TEXAS SNAPSHOT, DECEMBER 2005

Houston Industrial Market

The lack of alternative investments in Houston's industrial market is forcing investors to reduce their return expectations, with current cap rates on new industrial product at 7.0 percent to 7.25 percent on stabilized NOI, compared to first-tier industrial markets, such as Southern California and Northern New Jersey, with sub-6.0 percent cap rates. This trend is allowing real estate developers to continue to develop in an environment of increasing costs and flat rents. Positive absorption in the Houston area is also beginning to increase with the absorption at 2.3 million square feet through the third quarter, which will further serve to increase development volumes in the future.

Wal-Mart's new 4 million-square-foot distribution center — with Phase I completed last June — is helping the Southeast submarket near the Port of Houston draw a significant amount of attention. Wal-Mart's project follows on the heels of The Home Depot's 800,000-square-foot distribution center completed in 2001, and there is every reason to expect new distribution centers in the area. Additionally, the $1.2 billion Bayport Container & Terminal Project, which is set to complete Phase I next July, also is helping to generate activity in the Southeast submarket.

Houston's northwest and southwest sectors are seeing the most industrial development activity. Of the 1.7 million square feet of investment-grade product under construction at the close of third quarter, the northwest submarket accounts for 970,000 square feet. With few exceptions, these industrial projects are less than 100,000 square feet and are geared toward mid-size tenants. Among the more prominent projects under construction, ProLogis is expanding Jersey Village Park in the Northwest submarket by 300,000 square feet (leased to Goodman Manufacturing) and adding a speculative 200,000-square-foot bulk warehouse. Also in the northwest, Vantage Companies is developing Bondesen North Business Park, a 215,000-square-foot, five-building project with delivery expected by year-end. Investment-grade industrial deliveries in the third quarter totaled 1.4 million square feet, with the Southwest submarket adding 911,000 square feet of primarily bulk warehouse space.

Simmons Vedder is entering the Houston industrial arena with a 600,000-square-foot project after successfully completing office and high-rise condominium projects. Other local developers have been significantly increasing their level of industrial activity. Clay Development has gone from developing mostly built-to-suits less than 100,000 square feet to larger speculative projects in the La Porte/Deer Park submarket. McShane Development Corporation also is completing its second speculative project, Colony Crossing, in Missouri City along the Beltway, while the Houston-based brokerage firm of Caldwell Watson is branching out and working on more development projects.

With the improving economy (both locally and nationally), landlords are favoring service companies desiring visibility along the Beltway and distribution companies looking to upgrade the functionality of their facilities. Construction material distributors and high-tech, light manufacturing and service companies are driving much of the absorption citywide. Even though nationally the manufacturing sector is still recovering from the structural changes to the U.S. economy, locally the manufacturing sector is benefiting from sustained strong energy prices that are disproportionately favoring Houston-area businesses.

Occupancy levels in the Houston market are nearing the 90 percent mark. And while industrial rental rate growth is not expected until occupancy levels reach 90 percent or better, stable rents are nevertheless a welcome factor when considering the rate declines of 2002 and 2003. Bulk warehouse average quoted rental rates continued at $3.00 per square foot, office warehouse at $4.92 per square foot, and service centers at $7.12 per square foot. Industrial rental rate growth is expected as occupancy levels continue strengthening during the next 6 to 9 months.

Direct vacancy of 12.8 percent (for all product lines combined) in the third quarter continued relatively unchanged from mid-year levels. On an annual basis, however, vacancy fell by 200 bps from 14.8 percent 1 year ago. A stronger economic climate is positively impacting the market, with all product lines recording occupancy improvements on an annual basis. Direct vacancy rates continue to dwindle with office warehouse space at 12.9 percent posting the strongest annual improvement of 290 bps, followed by bulk warehouse space at 13.2 percent compared to 15 percent 12 months earlier and service center space at 11.4 percent from 13.1 percent at this time last year.

North Houston is definitely the submarket to watch in the near future for several reasons. Expansion at the Intercontinental Airport and the relocation of cargo facilities from the central Houston industrial sector is expected to continue generating increased market activity, both in terms of new development and absorption of existing space. Also, as rising land costs continue to diminish development opportunities in the northwest sector, developers and investors are beginning to look east along the Beltway for alternative choices. The north sector represents a strong alternative, given its excellent access and proximity to the airport, as well as Interstate 45, the Hardy Toll Road and the Beltway.

— David Hudson is senior vice president, director of industrial leasing division, for Trammell Crow Company in Houston.

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