FEATURE ARTICLE, DECEMBER 2005

2006 Broker Outlook

Houston

Houston's office leasing market registered positive absorption for the sixth consecutive quarter with 450,478 square feet as absorption increased to nearly 1.5 million square feet. The annual net gain through the close of the third quarter marked the highest absorption total since 2000 and remains on track for continued improvement in the year ahead.   With the office leasing market gaining strength, the majority of the improvement this year has occurred within Houston's suburbs as vacancy dropped by 1.8 percent to 16.8 percent this year — a level unseen in 5 years — where demand in the suburbs has outpaced the central business district (CBD).    

According to Grubb & Ellis' third quarter office market trends survey, the majority of the annual space gain occurred within Class A and B properties with 682,021 and 537,232 square feet of positive absorption, respectively.   Meanwhile, Houston's office market is seeing less sublease space coming on line overall. However, downtown is seeing a surge of new sublease spaces coming online within Chase Tower.

The most notable downtown transaction involved Bank of America Corporation extending a 252,900-square-foot lease until 2019 after working out a deal to give back three floors, totaling 100,000 square feet, of Class A office space in exchange for a 10-year extension.

Another notable deal involved Waste Management renewing its lease for approximately 202,000 square feet at the First City Tower office building in downtown Houston. First City Tower, located at 1001 Fannin, is approximately 1.3 million square feet and is 49 stories tall.

Last year, ATOFINA Petrochemicals signed a 15-year lease for 150,000 square feet with intentions of moving into Louisiana Place this month. After ATOFINA's move, the firm will be joined by parent company, Philadelphia-based Total Holdings U.S.

Panhandle Energy has decided to keep the seven floors it occupies at 5444 Westheimer Road and expanded by three more floors in the Uptown/Galleria submarket. The company had considered moving to the CBD. More space was needed to consolidate operations with CrossCountry Energy, a natural gas pipeline business. Employees were completely moved into the Galleria area in June. The building, which has a total of 382,000 square feet, is 94.5 percent occupied with this lease renewal and expansion.

Stanford Financial Group signed a 10-year lease for 112,000 square feet of Class A office space at Galleria Tower II. The asset management company maintained its corporate headquarters across the street at 5050 Westheimer Road. The firm occupied seven floors of the 320,359-square-foot Galleria Tower II at 5051 Westheimer Road in May 2005.

Meanwhile, St. Luke's Episcopal Health System Corporation has expanded outside of the Texas Medical Center with a long-term lease for 139,424 square feet at 3100 Main Street. St. Luke's occupied its space in January of this year. The deal was valued at more than $20 million. St Luke's moved from 6620 Main to make room for Baylor College of Medicine physicians.

The Katy/Freeway/Energy Corridor submarket has outperformed all submarkets for the year with 432,882 square feet of positive absorption through the end of third quarter as several engineering and energy-related companies have expanded and/or relocated to the submarket.  

Class A, as well as Class B, properties are filling up in Westchase. Good quality, well-managed and maintained properties are getting the upper hand.

For instance, Petroleum Geo-Services (PGS) inked a 10-year lease for a vacant west Houston building that formerly served as the headquarters for Landmark Graphics Corporation earlier this year. PGS moved 400 employees into the 146,765-square-foot building at 15150 Memorial Drive in March 2005, as the firm consolidated three Houston offices into the six-story building.

Westchase, Katy Freeway, Greenway, Sugar Land and The Woodlands are growing and will continue to see positive absorption in 2006. These submarkets are growing due to proximity to executive's homes, accessibility to Beltway 8 (Westchase), a desire to be in a secured environment (The Woodlands) and a desire to be close to clients in the energy corridor (Katy Freeway).

While Houston is still lagging behind the nation in terms of job creation, it's beginning to catch up. Employers in the Houston area created 30,500 jobs, a 1.3 percent increase, during the past 12 months, according to an August 2005 report from the Texas Workforce Commission. In order for the market to improve in 2006, the city will need more job creation.

The outlook for Houston's office market is that it will see continued growth with increasing tenant demand, heralding a recovery in the leasing market, and strong investor interest reflecting a highly sought after investment market.

— Keith Lloyd is senior vice president specializing in the office market in Grubb & Ellis' Houston office.

The current year has proven to be a strong one for Houston's industrial market, which registered nearly 1.5 million square feet of positive net absorption in the third quarter of this year as the annual absorption figure grew to 9.2 million square feet. As a result, Houston's industrial vacancy has declined by 1.25 percent to 6.25 percent for the year, reaching its lowest level in 6 years — thanks in part to an increase in leasing activity and restraint on new construction.

The largest transaction for the year involved Wal-Mart's 4 million-square-foot distribution center near Baytown, which is expected to give a boost to business development in Chambers County.   The Deer Park/LaPorte market is also seeing some new development as PolyOne Corporation leased 131,000 square feet at the Battleground Distribution Center Phase II with intentions to move into their facility early in 2006.  

The northwest submarket is the largest industrial submarket and it is also the one that is growing fastest. The Northwest Far submarket led the city with the largest annual absorption gain of nearly 1.7 million square feet through the end of third quarter. As a result, overall vacancy has declined by 1.2 percent to 6.2 percent within the past year reaching its lowest level in 6 years.

The majority of the larger transactions for the year occurred within this submarket. Houston-based XL Parts delivered an 187,000-square-foot office and distribution facility earlier this year that nearly doubled the amount of space previously occupied. Emser Tile and Stone more than doubled its space by signing a lease at 9835 Genard for an additional 187,688 square feet bringing the firm's total to 299,688 square feet of warehouse/distribution space. Empire Company, Inc. leased 140,003 square feet of warehouse/distribution space at Alamo Crossing Commerce Center in July.    Yuan Tai Furniture Distribution constructed a 350,000-square-foot warehouse at 9500 West Sam Houston Parkway.

On the north side of Houston, McKesson Corporation signed a 10-year lease with renewal and expansion options in the Woodlands.   The facility will be used for distribution of pharmaceutical products throughout South Texas. The project is scheduled for completion early in 2006. Montgomery County recently adopted a tax abatement agreement that would exempt the project from paying county taxes on the building and inventory of more than $50 million for 10 years. After the 10 years, the county has agreed to a Freeport exemption, a tax break on inventory that comes in from out of state, is assembled in the county and is shipped back out of state within 175 days.

Moving to the west, Igloo increased its Katy location with an 805,000-square-foot manufacturing/distribution facility and an 87,000-square-foot corporate office at 777 Igloo Road. The expansion is across the street from the 500,000-square-foot manufacturing/distribution facility. Igloo has nearly 1.4 million square feet of space housed on 105 acres. The company relocated almost a year ago to its new Katy campus.

In Fort Bend County, Thermo Electron Corporation leased a new 150,000-square-foot facility at 1400 Gillingham Lane in the Sugar Land Business Park. The company was lured to Sugar Land with a seven-year, 90 percent tax abatement and $1.3 million in public cash.  

Leasing activity is strong, but the trend for tenants that want to own their own buildings is even stronger.   Free-standing buildings are moving quickly. Many tenants are tired of paying rent and want to own their own buildings when feasible. Low interest rates and the availability of financing are a major factor in this trend. Crane-served facilities are in short supply and are selling at or near replacement cost. Developers have accelerated the rate at which they are building speculative free-standing buildings.

If the national economy stays good and continues to experience oil at more than $60 per barrel and natural gas in the $12 (or higher) range, the industrial market in Houston should continue to do well. The trends of 2005 are expected to continue into 2006.

— Thad Hickman is a senior vice president specializing in the industrial market with Grubb & Ellis in Houston.

During the last few years, Houston has seen new apartment construction at its highest level in two decades. In 2004, 62 projects containing 16,286 units were completed. Another 45 projects containing 10,887 units have been completed so far in 2005, with 6,657 units currently under construction. The areas experiencing the most construction are in the suburbs, particularly in the Far West, Champions, Woodlands/Conroe, Friends-wood/Pearland and Fort Bend areas. Although the heavy construction kept overall occupancy levels depressed at around 87 percent, strong demand offered hope that the once beleaguered market was gaining strength. Rental rates increased ever so slightly during the year, and rental concessions decreased, something much needed in a market where 2 to 3 months' free was commonplace only 1 year ago.

The debate on whether Houston's multifamily market was overbuilt took a back seat in the aftermath of Hurricane Katrina. Shortly after the devastating August 29th hurricane, an estimated 125,000 people that were displaced from their homes, schools and jobs came to seek shelter in the greater Houston area. The magnitude of the impact from Hurricane Katrina and the resulting influx of evacuees is just now beginning to come into focus as third quarter apartment market figures were recently released.

According to www.oconnordata.com, multifamily demand recorded unprecedented absorption during the third quarter. During the quarter, more than 20,000 units were absorbed, bringing annual absorption up to 25,294 units. In the month of September alone, 17,496 units were absorbed. The majority of the absorption occurred in the Class A and B markets. The Class A market posted impressive gains during the quarter by absorbing 8,979 units while the Class B market absorbed 8,151 units. The Class C market, which has struggled recently, reported absorption of 2,163 units. Strong absorption figures propelled occupancy levels up to their highest point in several years.

Overall occupancy, after bottoming out in the first quarter of 2005 at 86.85 percent, gained 3.33 points during the quarter to reach 90.61 percent. This is the highest average occupancy that Houston has seen since the first quarter of 2003 and the first time occupancy has exceeded 90 percent in 2 years. The Class A market posted the most drastic increase in occupancy, picking up a staggering 6.11 points during the quarter and 8.99 points during the last year to reach its highest level (at 93.88 percent) in 4 years. Class B occupancy gained 3.18 points during the quarter to reach 91.24 percent, its highest level since the first quarter of 2003. The Class C market reversed its 13-quarter trend of declining occupancy and picked up 1.85 points to bring occupancy up to 88.30 percent. Occupancy levels should continue to increase during the last part of 2005, as evacuees who remain in shelters, hotels and friend's/relative's homes move into apartments in the months to come.  

During the next year, lingering effects of Hurricane Katrina are expected to have an impact on the market. Evidenced by O'Connor's multifamily statistics, the influx of evacuees has no doubt had a dramatic short-term impact on the Houston apartment market. Absorption figures during the last quarter were 10 times their normal rates and occupancy levels surged. It is not likely that these initial absorption levels will be sustained more than 2 to 3 months. In 2006, absorption levels are expected to decline precipitously during the course of the year as many evacuees move on, either relocating back to Louisiana, moving elsewhere or even purchasing homes here in Houston. Occupancy levels will likely remain elevated into at least early 2006, as many households that have settled into employment (especially those with school children) will stay in town until the Gulf Coast area is rebuilt. And finally, with the dramatic increase in occupancy, we expect to see rental rates continue to gradually increase during the year.

— Richard Zigler is the director of research and Leslie Countryman is a market analyst for O'Connor & Associates in Houston.

©2005 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.