 778,344 32%
Woodlands 3 704,800 97%
Total 4 1,483,144 63%
AVERAGE OFFICE RENTS HOUSTON METRO AREA
SOURCE CoStar, Transwestern *Through Q1 2018 Note: All classes of office space
Build-to-Suit Projects Driving ActivityConstruction activity continues to dwindle in the Houston market following the close of the recent development cycle. High availability and increasing vacancy have developers hesitant to build without a significant prelease commitment. At the close of the first quarter, the construction pipeline totaled 1.5 M SF as 63% preleased. Currently, there are four developments under construction which include Capitol Tower (CBD, 778,000 SF - 32% leased to Bank of America and Quantum Energy), CityPlace 2 (The Woodlands, 326,000 SF - 100% Leased to ABS) and HP's Build-to-Suit Campus (The Woodlands, two-189,000 SF buildings).
Three deliveries occurred in the first quarter, the most notable of these was the Kirby Collection, a 246,989 SF mixed-use property in Greenway Plaza delivered at 44% preleased. Tillman Fertitta’s, The Post Oak a 104,579 SF mixed-use property in Galleria/Uptown delivered at 68% preleased. Also of note, Grandway West IV a 72,045 SF building in Katy Far West delivered at 93% preleased. Despite the vast amount of space on the market, potential exists for an additional 3-4 buildings to break ground over the year as tenants remain enamored with new construction given the efficiencies, amenities and ability to impact employee retention.
INVESTMENT MARKET
Investors Keep Eyes on Houston Sales were robust for the quarter totaling $715.7 million, driven largely by the closing of several notable portfolio sales. Brookhollow Central (3-building campus totaling 797,971 SF) was purchased by Hertz Investment Group for approximately $70.5 million. Other notable transactions include, Loop Central's acquisition by Griffin Partners (3-building portfolio totaling 575,000 SF, undisclosed price) and The Offices at Pin Oak Park's acquisition by Norvin Healthcare Properties (5-building portfolio totaling 504,721 SF, $110.0 million). These figures represent assets for which pricing information could be obtained.
COMPARATIVE OFFICE INVESTMENT SALES VOLUME SELECT METRO AREAS
SOURCE Real Capital Analytics, Transwestern ,*Through Q1 2018
AVERAGE OFFICE SALE PRICE HOUSTON METRO AREA
SOURCE Real Capital Analytics, Transwestern,*Through Q1 2018
Notable Q1 TransactionsBUILDING SUBMARKET SF SALE PRICE SELLER BUYER
Brookhollow Central(3-bldg Campus) North Loop West 797,971 $70,500,000 Parmenter Realty Partners Hertz Investment Group
The Offices at Pin Oak Park (5-bldg Campus) Bellaire 504,721 $110,000,000 Griffin Partners Norvin Healthcare Properties
One Northwest Centre Northwest Far 151,835 N/A Boxer Property ManhattanLife
SOURCE Real Capital Analytics, Costar, Transwestern
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REAL ESTATE OUTLOOK HOUSTON METRO Q1 2018 3
Investors are maintaining a watchful eye on the Houston office market as the long-term outlook of the city is highly desirable. Of particular interest are well located urban infill properties that can be renovated to compete alongside new construction. While distressed assets are always of interest to investors, this ownership cycle has been well capitalized and able to weather the downturn. However, as sublease space converts to direct space pushing vacancy ever higher, fatigue could begin setting in.
OUTLOOK
Despite Speed Bumps, Future Still BrightThe Houston office market has had its fair share of turbulence over the past few years as it begins to recover from the impacts of a hurricane and the downturn of the energy market. The Houston economy has seen diversification outside of the energy sector resulting job growth, but it hasn't translated to office using employment. However, with energy prices sustaining in the low-mid $60s and the professional and business services sector picking up steam (9,700 jobs created in the first two months of 2018), the office sector could begin to experience a slow and measured recovery starting in the second half of 2018 and on into 2019.
While office market fundamentals may weaken in the short term with over 1.0 million SF of sublease space set to expire, the long term outlook for the Houston market remains strong. This prognosis is underscored by the heightened investment activity in the market with major transactions such as Houston Center, Brookhollow Central and Greenway Plaza changing hands. Look for job growth to become more robust throughout the year with office using employment trending upwards in the second half. As it stands several employers are already in expansion mode such as Amazon, SABIC, Zenith Energy and KPMG. Look for this list to increase as more companies right their books on the backs of $60 oil.
Multi-tenant market vs Transwestern comprehensive market coverage
MULTI-TENANT ENTIRE MARKET
Inventory 198.6 MSF 241.0 MSF
Total Availability 22.0% 23.2%
Q1 2018 Net Absorption (813,083) SF (946,738) SF
WHY OUR METHODOLOGY IS THE BEST INDICATOR OF CURRENT MARKET CONDITIONSWe include owner occupied and single-tenant buildings in our inventory, vacancy and absorption statistics to capture more market activity than many of our competitors. This allows us to better correlate changes in the market with changes in employment. As single-tenant space does compete with multi-tenant space, we believe it is critical to understand all components of the market. The inclusion of single-tenant and owner-occupied space tends to yield lower vacancy rates and higher absorption totals than some of our competitors’ results, but our coverage of the market is more comprehensive.
OFFICE ABSORPTION AND EMPLOYMENT HOUSTON METRO AREA
SOURCE Bureau of Labor Statistics, Transwestern *12-month job growth through Feb 2018, net absorption YTD through Q1 2018
NOTE Includes buildings 50,000 SF RBA and greater; does not include buildings under construction or owned by the government
* Total Availability represents all space currently being marketed for lease (Direct, Sublet, Under Construction and delivering within 12 months) regardless of vacancy.
Includes buildings 50,000 SF RBA and greater; does not include buildings under construction or owned by the government.
* Total Availability represents all space currently being marketed for lease (Direct, Sublet, Under Construction and delivering within 12 months) regardless of vacancy.
6 REAL ESTATE OUTLOOK HOUSTON METRO Q1 2018
HOUSTON METRO MARKETFIRST QUARTER 2018
SOURCE CoStar, Transwestern
NOTE Includes buildings 50,000 SF RBA and greater; does not include buildings under construction or owned by the government
* Total Availability represents all space currently being marketed for lease (Direct, Sublet, Under Construction and delivering within 12 months) regardless of vacancy.
Availability Continues to Decline as Co-Working Rises The Houston office market ended 2017 on a strong note, as total availability declined for the second straight quarter, the investment market remained hot, and WTI crude prices settled above $60 per barrel. Despite absorption remaining negative for the fourth quarter, citywide availability declined by 0.5%, ending the year at 22.8%. This change was largely attributable to the reduction in sublease supply (-900k square feet) as tenants Motiva (Saudi Aramco), Stewart Title, Empyrean Benefits Solutions, and several others opted for sublease alternatives. At the end of the year, sublease space totaled 8.9 M SF with 1.3 M SF set to expire over the next 12 months. Late year activity also saw the rise of co-working space throughout the market. Several providers such as WeWork, Spaces, The Cannon and The Work Lodge announced or opened locations, pushing co-working space totals past 500k SF with both urban and suburban alternatives. The quick expansion of co-working space has both providers and landlords taking notice. In December, Brookfield Properties and Onex made an indicative proposal on IGW, the holding company of Regus and Spaces, as Brookfield Asset Management looks to gain a foothold in the co-working market. Additionally, Servcorp, announced that they will pivot into a co-working strategy in order to capitalize on the trend.
NET ABSORPTION
Quarterly Absorption Flat After Down YearCumulative annual absorption totals of negative 3.9 million square feet highlight the delayed impacts of the energy downturn. However, the
HOUSTON OFFICE MARKETYEAR-END 2017
REAL ESTATE OUTLOOK
Office Market Signals RecoveryThe Rise of Co-Working in Houston
NET ABSORPTION AND VACANCY RATE TRENDS HOUSTON METRO AREA
CONTIGUOUS BLOCKS OF AVAILABLE SPACE HOUSTON METRO
SOURCE CoStar, Transwestern *Through Q4 2017
SOURCE CoStar, Transwestern *Through Q4 2017
Note: Delivery of preleased space counts as positive net absorption
Notable Q4 LeasesTENANT SF LEASE TYPE BUILDING SUBMARKET
Motiva (Saudi Aramco) 173,000 Sublease Two Allen Center CBD
Stewart Title 156,151 Sublease 1360 Post Oak Galleria/Uptown
Empyrean Benefits* 106,904 Sublease 3010 Briarpark Dr Westchase
Talos Energy 98,000 Relocation/Expansion Three Allen Center CBD
TransCanada 82,916 Expansion Bank of America Center CBD
-4000-3000-2000-1000
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171615141312111009080706 5%
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200,000 SF100,000 SF50,000 SF25,000 SF
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* Empyrean leveraged sublease alternative with minimal remaining term to execute direct deal.
fourth quarter saw negative absorption of only 51,628 SF. This represents a marked improved over the recent quarter totals of -2.1M SF (1Q 2017), -1.1 M SF (2Q 2017), and -0.6 M SF (3Q 2017). Class A absorption for the fourth quarter totaled -86,067 SF, bringing the 2017 annual absorption for the property class to -3.1 M SF. Class B absorption for the fourth quarter was positive 82,959 SF with Class B annual absorption totaling negative 791,000 SF.
DIRECT VACANCY & TOTAL AVAIL ABILIT Y
Total Availability Declines, Vacancy IncreasesThe overall office availability rate (all space marketed as available for lease, both direct and sublet) decreased 0.5% over the quarter, ending the year at 22.8%. The fourth quarter saw several tenants (Stewart Title, Empyrean Benefits Solutions and Saudi Aramco) opt to leverage sublease alternatives. In total, sublease supply decreased by 894,000 SF over the quarter. Class A availability finished the year at 24.0%, down by 0.4% over the quarter. Class B availability decreased by 0.7% over the period, ending the year at 22.2%.
While decreases in sublease space triggered declines in availability, vacancy continued to rise over the quarter. Overall direct vacancy ended 2017 at 15.5%, increasing by 1.7% year-over-year. Class A direct vacancy ended the year at 15.2%, up 2.1% annually and 0.1% over the quarter. Class B direct vacancy increased by 1.1% year-over-year, ending 2017 at 16.7%. With 1.3 million SF of sublease space set to expire over the next 12 months, direct vacancy is anticipated to continue increasing through the first half of 2018. This is especially pronounced in the North Houston District where 868,845 SF is set to expire by end of year 2018.
RENTAL R ATES
Asking Rates Level OffOverall asking rates for the Houston metro area decreased marginally over the quarter, finishing 2017 at $30.59 PSF full service. Class A rates declined by 1.9% over the year, closing at $35.83 PSF full service, while Class B asking rates declined by 4.0%, ending at $21.78 PSF full service. Though there are signs of improvement, the market remains firmly in the tenants favor with credit grade tenants able to attain generous concession packages. The submarkets with the highest gross asking rents are the Central Business District (Class A - $45.17 PSF), the Katy Fwy East (Class A, $42.41 PSF), and Galleria/Uptown (Class A - $39.26 PSF).
SUPPLY AND DEVELOPMENT
Construction Pipeline After the delivery of 33.0M SF over the past seven years, construction activity has slowed greatly. Considering the number of large blocks and total space available for lease, developers are wary of additional speculative construction. Still, as tenants strive to retain talent and attain efficiency both in their space footprint as well as their operating expenses, the potential for additional construction tethered to a lead tenant or build-to-suit remains in play. At year end, the Houston area
Office Under ConstructionHouston Metro | Q4 2017
SUBMARKET NUMBER OF BLDGS SF % PRE-
LEASED
CBD 1 778,344 32%
Woodlands 3 704,800 97%
South 2 300,000 7%
West Loop 1 104,579 70%
Kingwood 1 100,000 0%
FM 1960 1 73,000 100%
Katy 1 72,045 51%
Total 7 2,032,768 67%
AVERAGE OFFICE RENTS HOUSTON METRO AREA
SOURCE CoStar, Transwestern *Through Q4 2017 Note: All classes of office space
Total Available SpaceHouston Metro | Q4 2017
SUBMARKETSUBLEASE SPACE (SF)
% OF SUPPLY
% TOTAL AVAILABLE
CBD 2,067,450 4.7% 18.4%
Katy Fwy West 1,924,169 7.2% 26.3%
Westchase 1,445,315 8.2% 28.0%
West Loop 932,700 2.7% 12.8%
N Houston District 905,617 7.0% 14.2%
All of Houston 8,935,719 3.7% 16.2%
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2 REAL ESTATE OUTLOOK HOUSTON METRO Q4 2017
HOUSTON METRO MARKETYEAR-END 2017
construction pipeline totaled 2.1 M SF with 33.0% available for lease. Houston's largest office developments currently under construction are Capitol Tower (CBD, 778,000 SF - 27% leased to Bank of America), CityPlace 2 (The Woodlands, 326,000 SF - 100% Leased to ABS) and HP's Build-to-Suit Campus (The Woodlands, two-189,000 SF buildings). Notable fourth quarter deliveries include The Kirby Collection, a mixed-use project with a significant office component (Greenway Plaza, 188,547 SF, 21% leased) and Members Choice Credit Union (Katy Fwy West, 86,265 SF, 62% leased).
INVESTMENT MARKET
Investments Rebound Sharply Over 2017 Houston investment activity rebounded sharply in 2017, as annual sales totaled $3.8 billion, marking the highest total since registering $4.6 billion in 2013. Regardless of elevated vacancy figures, the strength in the underlying fundamentals of the market have investors buying into Houston's future. Of particular interest to investors are well located urban infill properties with upside available through renovation and lobby/service activation. Notable properties that traded over the course of 2017 include Greenway Plaza (4.9 M SF, $210 PSF), Houston Center (4.2 M SF, $218 PSF) and Greenspoint Place (2.0 M SF, undisclosed).
Sales for the quarter totaled $1.3 billion, bolstered by the closing of Houston Center, as Brookfield Properties officially acquired the 4.2 M SF Class A property portfolio for $875 million. The fourth quarter saw another iconic property trade hands, as M-M Properties and Baupost Group were reported as having acquired Marathon Oil Tower, a 41-story 1.2 M SF Class A office building for $175.0 M from CBRE Global Investors. These figures represent assets for which pricing information could be obtained.
COMPARATIVE OFFICE INVESTMENT SALES VOLUME SELECT METRO AREAS
SOURCE Real Capital Analytics, Transwestern ,*Through Q4 2017
AVERAGE OFFICE SALE PRICE HOUSTON METRO AREA
SOURCE Real Capital Analytics, Transwestern,*Through Q4 2017
Notable Q4 TransactionsBUILDING SUBMARKET SF SALE PRICE SELLER BUYER
Marathon Oil Tower Galleria/Uptown 1,197,300 $175.0 million CBRE Global Investors M-M Properties/Baupost Group
Westchase Park Plaza Westchase 232,108 $24.0 million Parmenter Realty Partners Hertz Group
Nitya Tower (FKA Norfolk Tower) Greenway Plaza 207,562 Undisclosed TA Realty Nitya
A Return To Normal or More of the Same in 2018?After suffering through the worst of the effects of the energy downturn, the Houston office market appears poised to begin a tangible recovery in 2018 as WTI prices have settled over $60 per barrel, more favorable corporate tax rates are set to kick in and a strong national economy has consumer confidence near 20-yr highs. Diversification in industries such as healthcare, petrochemical, distribution and retail/hospitality have helped offset many of the jobs lost through the energy downturn; however, there is little doubt that the market needs a return to form for energy or the emergence to help alleviate the vacant and available supply. As such, the late year surge in crude prices is especially notable. Still, job growth in the sector will require prices to maintain in the $60's for the balance of 2018.
Considering current market conditions, overall market activity is projected to remain light over the first half of 2018 with the second quarter seeing direct vacancy crest. Tangible improvement should begin in the second half of 2018, as job growth stimulates absorption. All core metrics are forecast to improve, with availability and vacancy deceasing, while absorption returns to positive absorption. Additionally, the quick rise of co-working should continue to benefit landlords (in the short-run) as their demand for space increases co-working market totals significantly and helps to reduce direct available supply. With all signs pointing up, the only headwinds remaining for the Houston office market center around the energy sector and the highly unpredictable nature of crude prices.
Multi-tenant market vs Transwestern comprehensive market coverage
MULTI-TENANT ENTIRE MARKET
Inventory 200.4 MSF 241.8 MSF
Overall Vacancy 20.7% 17.0%
2017 Net Absorption (2,035,970) SF (3,990,948) SF
WHY OUR METHODOLOGY IS THE BEST INDICATOR OF CURRENT MARKET CONDITIONSWe include owner occupied and single-tenant buildings in our inventory, vacancy and absorption statistics to capture more market activity than many of our competitors. This allows us to better correlate changes in the market with changes in employment. As single-tenant space does compete with multi-tenant space, we believe it is critical to understand all components of the market. The inclusion of single-tenant and owner-occupied space tends to yield lower vacancy rates and higher absorption totals than some of our competitors’ results, but our coverage of the market is more comprehensive.
OFFICE ABSORPTION AND EMPLOYMENT HOUSTON METRO AREA
SOURCE Bureau of Labor Statistics, Transwestern *12-month job growth through Nov 2017, net absorption YTD through Q4 2017
Harvey Delays Office Recovery Slightly While the office market has been under storm clouds for several quarters, the third quarter saw Hurricane Harvey eclipse the sun and pour over five feet of water on the Houston Metro area. Initial reports on the storm's capital impacts were significantly exaggerated as they were tethered to estimates based upon flood maps. However, a detailed review indicated that the storm damaged just under 70 office buildings with a net rentable area impact of 2.0 million square feet, or 0.8% of total supply, significantly less than initially anticipated. A lack of strong winds spared most office buildings from significant harm, leaving property damages mostly to parking garages, first and sub-floors as well as minor roof leaks. Of the properties damaged, over 75% were fully operational within two weeks of the event. The most tangible impact that Harvey had upon the Houston office market was essentially delaying the sectors recovery for an additional quarter.
NET ABSORPTION
2017 Year-to-Date Absorption Totals Negative 3.9M SFYear-to-date absorption totals of negative 3.9 million square feet continue to highlight the delayed impacts of the energy downturn as well as the trend of companies striving for efficiency and reducing their space footprint. Absorption for the quarter totaled negative 732,000 square feet and was equally distributed among classes. Class A properties totaled negative 360,000 square feet with the West Loop
HOUSTON OFFICE MARKETTHIRD QUARTER 2017
REAL ESTATE OUTLOOK
Hurricane Harvey Takes a Toll on HoustonSublease space decreases by 930K SF
NET ABSORPTION AND VACANCY RATE TRENDS HOUSTON METRO AREA
CONTIGUOUS BLOCKS OF AVAILABLE SPACE HOUSTON METRO
SOURCE CoStar, Transwestern *Through Q3 2017
SOURCE CoStar, Transwestern *Through Q3 2017
Note: Delivery of preleased space counts as positive net absorption
SF In
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Notable Q3 LeasesTENANT SF LEASE TYPE BUILDING SUBMARKET
NRG Energy 431,307 Sublease One Shell Plaza CBD
McDermott 186,000 Sublease Westway Plaza II West Belt
USCIS 100,020 Renewal Northpoint Plaza North District
EDF Trading 60,000 New Lease 601 Travis CBD
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and Central Business District primarily accounting for the negative absorption. Class B finished the third quarter with negative 398,000 square feet of absorption, due to space give backs in the Houston North District and the West Loop submarkets.
DIRECT VACANCY & TOTAL AVAIL ABILIT Y
Total Availability Declines While Vacancy RisesThe overall office availability rate (all space marketed as available for lease, both direct and sublet) decreased 0.3% over the quarter, ending at 23.3%. Class A properties drove the decrease, declining by 0.5% to finish the period at 24.4%. While Class B properties ticked up marginally, finishing at 23.0%.
Direct vacancy rose for the twelfth consecutive quarter, up 0.3% and closing at 15.4% overall. Class A properties saw vacancy increase by 0.2%, ending at 15.1%, while Class B properties were up 0.4% to 16.7%. Currently, over 1.5 million SF of sublease space is set to expire over the next 12 months, equating to roughly 20% of total sublease supply. This is especially pronounced in the North Houston District where 868,845 SF is set to expire by end of year 2018. As more sublease space expires city-wide, vacancy rates will continue to trend up.
RENTAL R ATES
Asking Rates Continue to AscendOverall asking rates for the Houston Metro area increased by 1.5% over the quarter and 2.0% over the year, finishing the period at $30.92 PSF full service. Despite the increase in asking rates, concessions remain elevated throughout the market with generous concession packages and tenant improvement allowances being offered in order to maintain the highest rent figures.
Class A rates closed the quarter up 0.6% (+$0.20), ending at $35.83 PSF full service, while Class B asking rates declined by 1.2%, ending at $21.97 PSF full service. The submarkets with the highest asking rents are the Katy Fwy East ($45.00 PSF), the Central Business District ($44.35 PSF) and Galleria/Uptown ($38.83 PSF).
SUPPLY AND DEVELOPMENT
Development Pipeline Remains in CheckHouston area construction activity has slowed greatly due to both the delivery of over 33.0M SF in the past seven years and the downturn in the energy sector. Given the ample amount of space currently on the market for lease, developers are wary of additional speculative construction. Still, as tenants strive to retain talent and attain efficiency both in their space footprint as well as their operating expenses, the potential for additional construction tethered to a lead tenant remains high. Specifically, in core office submarkets such as the CBD, the Woodlands and West Loop. At the close of the third quarter, the Houston construction pipeline totaled 2.3 million square feet and is currently 52.5% preleased.
Office Under ConstructionHouston Metro | Q3 2017
SUBMARKET NUMBER OF BLDGS SF % PRE-
LEASED
CBD 1 778,344 27.0%
Woodlands 2 515,800 100.0%E Fort Bend Co/Sugar Land 3 247,200 30.1%
Greenway Plaza 1 188,547 0.0%
Westchase 1 187,011 80.9%
Northeast 1 115,601 100.0%
West Loop 1 104,579 46.8%
Energy Corridor 1 86,255 61.5%
Katy 1 72,045 50.8%
Total 12 2,295,382 52.5%
AVERAGE OFFICE RENTS HOUSTON METRO AREA
SOURCE CoStar, Transwestern *Through Q3 2017 Note: All classes of office space
Total Available SpaceHouston Metro | Q3 2017
SUBMARKETSUBLEASE SPACE (SF)
% OF SUPPLY
SUBMARKET % TOTAL
AVAILABLE
Energy Corridor 2,386,277 6.6% 25.3%
CBD 2,178,987 5.0% 25.8%
Westchase 1,543,705 8.8% 29.0%
Galleria 842,634 5.0% 21.3%
North District 877,698 6.8% 48.8%
All of Houston 9,829,433 4.1% 23.3%
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2 REAL ESTATE OUTLOOK HOUSTON METRO Q3 2017
HOUSTON METRO MARKETTHIRD QUARTER 2017
The largest projects currently under construction are Capitol Tower (CBD, 778,000 SF - 27% leased to Bank of America), CityPlace 3 (The Woodlands, 328,000 SF - 100% Leased to HP), CityPlace 2 (The Woodlands, 326,000 SF - 100% Leased to ABS) and The Kirby Collection, a mixed-use project with a significant office component (Greenway Plaza, 212,000 SF, 0% preleased).
INVESTMENT MARKET
Houston Investment Market is Red-HotHarvey had little impact on Houston's investment market as a flurry of activity took place throughout the quarter. The underlying fundamentals of the market are strong and stabilization in the energy sector should begin to avail itself over the next 9-12 months, keeping sentiment positive amongst the investor community. Sales for the quarter (including the under contract Houston Center), totaled $1.4 billion and were comprised of 15 transactions.
The most significant transaction of the third quarter was Brookfield Properties acquisition of Houston Center from JPMorgan Asset Management. The four building portfolio located in Houston's Central Business District totals over 4.0 million square feet and is under contract for approximately $875 million. Additionally, Bank of America corporation acquired Energy Center IV from Trammell Crow Company for $275 million or $461.00 PSF (6.0% cap rate). The 597,000 square foot Class A facility is located in the Katy Fwy West submarket and is under long-term lease to ConocoPhillips.
The market remains full of potential with a plethora of well located infill properties representing value add opportunities to investors. As such, investment activity should remain strong through the balance of 2017. These figures represent assets for which pricing information could be obtained.
COMPARATIVE OFFICE INVESTMENT SALES VOLUME SELECT METRO AREAS
SOURCE Real Capital Analytics, Transwestern ,*Through Q3 2017
AVERAGE OFFICE SALE PRICE HOUSTON METRO AREA
SOURCE Real Capital Analytics, Transwestern,*Through Q3 2017
Notable Q3 TransactionsBUILDING SUBMARKET SF SALE PRICE SELLER BUYER
Greenspoint Plaza North District 2,080,000 N/A Northwestern Mutual Lincoln Property Co & H.I.G. Realty Partners joint venture
Energy Center IV Katy Freeway West 597,000 $275.0 million Trammell Crow Company Bank of America Corporation
1700 W Loop S Galleria/Uptown 272,941 $52.0 million Bridge Investment Group Lingerfelt Commonwealth Partners
SOURCE Real Capital Analytics, HFF, Transwestern
Sales
Volu
me i
n Billi
ons
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$0
$50
$100
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REAL ESTATE OUTLOOK HOUSTON METRO Q3 2017 3
OUTLOOK
Light at the End of the Tunnel?The Houston office market has been in limbo for several quarters as office using job growth has been all but non-existent following the energy sector downturn. Large swaths of expiring sublease space compete head-to-head with direct vacant blocks and recent activity has been a shuffling of tenants as opposed to expansionary. While diversification in industries such as healthcare, petrochemical, distribution and retail/hospitality have helped offset many of the jobs lost in the energy sector, there is little doubt that the market needs a return to form for crude prices or the emergence of an alternative industry to help alleviate the vacant and available supply. As such, eyes will continue to focus upon Houston's strategy to support Tech growth, North American crude inventories, OPEC’s willingness to maintain production cuts, and the resulting impacts to the spot price of WTI.
Overall market activity is projected to remain flat through the remainder of the year as leasing activity continues to fall below historical averages. Tenants with near term expirations are in a favorable market to extend early and lock in favorable terms. The energy sector will continue to see Mergers and acquisitions at a rapid pace leaving the potential for additional blocks of space to be brought on-line due to redundancies.
Multi-tenant market vs Transwestern comprehensive market coverage
MULTI-TENANT ENTIRE MARKET
Inventory 199.2 MSF 241.8 MSF
Overall Vacancy 21.0% 17.1%
Q3 Net Absorption (291,372) SF (3,993,708) SF
WHY OUR METHODOLOGY IS THE BEST INDICATOR OF CURRENT MARKET CONDITIONSWe include owner occupied and single-tenant buildings in our inventory, vacancy and absorption statistics to capture more market activity than many of our competitors. This allows us to better correlate changes in the market with changes in employment. As single-tenant space does compete with multi-tenant space, we believe it is critical to understand all components of the market. The inclusion of single-tenant and owner-occupied space tends to yield lower vacancy rates and higher absorption totals than some of our competitors’ results, but our coverage of the market is more comprehensive.
OFFICE ABSORPTION AND EMPLOYMENT HOUSTON METRO AREA
SOURCE Bureau of Labor Statistics, Transwestern *12-month job growth through May 2017, net absorption YTD through Q2 2017
Rising Crude Inventories Slow RecoveryAfter a promising start to the year, the Houston offi ce market encountered additional headwinds during the second quarter as the burgeoning oil recovery slowed due to rising North American crude inventories. For the second consecutive period, negative absorption surpassed one million square feet with overall year to date totals just under negative 2.5M SF. Direct vacancy rates and total availability increased by 0.4% over the period, ending at 15.1% and 23.6%, respectively. On a positive note, sublease supply continued to decline and now stands at 10.8M SF for the market area. Despite the temporary set back, investor sentiment for the Houston market remains positive as long term fundamentals including population growth, industry diversifi cation, pro-business environment and low cost of living remain in place. Driven by the delivery of over 33.0M SF since 2010, many well located second generation buildings are undergoing renovations in order to remain competitive with newer options and appealing to a changing workforce that contains fi ve generations.
NET ABSORPTION
Year-to-Date Absorption a Negative 2.5M SFThrough the second quarter, the offi ce sector continued to experience negative absorption due to slow leasing activity, expiring sublease listings, and companies continuing to reduce their space footprint. Class A properties drove negative absorption for the quarter, totaling a negative 1.5M SF. Class B properties seemed to fi nd their footing this quarter, after three consecutive periods in the red, absorption totaled
HOUSTONOFFICE MARKETMID-YEAR 2017
REAL ESTATE OUTLOOK
One Step Forward, Two Steps Back Offi ce market working to fi nd way back up
NET ABSORPTION AND VACANCY RATE TRENDS HOUSTON METRO AREA
CONTIGUOUS BLOCKS OF AVAILABLE SPACE HOUSTON METRO
SOURCE CoStar, Transwestern *Through Q2 2017
SOURCE CoStar, Transwestern *Through Q2 2017
Note: Delivery of preleased space counts as positive net absorption
SF In
Thou
sand
s
Notable Q2 LeasesTENANT SF LEASE TYPE BUILDING SUBMARKET
Apache 524,000 Renewal/Extension 2000 Post Oak Blvd Galleria/Uptown
Bank of America 209,000 Prelease Capitol Tower Central Business District
Motiva Enterprises 204,500 Renewal/Expansion One Allen Center Central Business District
Winstead PC 66,000 Renewal/Contraction JPMorgan Chase Tower Central Business District
-3000-2000-1000
010002000300040005000600070008000
Net Absorption
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Vacancy RateNet Absorption
0
50
100
150
200Class A SubletClass A Direct
200,000 SF100,000 SF50,000 SF25,000 SF
Class B SubletClass B Direct
OUTLOOKK
a positive 210,000 SF, lowering direct vacancy by 0.5%. The Central Business District was the most heavily impacted submarket this quarter with absorption totaling a negative 290,000 SF as impacts from the energy downturn continue to present themselves.
DIRECT VACANCY & TOTAL AVAIL ABILIT Y
Class A Stumbles, Class B ImprovesThe overall offi ce availability rate (all space marketed as available for lease) increased 0.4% over the quarter, closing mid-year at 23.6%. Total availability trended up across the board, with Class A and B properties recording 25.1% and 22.9%, respectively. Direct vacancy increased by 0.4% over the period, fi nishing at 15.1%.
Class A properties saw vacancy increase by 0.9%, ending at 14.9%, while Class B properties reversed course with vacancy decreasing from 16.5% to 16.2%. Until the energy sector fi nds it's balance between supply and demand, total availability and direct vacancy are projected to continue to rise over the short-term.
RENTAL R ATES
Asking Rates SoftenOverall asking rates declined by 0.6% over the quarter, but are still up 2.8% year-over-year, currently $29.91 PSF full service. Class A rates closed the quarter down 1.7% (-$0.60), ending at $35.86 PSF full service. Class B asking rates dropped by 1.1%, ending at $21.82 PSF full service. Considering the large amount of supply that still needs to be absorbed, asking rates should continue to decrease over the near-to-mid term as more exposure hits the market. Financial concessions continue to play a signifi cant role in large user lease transactions.
SUPPLY AND DEVELOPMENT
Construction Ticks UpThe delivery of over 33.0M SF over the past seven years hasn't dampened tenants appetite for new construction. The challenge of becoming more effi cient from a space use perspective combined with recruiting and engaging fi ve generations in the workforce has kept new construction a valid alternative for large tenants, even in this down market. This has also put pressure on landlords of existing product, to look to enhance their features, amenities and service offerings in order to remain competitive. Early this quarter, both Bank of America and HP looked to new construction to fi ll their space requirement's. Bank of America inked a lease as the lead tenant in Skanska's Capitol Tower, gaining naming rights and taking 210,00 SF of the 778,000 SF Class A building located in the Central Business District. HP leased a two building, build-to-suit, totaling 378,000 SF in Springwoods Village. Springwoods Village also includes the Exxon Mobil headquarters, Southwestern Energy and CHI St Lukes. Additional construction is underway for ABS as they follow Exxon north from Greenspoint.
Offi ce Under ConstructionHouston Metro | Q2 2017
SUBMARKET NUMBER OF BLDGS SF % PRE-
LEASED
CBD 1 778,344 27%
The Woodlands 3 704,800 97%
South Main/Med Ctr 1 250,000 100%
SW Fwy/Sugar Land 3 247,200 30%
Greenway Plaza 1 188,547 0%
Westchase 1 104,579 78%
West Loop 1 104,579 6%
Kingwood/Humble 1 100,000 100%
Energy Corridor 1 86,255 55%
Northeast 1 85,000 61%
Katy Far West 1 72,045 51%
Total 13 2,803,781 57%
AVERAGE OFFICE RENTS HOUSTON METRO AREA
SOURCE CoStar, Transwestern *Through Q2 2017 Note: All classes of offi ce space
Total Available SpaceHouston Metro | Q2 2017
SUBMARKETSUBLEASE SPACE (SF)
% OF SUPPLY
SUBMARKET % TOTAL
AVAILABLE
Energy Corridor 2,480,480 6.8% 24.7%
CBD 2,504,810 5.7% 27.0%
Westchase 1,530,831 8.7% 28.9%
Galleria 1,002,692 6.0% 22.4%
North District 890,977 6.8% 46.9%
All of Houston 10,772,877 4.4% 23.6%
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2 REAL ESTATE OUTLOOK HOUSTON METRO Q2 2017
HOUSTON METRO MARKETMID-YEAR 2017
ET
The largest projects currently under construction are Capitol Tower (CBD, 778,000 SF - 27% leased to Bank of America), CityPlace 3 (The Woodlands, 328,000 SF - 100% leased to HP), CityPlace 2 (The Woodlands, 326,000 SF - 100% Leased to ABS) and The Kirby Collection, a new mixed-use project with a large offi ce component (Greenway Plaza, 212,000 SF). The current preleased percentage of properties currently under construction is 57%.
INVESTMENT MARKET
Interest in Houston continues to increaseInvestment activity continues to pick up throughout the Houston metro, regardless of the setback in the energy sector. The underlying fundamentals of the market are strong and stabilization in the energy sector should avail itself over the next 9-12 months, creating positive sentiment amongst investors. Sales for the quarter totaled $946 million, comprised of 20 transactions, up 408% year-over-year, when there was just $186.3 million in investment sales.
Early in the quarter, Canada Pension Plan Investment Board (CPPIB) and TH Real Estate/Silverpeak Real estate completed a transaction to acquire a 49.5% stake in Greenway Plaza & Phoenix Tower (5.0 MSF) from Parkway Inc. Shortly thereafter, CPPIB doubled down and acquired the remainder of Greenway Plaza along with Parkway's outright operations and remaining portfolio in Houston (8.7 MSF). The size and nature of these transactions underscore the belief in the long term viability of the Houston offi ce market.
As market activity continues to trend up, so to have price per square foot trade averages. Offi ce sales averaged $172/SF, an increase of 11% quarter-over-quarter. Cap rates also compressed slightly, down 0.1% and settling at 7.9% for the period. These fi gures represent assets for which pricing information could be obtained.
COMPARATIVE OFFICE INVESTMENT SALES VOLUME SELECT METRO AREAS
SOURCE Real Capital Analytics, Transwestern ,*Through Q2 2017
AVERAGE OFFICE SALE PRICE HOUSTON METRO AREA
SOURCE Real Capital Analytics, Transwestern,*Through Q2 2017
Notable Q2 TransactionsBUILDING SUBMARKET SF SELLER BUYER
Greenway Plaza Portfolio Greenway Plaza 5,013,052 Parkway TH Real Estate/CPPIB
Noble Energy Center II FM 1960 470,623 Trammel Crow CalSTRS
1700 West Loop South Galleria/Uptown 272,941 The ROC Fund Lingerfelt Commonwealth Partners
Bellaire Atrium I & II Bellaire 350,000 Braun Properties SLS Properties
SOURCE Real Capital Analytics, HFF, Transwestern
Sales
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REAL ESTATE OUTLOOK HOUSTON METRO Q2 2017 3
OUTLOOK
Patience and EnergyThe Houston metro area has been lauded for how diversifi cation has helped to mitigate the effects of the energy downturn. Growth in industries such as healthcare, petrochemical, distribution and retail/hospitality have helped offset many of the jobs lost in the energy sector. However, as those sectors wind down their growth cycles, it leaves little doubt that a true recovery for offi ce will be tethered to stabilization and return to form in the energy sector. As such, continued focus will be placed upon North American crude inventories, OPEC’s willingness to maintain production cuts, and the resulting impacts to the spot price of WTI.
Overall market activity is projected to remain muted through the third quarter with rising vacancy and falling asking rates. Insulated suburban submarkets such as Sugar Land and The Woodlands will continue to perform above market standards, while areas such as the Energy Corridor and Central Business District face the majority of the headwinds left to navigate.
Multi-tenant market vs Transwestern comprehensive market coverage
MULTI-TENANT ENTIRE MARKET
Inventory 198.8 MSF 242.4 MSF
Overall Vacancy 18.5% 15.1%
Q2 Net Absorption (1,749,399 SF) (2,471,884) SF
WHY OUR METHODOLOGY IS THE BEST INDICATOR OF CURRENT MARKET CONDITIONSWe include owner occupied and single-tenant buildings in our inventory, vacancy and absorption statistics to capture more market activity than many of our competitors. This allows us to better correlate changes in the market with changes in employment. As single-tenant space does compete with multi-tenant space, we believe it is critical to understand all components of the market. The inclusion of single-tenant and owner-occupied space tends to yield lower vacancy rates and higher absorption totals than some of our competitors’ results, but our coverage of the market is more comprehensive.
OFFICE ABSORPTION AND EMPLOYMENT HOUSTON METRO AREA
SOURCE Bureau of Labor Statistics, Transwestern *12-month job growth through May 2017, net absorption YTD through Q2 2017
Houston Offi ce Market Indicators - Asking Rental Rates
OVERVIEW
Sublease space on the decline for first time since 2012As the long and grinding year of 2016 came to a close, sentiment surrounding the Houston office sector took a positive turn as several indicators point to the beginnings of a market rebound. Unfortunately, these indicators occurred primarily on the economic side with factors such as oil, jobs and PMI gaining ground, whereas office metrics have generally continued to weaken following the recent downturn. One core metric that showed visible improvement was total available sublease space. The decline in the fourth quarter, marked the first decrease since 2012, and sublease space closed the year at 11.6M SF available after peaking with over 12.5M SF available in the third quarter. Sublease space reductions were triggered through various scenarios making it difficult to determine if the decline is the beginning of a trend or simply a short-term break from an endless supply of space. ConocoPhillips represented the largest reduction in sublease availability (597k SF) as they opted to retain their Energy Corridor listing in order to consolidate operations from an aging multi-building campus. Alternatively, tenants such as Thompson & Knight and Breitburn Energy looked to leverage sublease availability to lock in favorable terms at high-quality Class A locations. A trend that will continue given the extended term, credit worthy nature and desirable locations of many sublease offerings.
NET ABSORPTION
Absorption continues to fall shortIn the fourth quarter, impacts of the energy downturn are still being realized as quarterly net absorption for all classes of office was again negative, posting -737,000 SF, with Class A coming in at -230,000 SF.
HOUSTON OFFICE MARKETYEAR-END 2016
REAL ESTATE OUTLOOK
Office Market Beginning to Show Signs of Improvement Sublet Supply Decreases
NET ABSORPTION AND VACANCY RATE TRENDS HOUSTON METRO AREA
CONTIGUOUS BLOCKS OF AVAILABLE SPACE HOUSTON METRO
SOURCE CoStar, Transwestern *Through Q4 2016
SOURCE CoStar, Transwestern *Through Q4 2016
Note: Delivery of preleased space counts as positive net absorption
Notable Q4 LeasesTENANT SF LEASE TYPE BUILDING SUBMARKET
Breitburn Energy Partners 109,476 Sublease Heritage Plaza CBD
ABM Industries, Inc. 63,000 New 14141 Southwest Fwy East Fort Bend Co/Sugar Land
Thompson & Knight 60,628 Sublease 811 Main St CBD
Diamond McCarthy, LLP 46,840 New 2 Houston Center CBD
05 06 07 08 09 10 11 12 13 14 15 16
Net Absorption (Thousands of SF) Direct Vacancy Rate Total Availability
5%7%9%
11%13%15%17%19%21%23%
-1,00001,0002,0003,0004,0005,0006,0007,0008,000
25,000 SF 50,000 SF 100,000 SF 200,000 SF
Class A Direct Class A Sublet Class B Direct Class B Sublet
020406080100120140160180
For the year, absorption managed to post positive totals with the broad market absorbing a total of 588,000 SF driven by preleased deliveries earlier in the year. The Class A market recorded 1.4M SF of positive absorption for the year, while Class B felt the impacts of flights to quality and posted negative absorption of -1.0 M SF year end 2016. Leasing activity is beginning to ramp up throughout the market, but quarterly absorption for the next 3-6 months will lag this activity, leading way to negative absorption totals in early 2017.
VACANCY & AVAIL ABILIT Y
Total availability decreases The overall office availability rate (all space marketed as available for lease) declined modestly over the quarter, down -0.1%, to finish the year at 21.9% - a direct result of the decrease in available sublease supply. Total availability for Class A & B properties closed the year at 23.3% and 21.2%, respectively. Direct vacancy increased by 0.3%, finishing at 14.2%, and should continue to rise as sublease space and more efficient new construction serve as desirable alternatives for leasing activity, leaving vacant direct space in its wake.
Overall vacancy was 16.1% at year end, up 0.1% from the previous quarter and 2.1% year-over-year. Class A overall vacancy closed up 0.2% to end the year at 16.4%, while Class B followed suit, increasing by 0.4% over the quarter and ending the year at 16.4% vacant. As the market moves forward in stabilization mode, vacancy rates are projected to rise as overall availability decreases. RENTAL R ATES
Face rates don't tell the full story Asking rates for the office market continued their familiar ascent over 2016, displaying increases across both Class A & B properties. These increases were generated through a combination of new high-quality buildings being added to supply in addition to landlords attempting to hold on to face rates in-spite of market conditions. Regardless of the situation, concessions play a significant part in deal activity and are particularly impactful in large lease transactions where tenant improvement allowances and rent abatements are core negotiations. Class A rents increased 0.5% year-over-year to $35.50 per SF gross, while Class B rents increased by 3.2% to $21.95 per SF gross from the close of the year.
SUPPLY AND DEVELOPMENT
Development cycle continues to shift downwardThere were no new office buildings delivered in the fourth quarter as Houston continues to wind down its most recent construction cycle with a total of 2.9 million SF of office space under construction. All properties currently under development are anticipated to deliver in 2017. This level of activity is a stark contrast from the 7.2 million SF under construction in the fourth quarter of 2015 and even further from the 16.6 million SF ending 2014. In total, Houston has delivered approximately 25.0 million SF of office since the beginning of 2014.
Office Under ConstructionHouston Metro | Q4 2016
SUBMARKET NUMBER OF BLDGS SF % PRE-
LEASED
CBD 1 1,056,658 38%
West Loop 2 484,579 71%
Energy Corridor 2 324,428 41%
Katy 2 234,538 0%
Greenway Plaza 1 212,878 11%
Sugar Land 2 187,200 7%
Westchase 1 186,000 100%
Kingwood 1 100,000 100%
Northeast 1 85,000 92%
Gulf Frwy/Pasadena 1 82,800 100%
Total 14 2,954,081 46%
AVERAGE OFFICE RENTS HOUSTON METRO AREA
SOURCE CoStar, Transwestern *At Q4 2016 Note: All classes of office space
Total Available SpaceHouston Metro | Q4 2016
SUBMARKET SUBLEASE SPACE (SF)
% SUBLEASE
Energy Corridor 3,130,327 8.4%
CBD 2,469,302 5.2%
Westchase 1,406,051 8.0%
Galleria 1,158,965 7.0%
North District 1,147,254 8.7%
All of Houston 11,649,891 4.6%
05 06 07 08 09 10 11 12 13 14 15 16*
Asking Rents ($/SF Gross) Class A Class B
$16$18$20$22$24$26$28$30$32$34$36 $35.50
$21.95
2 REAL ESTATE OUTLOOK HOUSTON METRO YE 2016
HOUSTON METRO MARKETYEAR-END 2016
While the construction rate is slowing precipitously, the demand for efficient new construction continues, but will require anchor tenants such as HP and Bank of America who are both looking at new facilities and more efficient space utilization.
The largest projects currently under construction are 609 Main (CBD, 1.1 million SF) and Amegy Bank’s new headquarters located at 1717 West Loop South (Post Oak Park, 380,000 SF). The preleased percentage of properties currently under construction is 45% and is anticipated to increase further prior to delivery through the 2017 calendar year.
INVESTMENT MARKET
Investment activity picks upInvestment activity turned up in the final quarter of 2016 as deal volume in the metro recorded $851.0 million in office sales, more than doubling the total from the third quarter, while down 48% on a year-over-year basis. In October, the previously announced Cousins merger/acquisition/spin-off of Parkway Properties and their Galleria, Greenway Plaza, and Westchase assets was made final (~8.7M RSF). While this was a portion of a larger 35 property portfolio trade, the Houston properties will be spun off into their own local REIT, HoustonCo, that is positioned for additional acquisitions. Additionally, the Columbia Portfolio traded over the quarter as Spear Street Capital acquired 5 Houston Center, 5 Post Oak Park and Energy Center I for approximately $272 million, or $232 per SF. These Class A assets are strategically located in core Houston submarkets and offer Spear Street a value add opportunity through enhancing building features and amenities, elevating the offerings. This strategy will continue to be emulated throughout the market. Pricing per square foot averages acted in line with deal activity as quarter over quarter averages were up (162%) while year-over-year averages declined (-61%), coming in at $221/SF. Cap rates were flat over the quarter, currently averaging 8.0%. These figures represent assets for which pricing information could be obtained.
COMPARATIVE OFFICE INVESTMENT SALES VOLUME SELECT METRO AREAS
SOURCE Real Capital Analytics, Transwestern ,*Through Q4 2016
AVERAGE OFFICE SALE PRICE HOUSTON METRO AREA
SOURCE Real Capital Analytics, Transwestern,*Through Q4 2016
Notable Q4 TransactionsBUILDING SUBMARKET SF SELLER BUYER
5 Houston Center CBD 580,875 Columbia Property Trust Spear Street Capital, LLC
5 Post Oak Park Post Oak Park 567,264 Columbia Property Trust Spear Street Capital, LLC
Energy Center I Katy Fwy /Energy Corridor 332,000 Columbia Property Trust Spear Street Capital, LLC
SOURCE Real Capital Analytics, HFF, Transwestern
Sales Volume in Billions Atl Dal Den Hou
05 06 07 08 09 10 11 12 13 14 15 16*$0.0
$1.0
$2.0
$3.0
$4.0
$5.0
$6.0
Average Sale Price Per SF
05 06 07 08 09 10 11 12 13 14 15 16*
$203
$0
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REAL ESTATE OUTLOOK HOUSTON METRO YE 2016 3
OUTLOOK
Steady as she goesSentiment in the Houston office market is becoming positively optimistic as more signs point to having reached the bottom of the energy downturn and beginning a recovery. Factors such as positive job creation through a challenging 2016, crude prices stabilizing as OPEC agreed to production limits, and a pro-energy/business friendly administration being elected to office have resulted in an upbeat market. That being said, enthusiasm should be tempered as recovery will be a slow process that won’t always move in an upward trajectory. There are still several areas limiting the speed of recovery; overall job growth for 2017 is projected to be well below healthy market norms (~20k in 2017), the Petrochemical boom on the east side is waning, and while stabilizing in the high $40’s to low $50’s - short term energy forecasts show limited potential for additional increases through 2017. Additionally, the market has a total of 54 million SF of space marketed as available with 32 million occurring in Class A properties – a 4 to 5 year supply with job creation at typical levels of 60k per year. Simply put, the recovery will be slow and measured until once again, the energy engine moves into high gear.
Multi-tenant market vs Transwestern comprehensive market coverage
MULTI-TENANT ENTIRE MARKET
Inventory 196.8 MSF 248.4 MSF
Overall Vacancy 18.9% 15.4%
Q4 Net Absorption 394,220 SF (383,000) SF
WHY OUR METHODOLOGY IS THE BEST INDICATOR OF CURRENT MARKET CONDITIONSWe include owner occupied and single-tenant buildings in our inventory, vacancy and absorption statistics to capture more market activity than many of our competitors. This allows us to better correlate changes in the market with changes in employment. As single-tenant space does compete with multi-tenant space, we believe it is critical to understand all components of the market. The inclusion of single-tenant and owner-occupied space tends to yield lower vacancy rates and higher absorption totals than some of our competitors’ results, but our coverage of the market is more comprehensive.
OFFICE ABSORPTION AND EMPLOYMENT HOUSTON METRO AREA
SOURCE Bureau of Labor Statistics, Transwestern *12-month job growth through November 2016, net absorption through Q4 2016
05 06 07 08 09 10 11 12 13 14 15 16
Net Absorption (Thousands of SF) Payroll Job Growth (in Thousands)
-100
-75
-50
-25
0
25
50
75
100
125
-1,000
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
4 REAL ESTATE OUTLOOK HOUSTON METRO YE 2016
HOUSTON METRO MARKETYEAR-END 2016
Houston Office Market Indicators - All Space
SUBMARKET TOTAL BLDGS INVENTORY SF AVAILABLE
IMMEDIATELY
DIRECT VACANCY
2015
DIRECT VACANCY
Q4 2016
VACANCY W/ SUBLET
Q4 2016
**TOTAL AVAILABILITY
Q4 2016
UNDER CONSTRUCTION
***NET ABSORPTION
Q4 2016
NET ABSORPTION
YTD 2016
Central Business District 87 48,149,909 6,066,889 12.5% 12.6% 15.0% 20.6% 1,056,658 (48,000) (61,000)
NOTE Includes buildings 50,000 SF RBA and greater; does not include buildings under construction or owned by the government
* Inventory and number of buildings adjusted per changes in CoStar** Total availability reflects all space being marketed as available for lease regardless of current occupancy status** *Absorption methodology has been updated for existing buildings to reflect tenant occupancies
6 REAL ESTATE OUTLOOK HOUSTON METRO YE 2016
HOUSTON METRO MARKETYEAR-END 2016
Houston Office Market Indicators - Class B
SUBMARKET TOTAL BLDGS INVENTORY SF AVAILABLE
IMMEDIATELY
DIRECT VACANCY
Q4 2016
VACANCY W/ SUBLET
Q4 2016
**TOTAL AVAILABILITY
Q4 2016
UNDER CONSTRUCTION
***NET ABSORPTION
Q4 2016
NET ABSORPTION
YTD 2016
Central Business District 38 14,766,772 2,584,185 17.5% 19.3% 23.0% - 15,000 (59,000)
NOTE Includes buildings 50,000 SF RBA and greater; does not include buildings under construction or owned by the government
* Inventory and number of buildings adjusted per changes in CoStar** Total availability reflects all space being marketed as available for lease regardless of current occupancy status** *Absorption methodology has been updated for existing buildings to reflect tenant occupancies REAL ESTATE OUTLOOK HOUSTON METRO YE 2016 7
SOURCE CoStar, TranswesternNOTE Rents for properties using triple net terms have been grossed up to full service with operating expense data, rents reflect full service equivalent
Office sector scuffles to find footing after downturnThe Houston office market continues to struggle as the local economy remains uncertain, pinned to the turmoil in the energy sector and ambiguity surrounding the pending election cycle. Currently, tenants are hesitant to make long-term leasing decisions until clarity avails itself in both the energy markets and governmental policy. Vacancy is on an upward trajectory as sublease space continues to be added to the market, particularly in submarkets traditionally occupied by the energy tenants. The significant decline in leasing activity paired with the increasing supply of available sublease space pushed net absorption into the red during the third quarter. Market conditions currently favor the tenant as landlords must leverage significant concession packages to compete in a sea of available space alternatives, especially for large users 20,000 SF and up.
NET ABSORPTION
Absorption pushes red in the ledgerNet absorption for all classes of office ran red for the third quarter totaling a net negative 397,000 SF. Year-to-date totals were more favorable coming in at 1.3 million SF, but are still well below historical averages. The Class A market recorded 429,000 SF of positive absorption for the quarter, while Class B recorded a sixth consecutive quarter of negative absorption at 795,000 SF. Following several quarters of positive absorption driven by preleased deliveries, the office market experienced its first quarter of overall negative absorption since mid-year 2015. Absorption over the final quarter of 2016 is anticipated to be minimal to slightly negative as true recovery appears most likely to begin in mid-2017 at the earliest.
HOUSTON OFFICE MARKETTHIRD QUARTER 2016
REAL ESTATE OUTLOOK
Office Market Struggling to Gain Traction in Down Economy Sublease space continues to impact vacancy
NET ABSORPTION AND VACANCY RATE TRENDS HOUSTON METRO AREA
CONTIGUOUS BLOCKS OF AVAILABLE SPACE HOUSTON METRO
SOURCE CoStar, Transwestern *Through Q3 2016
SOURCE CoStar, Transwestern *Through Q3 2016
Note: Delivery of preleased space counts as positive net absorption
Notable Q3 LeasesTENANT SF LEASE TYPE BUILDING SUBMARKET
Lloyd's Register 86,892 Renewal 1330 Enclave Parkway Katy Freeway West
Orrick, Herrington & Sutcliffe 56,731 Prelease 609 Main at Texas CBD
Hogan Lovells 43,000 Prelease 609 Main at Texas CBD
Lockheed Martin Corporation 40,742 Renewal Two Corporate Plaza NASA/Clear Lake
05 06 07 08 09 10 11 12 13 14 15 16*
Net Absorption (Thousands of SF) Direct Vacancy Rate
6%7%8%9%
10%11%12%13%14%15%
-1,00001,0002,0003,0004,0005,0006,0007,0008,000
020406080100120140160
25,000 SF 50,000 SF 100,000 SF 200,000 SF
Class A Direct Class A Sublet Class B Direct Class B Sublet
VACANCY
Sublease space nearly reaches 12.0 million SF The overall office vacancy rate (including sublet) was 15.6% at third quarter, up from 14.7% at second quarter. Direct vacancy was 13.8%, up from 13.1% last quarter. Total available sublease space grew by 1.2 million SF this quarter to 11.9 million SF on the market. Also, in the third quarter, Shell announced they were vacating their entire space in One Shell Plaza, which totals approximately 800,000 SF, after initially only marketing 350,000 SF of space. FMC Technologies, WorleyParsons, NOV, and Freeport-McMoRan also put over 900,000 SF of combined sublease space on the market. With the continuation of space reductions through a slow market, sublease space will likely exceed 12.0 million SF by year-end. The submarkets that will continue to be affected by large amounts of sublease space are the Energy Corridor, CBD, Westchase, and the Galleria due to the strong oil and gas presence in those markets.
Class A overall vacancy was 15.5% at third quarter, up from 14.6% at second quarter, and Class A direct was 13.0%, up from 12.4% over the same period. Class B overall vacancy was 16.1%, a jump from 15.2% at mid-year, and Class B direct vacancy rose to 15.0%, from 14.2% over the same period. Looking ahead, vacancies are anticipated to increase further as leasing velocity remains low and companies continue to put sublease space on the market.
RENTAL R ATES
Concession packages increasing While overall face rents increased modestly year-over-year, the underlying value of concession packages being offered foretells a different story. Class A rents declined 0.2% year-over-year to $35.24 per SF gross, and Class B rents carried the increase in face rents, rising by 1.2% to $21.53 per SF gross from the close of the year. In the current, tenant-favored market, landlords are offering significant concession packages with generous tenant improvement packages and free rent in order to entice prospective tenants. Rental rates have not seen a sharp decline, as rate decreases typically lag behind other indicators due to landlords maintaining face rents for as long as possible. As competitive spaces grow in number throughout the market, the value of the concessions in nearing its ceiling and declines in rates will begin to show through most areas.
SUPPLY AND DEVELOPMENT
Development cycle comes to a closeHouston is nearing the completion of its most recent development phase as there was a total of 2.6 million SF of office space under construction in the third quarter, as compared to 3.7 million SF just three months earlier. This space was 48% preleased, a metric that remains unchanged from the second quarter. There are no other buildings anticipated to deliver in 2016, with all 2.6 million SF anticipated to deliver by the end of 2017. The CBD is the only remaining submarket with over 1.0 million SF in the pipeline.
Office Under ConstructionHouston Metro | Q3 2016
SUBMARKET NUMBER OF BLDGS SF % PRE-
LEASED
CBD 1 1,056,658 38%
West Loop 2 520,000 75%
Energy Corridor 2 324,428 40%
Katy 2 285,465 18%
Greenway Plaza 1 191,802 48%
Westchase 1 186,000 100%
Total 9 2,564,356 48%
AVERAGE OFFICE RENTS HOUSTON METRO AREA
SOURCE CoStar, Transwestern *At Q3 2016 Note: All classes of office space
Total Available SpaceHouston Metro | Q3 2016
SUBMARKET SUBLEASE SPACE (SF)
% SUBLEASE
Energy Corridor 3,575,660 9.6%
CBD 2,757,005 5.8%
Westchase 1,485,336 8.5%
Galleria 1,092,267 8.3%
Greenspoint 982,267 5.9%
All of Houston 11,868,908 4.8%
05 06 07 08 09 10 11 12 13 14 15 16*
Asking Rents ($/SF Gross)
$16
$18
$20
$22
$24
$26
$28
$30 $28.60
2 REAL ESTATE OUTLOOK HOUSTON METRO Q3 2016
HOUSTON METRO MARKETTHIRD QUARTER 2016
The largest projects under construction are 609 Main (CBD, 1.1 million SF) and Amegy Bank’s new headquarters located at 1717 West Loop South (Post Oak Park, 380,000 SF).
There were 1.4 million SF of deliveries at 62% preleased in the third quarter. The preleased percentage is significantly lower than the first quarter’s 92% due to only one owner-occupied project delivering. The largest project deliveries include BHP’s new headquarters (Galleria, 600,000 SF) and West Memorial Place II (Katy Freeway West, 385,532 SF).
INVESTMENT MARKET
Investment opportunities feeling the burnThe investment landscape is changing quickly as the metro recorded $122.4 million in office sales during the third quarter, a decline of 27% over the previous quarter. Small or mid-size assets accounted for most of the sales activity, as large transaction sales have declined dramatically over the past year. Pricing per square foot averages took a major hit for the period, averaging $56 per SF as compared to $158 per SF at second quarter due mainly to the quality and size of assets traded. The majority of single-property sales were smaller, Class B and C assets. The average cap rate was 7.8%, up from the second quarter average of 7.6%. These figures represent assets for which pricing information could be obtained.
Owners are still hesitant to market their properties through the changing scope of the office market and the disparity in pricing expectations. The number of listings in 2016 has been lower than historical averages as owners are sourcing deals off market to keep lower pricing from being advertised. Additionally, investors are exercising more conservative underwriting projections throughout the office sector in order to maintain financial viability. However, the long-term outlook for Houston remains bright as it still remains one of the nation’s largest economies.
COMPARATIVE OFFICE INVESTMENT SALES VOLUME SELECT METRO AREAS
SOURCE Real Capital Analytics, Transwestern ,*Through Q3 2016
AVERAGE OFFICE SALE PRICE HOUSTON METRO AREA
SOURCE Real Capital Analytics, Transwestern,*Through Q3 2016
Notable Q3 TransactionsBUILDING SUBMARKET SF SELLER BUYER
9720 Cypresswood FM 1960/Hwy 249 83,077 Torchlight Loan Services, LLC Vista Equities Group, Inc.
6464 Savoy Southwest/Hillcroft 182,658 Younan Properties Ridgepoint Jr LLC
SOURCE Real Capital Analytics, HFF, Transwestern
Sales Volume in Billions Atl Dal Den Hou
05 06 07 08 09 10 11 12 13 14 15 16*$0.0
$1.0
$2.0
$3.0
$4.0
$5.0
$6.0
Average Sale Price Per SF
05 06 07 08 09 10 11 12 13 14 15 16*$0
$50
$100
$150
$200
$250
$56
REAL ESTATE OUTLOOK HOUSTON METRO Q3 2016 3
OUTLOOK
Baby steps on a soft floorThe combination of the downturn in the energy sector and the over-zealous nature of our most recent development cycle, the Houston office market is in a transition state as signs begin to point that we may have hit our floor. Availability from the new deliveries along with blocks of space being added via the sublease market present lingering reminders as their impact on market fundamentals displays itself. The current energy market has reached the bottom with job cuts and even found a floor in price per barrel; however, it may still take the office market an additional 12 to 18 months to see the return of office demand. Job growth for Houston is anticipated to remain flat or slightly positive for the year with impacts from the Super Bowl having little impact on office leasing.
The metro’s current development is 48% preleased and these projects are all anticipated to deliver by the end of 2017. Looking ahead, tenants will continue to adopt a wait-and-see approach as they debate the impacts of the upcoming Presidential election and policies that follow the winning candidate coupled with the continued volatility in the oil markets. Rental rates will likely remain flat or decline as a large abundance of space needs to be absorbed. Development activity will taper off as developers hold off on new projects and wait for the next development upcy-cle to break ground. With more sublease space hitting the market, vacancy rates will continue to impacted and trend upward.
Multi-tenant market vs Transwestern comprehensive market coverage
MULTI-TENANT ENTIRE MARKET
Inventory 209.5 MSF 248.4 MSF
Overall Vacancy 17.6% 15.6%
Q3 Net Absorption 13,723,349 SF (397,000) SF
WHY OUR METHODOLOGY IS THE BEST INDICATOR OF CURRENT MARKET CONDITIONSWe include owner occupied and single-tenant buildings in our inventory, vacancy and absorption statistics to capture more market activity than many of our competitors. This allows us to better correlate changes in the market with changes in employment. As single-tenant space does compete with multi-tenant space, we believe it is critical to understand all components of the market. The inclusion of single-tenant and owner-occupied space tends to yield lower vacancy rates and higher absorption totals than some of our competitors’ results, but our coverage of the market is more comprehensive.
OFFICE ABSORPTION AND EMPLOYMENT HOUSTON METRO AREA
SOURCE Bureau of Labor Statistics, Transwestern *12-month job growth through August 2016, net absorption through Q3 2016
05 06 07 08 09 10 11 12 13 14 15 16*
Net Absorption (Thousands of SF) Payroll Job Growth (in Thousands)
-100
-75
-50
-25
0
25
50
75
100
125
-1,000
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
4 REAL ESTATE OUTLOOK HOUSTON METRO Q3 2016
HOUSTON METRO MARKETTHIRD QUARTER 2016
Houston Office Market Indicators - All Space
SUBMARKET TOTAL BLDGS INVENTORY SF AVAILABLE
IMMEDIATELY
DIRECT VACANCY
2015
DIRECT VACANCY
Q3 2016
VACANCY WITH SUBLET
Q3 2016
UNDER CONSTRUCTION
NET ABSORPTION
Q3 2016
NET ABSORPTION
YTD 2016
Central Business District 87 47,919,574 5,804,977 11.3% 12.1% 14.6% 1,056,658 (112,000) (43,000)
SOURCE CoStar, TranswesternNOTE Rents for properties using triple net terms have been grossed up to full service with operating expense data, rents reflect full service equivalent
Leasing velocity remains downWhile the overall Houston economy is adding jobs, major office demand drivers like upstream energy and engineering are accruing further losses. This is in stark contrast to downstream energy which is booming on the east side of the metro with over $53 billion in construction either underway or planned. Vacancy is on the rise as upstream companies continue to reduce workforces, downsize and cut costs across the board. Net absorption stayed in the black through first quarter as deliveries were largely preleased, but rent growth finally tapered off, and concession packages remain high. Houston has firmly become a tenant's market, and conditions will become even more tenant-favorable as the year progresses.
NET ABSORPTION
Deliveries still driving positive absorptionNet absorption for all classes of space totaled 996,000 SF at first quarter, fueled largely by preleased deliveries. Class A recorded 1.2 million SF of positive absorption for the quarter, and Class B recorded a fourth quarter in a row of negative absorption at 191,000 SF. Though Class AA demand has given way to a more value office trend recently, Class B space is still suffering the effects of the previous flight-to-quality trend. Absent the volume of new deliveries, overall and Class A net absorption would have been negative 758,000 SF and negative 539,000 SF, respectively. The largest move-out by far this quarter was BMC in Westchase, while most others were in the small to mid-range.
HOUSTON OFFICE MARKETFIRST QUARTER 2016
REAL ESTATE OUTLOOK
Energy Downturn Hits Office Market Hard Fundamentals weakening as expected
NET ABSORPTION AND VACANCY RATE TRENDS HOUSTON METRO AREA
CONTIGUOUS BLOCKS OF AVAILABLE SPACE HOUSTON METRO
SOURCE CoStar, Transwestern *Through Q1 2016
SOURCE CoStar, Transwestern *Through Q1 2016
Note: Delivery of preleased space counts as positive net absorption
Notable Q1 LeasesTENANT SF LEASE TYPE BUILDING SUBMARKET
United Airlines 225,000 Prelease 609 Main at Texas CBD
Linde Processing Plants 50,380 New Linde Plaza Katy Freeway West
Citigroup 49,730 New Galleria Tower I Galleria
USI Insurance 46,902 New Air Liquide Center Katy Freeway East
Bureau Veritas 43,602 New Greenspoint Park North Belt West/Greenspoint
5%6%7%8%9%
10%11%12%13%14%
-1,00001,0002,0003,0004,0005,0006,0007,0008,000
05 06 07 08 09 10 11 12 13 14 15 16*
Net Absorption (Thousands of SF) Direct Vacancy Rate
020406080100120140160
25,000 SF 50,000 SF 100,000 SF 200,000 SF
Class A Direct Class A Sublet Class B Direct Class B Sublet
VACANCY
Vacancy rises with low demandThe overall office vacancy rate (including sublet) was 13.8% at first quarter, unchanged from year-end. Direct vacancy was 12.5%, up from 12.2% last quarter. Total available sublease space continues to grow, adding more than 940,000 SF this quarter to hit 8.7 million SF on the market. Sublease space is expected to continue rising over the course of 2016 and hit the 10 million SF range by the end of the year. Energy companies comprise the majority of sublease space on the market, accounting for 78% of the total. Total available space for lease in several submarkets is markedly higher than what is reported as vacant in statistics. Submarkets like the Energy Corridor and Galleria will continue to experience increasing downside pressure and rising availability rates as the energy downturn cuts deep into fundamentals.
Class A overall vacancy was 12.9% at first quarter, down just slightly from 13.0% at year-end, and Class A direct was 11.5%, up from 11.1% over the same period. Vacant available space declined over this period as deliveries were 92% preleased, adding 1.8 million SF of occupied Class A space to the existing inventory. Vacancy rates will continue trending upward in the period ahead as demand remains low and space still under construction delivers.
RENTAL R ATES
Rents begin to slip in 2016Asking rental rates for all classes of office space have increased 0.7% from year-end to $28.39 per SF gross. Class A rents were down 0.6% to $35.09 per SF gross, and Class B rents rose 0.1% to $21.30 per SF gross from the close of the year. Asking rents reached a tipping point at the end of 2015 and should trend downward in the period ahead. Rent declines lagged behind other indicators as landlords worked to maintain face rents as long as possible. Concessions are prevalent, especially in Class A, with free rent and improvement packages dramatically increasing.
SUPPLY AND DEVELOPMENT
Pipeline continues to coolThere was 5.9 million SF of office space under construction at first quarter, as compared to 7.2 million SF at year-end. This space was 49% preleased, as compared to 61% at the end of 2015. The majority of the construction pipeline, 4.8 million SF, is currently scheduled to deliver in the remaining three quarters of 2016.
There is no longer a standout submarket for construction activity, as the Energy Corridor, Westchase, CBD and Galleria all have around one million SF under construction. The Energy Corridor is the most vulnerable for negative performance given the current state of the oil and gas market and a construction pipeline only 23% preleased. The biggest projects under construction are Phillips 66's campus in Westchase at 1.1 million SF and 609 Main at Texas in the CBD at 1.0 million SF.
Office Under ConstructionHouston Metro | Q1 2016
SUBMARKET SF % PRE-LEASED
West Loop 1,285,000 71%
Energy Corridor 1,179,475 23%
Westchase 1,100,000 100%
CBD 1,056,658 27%
The Woodlands 511,913 10%
Greenway Plaza 398,696 27%
FM 1960/Hwy 249 165,754 27%
Katy 124,017 18%
Gulf Freeway/Pasadena 102,000 83%
Total 5,923,513 49%
AVERAGE OFFICE RENTS HOUSTON METRO AREA
SOURCE CoStar, Transwestern *Through Q1 2016 Note: All classes of office space
Total Available SpaceHouston Metro | Q1 2016
SUBMARKET SUBLEASE SPACE (SF)
% SUBLEASE
% TOTAL AVAILABLE
Energy Corridor 2,289,000 6.3% 21.1%
CBD 1,803,000 3.8% 20.1%
Westchase 1,107,000 6.8% 20.0%
Greenspoint 684,000 5.2% 41.8%
Galleria 888,000 5.6% 18.5%
All of Houston 8,688,000 3.6% 20.4%
$16
$18
$20
$22
$24
$26
$28
$30
05 06 07 08 09 10 11 12 13 14 15 16*
$28.39
Asking Rents ($/SF Gross)
2 REAL ESTATE OUTLOOK HOUSTON METRO Q1 2016
HOUSTON METRO MARKETFIRST QUARTER 2016
Deliveries dropped off significantly in the first quarter with the metro recording just 1.9 million SF added to the market at 92% preleased. Of the six buildings delivered this quarter, three were owner-occupied and one was single-tenant, which was reflected in the high preleased percentage. The largest projects delivered include FMC Technologies' campus at 510,000 SF in the Northeast submarket and Millennium Tower II at 445,000 SF in Westchase.
INVESTMENT MARKET
Volume falls off in Q1The metro recorded just $214.6 million in office sales transactions during the first quarter, further evidence that large asset transactions have tapered off. Sales for 2015 totaled a revised $3.2 billion. Pricing averaged $113 per SF this quarter, as compared to $330 per SF at fourth quarter and $239 per SF for all of 2015. Average prices were down sizably as sales this quarter were largely comprised of smaller Class B and C assets. The average cap rate was 7.3%, down from a revised fourth quarter average of 7.6%. Cap rates for all of 2015 averaged 7.2% These figures represent assets for which pricing information could be obtained.
The energy downturn and corresponding economic uncertainty have caused a disparity in pricing expectations, leaving some owners hesitant to list. There is a significant bid-ask spread as buyers and sellers of office assets work to adjust expectations in a down economy. Marathon Oil Tower was taken off the market in the first quarter as offers came in lower than expected. As the office sector in Houston is expected to get worse before seeing a recovery, fewer buildings are being listed for sale. Deals in 2016 are more likely to be sourced off market as owners try to keep lower pricing from being advertised.
COMPARATIVE OFFICE INVESTMENT SALES VOLUME SELECT METRO AREAS
SOURCE Real Capital Analytics, Transwestern ,*Through Q1 2016
AVERAGE OFFICE SALE PRICE HOUSTON METRO AREA
SOURCE Real Capital Analytics, Transwestern,*Through Q1 2016
Notable Q1 TransactionsBUILDING SUBMARKET SALE PRICE CAP RATE SELLER BUYER
5300 Memorial Midtown $31.5 million ($205/SF) 7.6% Parkway Properties Equus Capital Partners
Town & Country Central I Katy Freeway East $26.0 million ($175/SF) 7.7% Parkway Properties Equus Capital Partners
5433 Westheimer Galleria $15.2 million ($123/SF) 6.4% Songy Highroads & EDENS joint venture Urban Meridian
SOURCE Real Capital Analytics, HFF, Transwestern
Sales Volume in Billions
$0.0
$1.0
$2.0
$3.0
$4.0
$5.0
$6.0
Atl Dal Den Hou
05 06 07 08 09 10 11 12 13 14 15 16*
Average Sale Price Per SF
$113
$0
$50
$100
$150
$200
$250
05 06 07 08 09 10 11 12 13 14 15 16*
REAL ESTATE OUTLOOK HOUSTON METRO Q1 2016 3
OUTLOOK
Market in for rough road aheadThe office sector is experiencing the most fallout by far in the current economic conditions as workforce reductions, M&A activity, cost cutting and downsizing by energy companies further weakens fundamentals. Tenants and landlords must frequently adjust to changing market conditions as bankruptcy filings and sublease space steadily grows. Some of these market realities have not yet caught up with statistics as office metrics lag behind companies' real estate decisions. The office market will likely be extremely challenging for several years, and the full impact will not be realized until oil prices stabilize, and energy companies hit bottom and begin to recover.
The metro’s current development pipeline is 49% preleased, and a slower economy will limit further leasing activity in this space. Additionally, many of these tenants will vacate large blocks of space when they move to occupy new buildings. With tepid demand expected in the period ahead, we anticipate the overall vacancy rate for all classes of space to increase over the next two years, climbing to the high-17% range. As development activity drops off, Houston's strong net absorption will go with it allowing a different picture of the market to emerge. Asking rents will fall with better deals coming for tenants in the market. This is not the 1980s, but it is arguably the toughest office market since that time.
Multi-tenant market vs Transwestern comprehensive market coverage
MULTI-TENANT ENTIRE MARKET
Inventory 190.1 MSF 244.5 MSF
Overall Vacancy 16.4% 13.8%
Q1 Net Absorption 1.4 MSF 996,000 SF
WHY OUR METHODOLOGY IS THE BEST INDICATOR OF CURRENT MARKET CONDITIONSWe include owner occupied and single-tenant buildings in our inventory, vacancy and absorption statistics to capture more market activity than many of our competitors. This allows us to better correlate changes in the market with changes in employment. As single-tenant space does compete with multi-tenant space, we believe it is critical to understand all components of the market. The inclusion of single-tenant and owner-occupied space tends to yield lower vacancy rates and higher absorption totals than some of our competitors’ results, but our coverage of the market is more comprehensive.
OFFICE ABSORPTION AND EMPLOYMENT HOUSTON METRO AREA
SOURCE Bureau of Labor Statistics, Transwestern *12-month job growth through February 2016, net absorption through Q1 2016
-100
-75
-50
-25
0
25
50
75
100
125
-1,000
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
05 06 07 08 09 10 11 12 13 14 15 16*
Net Absorption (Thousands of SF) Payroll Job Growth (in Thousands)
4 REAL ESTATE OUTLOOK HOUSTON METRO Q1 2016
HOUSTON METRO MARKETFIRST QUARTER 2016
Houston Office Market Indicators - All Space
SUBMARKET TOTAL BLDGS INVENTORY SF AVAILABLE
IMMEDIATELY
DIRECT VACANCY
2015
DIRECT VACANCY
Q1 2016
VACANCY WITH SUBLET
Q1 2016
UNDER CONSTRUCTION
NET ABSORPTION
Q1 2016
Central Business District 87 47,919,574 5,625,758 11.3% 11.7% 13.6% 1,056,658 136,000
NOTE Rents for properties using triple net terms have been grossed up to full service with operating expense data, rents reflect full service equivalent
t 713.270.7700 f 713.270.6285www.transwestern.net/houston
1900 West Loop South, Suite 1300Houston, Texas 77027
SEATTLE
WALNUT CREEK
LOS ANGELES
SALT LAKECITY
DENVER
MINNEAPOLIS
MILWAUKEE
ST. LOUIS
CHICAGO
DETROIT GREENWICHNEW YORK
NEW JERSEY
BALTIMORENORTHERNVIRGINIA
BETHESDAWASHINGTON DC
DALLASFORTWORTH
HOUSTONAUSTIN
SAN ANTONIO
OKLAHOMACITY
NEW ORLEANS
ATLANTA
FORT LAUDERDALEORLANDO
MIAMI-DADE
SANFRANCISCO
PHOENIXORANGE COUNTY
SAN DIEGO
BOSTON
SILICONVALLEY
TRANSWESTERNLOCATIONS
aBout tR ansWesteRn
Transwestern is a privately held real estate firm specializing in agency leasing, property and facilities management, tenant advisory, capital markets, research and sustainability. The fully integrated global enterprise leverages competencies in office, industrial, retail, multifamily and healthcare properties to add value for investors, owners and occupiers of real estate. As a member of the Transwestern family of companies, the firm capitalizes on market insights and operational expertise of independent affiliates specializing in development, real estate investment management and research. Transwestern has 34 U.S. offices and assists clients through more than 180 offices in 37 countries as part of a strategic alliance with Paris-based BNP Paribas Real Estate.
Transwestern was founded in Houston, Texas in 1978, and Houston remains the corporate headquarters today. As one of the preeminent commercial real estate firms in Houston, we offer a comprehensive menu of real estate services designed to provide owners, tenants and investors with the optimum solutions for their unique requirements. Transwestern has seasoned veterans in every area of expertise with the integrity, experience and creativity to be the best partner for its clients. Transwestern’s Houston office currently employs over 400 team members and has been an innovator in the Houston market for 38 years.
Galleria :: Apache524,000 SF lease extension through 12/2019 at Post Oak Central
CBD :: Bracewell & Giuliani189,061 SF renewal at Pennzoil Place
Katy Freeway West :: G&A Partners 30,065 SF new lease at Westgate I
Recent office sales
Katy Freeway West :: Energy Center Three549,000 SF, Class ABuyer: ConocoPhillipsSeller: Trammell Crow Co & Principal Real Estate Investors joint venture
Galleria :: 2200 Post Oak 326,200 SF, Class ABuyer: Corporación MasaveuSeller: Stream, TRC Capital Partners & L&B Realty Advisors joint venture
OFFICE LEASE STATISTICS
Source: Transwestern analysis of CoStar data, includes buildings 50,000 SF RBA and greater, excluding government owned buildings
t 713.270.7700 f 713.270.6285www.transwestern.net/houston
1900 West Loop South, Suite 1300Houston, Texas 77027
SEATTLE
WALNUT CREEK
LOS ANGELES
SALT LAKECITY
DENVER
MINNEAPOLIS
MILWAUKEE
ST. LOUIS
CHICAGO
DETROIT GREENWICHNEW YORK
NEW JERSEY
BALTIMORENORTHERNVIRGINIA
BETHESDAWASHINGTON DC
DALLASFORTWORTH
HOUSTONAUSTIN
SAN ANTONIO
OKLAHOMACITY
NEW ORLEANS
ATLANTA
FORT LAUDERDALEORLANDO
MIAMI-DADE
SANFRANCISCO
PHOENIXORANGE COUNTY
SAN DIEGO
BOSTON
SILICONVALLEY
TRANSWESTERNLOCATIONS
aBout tR ansWesteRn
Transwestern is a privately held real estate firm specializing in agency leasing, property and facilities management, tenant advisory, capital markets, research and sustainability. The fully integrated global enterprise leverages competencies in office, industrial, retail, multifamily and healthcare properties to add value for investors, owners and occupiers of real estate. As a member of the Transwestern family of companies, the firm capitalizes on market insights and operational expertise of independent affiliates specializing in development, real estate investment management and research. Transwestern has 34 U.S. offices and assists clients through more than 180 offices in 38 countries as part of a strategic alliance with Paris-based BNP Paribas Real Estate.
Transwestern was founded in Houston, Texas in 1978, and Houston remains the corporate headquarters today. As one of the preeminent commercial real estate firms in Houston, we offer a comprehensive menu of real estate services designed to provide owners, tenants and investors with the optimum solutions for their unique requirements. Transwestern has seasoned veterans in every area of expertise with the integrity, experience and creativity to be the best partner for its clients. Transwestern’s Houston office currently employs over 400 team members and has been an innovator in the Houston market for 37 years.
Westchase :: EMAS93,614 SF sublease at 10500 Richmond Ave
CBD :: MRC Global50,237 SF sublease at Fulbright Tower
Post Oak Park :: Rockwater Energy32,000 SF new lease at 515 Post Oak Blvd
recent office sales
Galleria :: Galleria Place I & II396,445 SF total, two building portfolioBuyer: Lincoln Property CoSeller: Songy Highroads & Carlyle Group joint venture
E Fort Bend Co/Sugar Land :: Comerica Bank Building193,988 SF, Class ABuyer: Equus Capital PartnersSeller: Parkway Properties
OFFICE LEASE STATISTICS
Source: Transwestern analysis of CoStar data, includes buildings 50,000 SF RBA and greater, excluding government owned buildings
t 713.270.7700 f 713.270.6285www.transwestern.net/houston
1900 West Loop South, Suite 1300Houston, Texas 77027
SEATTLE
WALNUT CREEK
LOS ANGELES
SALT LAKECITY
DENVER
MINNEAPOLIS
MILWAUKEE
ST. LOUIS
CHICAGO
DETROIT GREENWICHNEW YORK
NEW JERSEY
BALTIMORENORTHERNVIRGINIA
BETHESDAWASHINGTON DC
DALLASFORTWORTH
HOUSTONAUSTIN
SAN ANTONIO
OKLAHOMACITY
NEW ORLEANS
ATLANTA
FORT LAUDERDALEORLANDO
MIAMI-DADE
SANFRANCISCO
PHOENIXORANGE COUNTY
SAN DIEGO
BOSTON
SILICONVALLEY
TRANSWESTERNLOCATIONS
aBout tr ansWestern
Transwestern is a privately held real estate firm specializing in agency leasing, property and facilities management, tenant advisory, capital markets, research and sustainability. The fully integrated global enterprise leverages competencies in office, industrial, retail, multifamily and healthcare properties to add value for investors, owners and occupiers of real estate. As a member of the Transwestern family of companies, the firm capitalizes on market insights and operational expertise of independent affiliates specializing in development, real estate investment management and research. Transwestern has 34 U.S. offices and assists clients through more than 180 offices in 38 countries as part of a strategic alliance with Paris-based BNP Paribas Real Estate.
Transwestern was founded in Houston, Texas in 1978, and Houston remains the corporate headquarters today. As one of the preeminent commercial real estate firms in Houston, we offer a comprehensive menu of real estate services designed to provide owners, tenants and investors with the optimum solutions for their unique requirements. Transwestern has seasoned veterans in every area of expertise with the integrity, experience and creativity to be the best partner for its clients. Transwestern’s Houston office currently employs over 400 team members and has been an innovator in the Houston market for 37 years.
t 713.270.7700 f 713.270.6285www.transwestern.net/houston
1900 West Loop South, Suite 1300Houston, Texas 77027
SEATTLE
WALNUT CREEK
LOS ANGELES
SALT LAKECITY
DENVER
MINNEAPOLIS
MILWAUKEE
ST. LOUIS
CHICAGO
DETROIT GREENWICHNEW YORK
NEW JERSEY
BALTIMORENORTHERNVIRGINIA
BETHESDAWASHINGTON DC
DALLASFORTWORTH
HOUSTONAUSTIN
SAN ANTONIO
OKLAHOMACITY
NEW ORLEANS
ATLANTA
FORT LAUDERDALEORLANDO
MIAMI-DADE
SANFRANCISCO
PHOENIXORANGE COUNTY
SAN DIEGO
BOSTON
SILICONVALLEY
TRANSWESTERNLOCATIONS
aBout tr ansWestern
Transwestern is a privately held real estate firm specializing in agency leasing, property and facilities management, tenant advisory, capital markets, research and sustainability. The fully integrated global enterprise leverages competencies in office, industrial, retail, multifamily and healthcare properties to add value for investors, owners and occupiers of real estate. As a member of the Transwestern family of companies, the firm capitalizes on market insights and operational expertise of independent affiliates specializing in development, real estate investment management and research. Transwestern has 34 U.S. offices and assists clients through more than 180 offices in 38 countries as part of a strategic alliance with Paris-based BNP Paribas Real Estate.
Transwestern was founded in Houston, Texas in 1978, and Houston remains the corporate headquarters today. As one of the preeminent commercial real estate firms in Houston, we offer a comprehensive menu of real estate services designed to provide owners, tenants and investors with the optimum solutions for their unique requirements. Transwestern has seasoned veterans in every area of expertise with the integrity, experience and creativity to be the best partner for its clients. Transwestern’s Houston office currently employs over 400 team members and has been an innovator in the Houston market for 37 years.
HOUSTON OfficeDecember 2014
recent office leasesGreenspoint/North Belt :: Nabors Industries314,000 SF renewal & expansion at One Commerce Green
Westchase :: Bristow Group115,000 SF new lease at CityWestPlace 4
Energy Corridor :: GE72,177 SF prelease at Westway Plaza
t 713.270.7700 f 713.270.6285www.transwestern.net/houston
1900 West Loop South, Suite 1300Houston, Texas 77027
SEATTLE
WALNUT CREEK
LOS ANGELES
SALT LAKECITY
DENVER
MINNEAPOLIS
MILWAUKEE
ST. LOUIS
CHICAGO
DETROIT GREENWICHNEW YORK
NEW JERSEY
BALTIMORENORTHERNVIRGINIA
BETHESDAWASHINGTON DC
DALLASFORTWORTH
HOUSTONAUSTIN
SAN ANTONIO
OKLAHOMACITY
NEW ORLEANS
ATLANTA
FORT LAUDERDALEORLANDO
MIAMI-DADE
SANFRANCISCO
PHOENIXORANGE COUNTY
SAN DIEGO
BOSTON
SILICONVALLEY
TRANSWESTERNLOCATIONS
aBout tr ansWestern
Transwestern is a privately held real estate firm specializing in agency leasing, property and facilities management, tenant advisory, capital markets, research and sustainability. The fully integrated global enterprise leverages competencies in office, industrial, retail, multifamily and healthcare properties to add value for investors, owners and occupiers of real estate. As a member of the Transwestern family of companies, the firm capitalizes on market insights and operational expertise of independent affiliates specializing in development, real estate investment management and research. Transwestern has 34 U.S. offices and assists clients through more than 180 offices in 38 countries as part of a strategic alliance with Paris-based BNP Paribas Real Estate.
Transwestern was founded in Houston, Texas in 1978, and Houston remains the corporate headquarters today. As one of the preeminent commercial real estate firms in Houston, we offer a comprehensive menu of real estate services designed to provide owners, tenants and investors with the optimum solutions for their unique requirements. Transwestern has seasoned veterans in every area of expertise with the integrity, experience and creativity to be the best partner for its clients. Transwestern’s Houston office currently employs over 385 team members and has been an innovator in the Houston market for 36 years.
HOUSTON OfficeSepTember 2014
recent office leases
Katy :: Det Norske Veritas 47,250 SF prelease at 22535 Colonial Pkwy
Energy Corridor :: Venari Resources28,655 SF new lease at West Memorial Place
Energy Corridor :: Tesco Corporation26,510 SF prelease at Westway Plaza
recent office sales
Energy Corridor :: Two Westlake Park454,843 SF, Class ASale price: $120 millionBuyer: PIMCO & Hicks Ventures Seller: KBS REIT II
OFFICE LEASE STATISTICS
Source: Transwestern analysis of CoStar data- Houston office buildings 15,000 SF and greater, excluding government owned buildings
t 713.270.7700 f 713.270.6285www.transwestern.net/houston
1900 West Loop South, Suite 1300Houston, Texas 77027
SEATTLE
WALNUT CREEK
LOS ANGELES
SALT LAKECITY
DENVER
MINNEAPOLIS
MILWAUKEE
ST. LOUIS
CHICAGO
DETROIT GREENWICHNEW YORK
NEW JERSEY
BALTIMORENORTHERNVIRGINIA
BETHESDAWASHINGTON DC
DALLASFORTWORTH
HOUSTONAUSTIN
SAN ANTONIO
OKLAHOMACITY
NEW ORLEANS
ATLANTA
FORT LAUDERDALEORLANDO
MIAMI-DADE
SANFRANCISCO
PHOENIXORANGE COUNTY
SAN DIEGO
BOSTON
SILICONVALLEY
TRANSWESTERNLOCATIONS
aBout tr ansWestern
Transwestern is a privately held real estate firm specializing in agency leasing, property and facilities management, tenant advisory, capital markets, research and sustainability. The fully integrated global enterprise leverages competencies in office, industrial, retail, multifamily and healthcare properties to add value for investors, owners and occupiers of real estate. As a member of the Transwestern family of companies, the firm capitalizes on market insights and operational expertise of independent affiliates specializing in development, real estate investment management and research. Transwestern has 34 U.S. offices and assists clients through more than 181 offices in 40 countries as part of a strategic alliance with Paris-based BNP Paribas Real Estate.
Transwestern was founded in Houston, Texas in 1978, and Houston remains the corporate headquarters today. As one of the preeminent commercial real estate firms in Houston, we offer a comprehensive menu of real estate services designed to provide owners, tenants and investors with the optimum solutions for their unique requirements. Transwestern has seasoned veterans in every area of expertise with the integrity, experience and creativity to be the best partner for its clients. Transwestern’s Houston office currently employs over 385 team members and has been an innovator in the Houston market for 36 years.
HOUSTON OfficeJULY 2014
Recent Office Leases
CBD :: Key Energy (renewal)89,000 SF in Fulbright tower
Energy Corridor :: IHI E&C International Corporation61,455 SF in One Eldridge Place
San Felipe/Voss :: Texas American Title50,000 SF at 2000 Bering
Recent Office saLes
Greenspoint/North Belt West :: Eight Greenspoint Plaza198,257 SF, Class ASale price undisclosedBuyer: Stream Realty & AllianceBernstein US RE Seller: ExxonMobil Corporation
OFFICE LEASE STATISTICS
Source: Transwestern analysis of CoStar data- Houston office buildings 15,000 SF and greater, excluding government owned buildings