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Market Rent and Comparable Analysis - O'Connor and Associates
Houston Office Market Fundamentals
First Quarter 2006
June 2006
By Logan Brown
Grubb & Ellis
Executive Summary
During the early months of 2006, Houston's office leasing market remarkably posted 873,574 square feet of positive net absorption, with over 2.7 million square feet of new growth recorded within the past 12 months. Overall, citywide absorption levels were the highest for Class A product. Class B and C product lagged far behind.
The increase in leasing velocity within the past year has stemmed from soaring profits posted by energy firms and pent-up demand for office space. Asking rents have increased steadily in Class A and B properties, but remain well below the peak recorded in the expansion cycle five years ago.
Investment Market Overview
Although capital flow slowed from the record pace seen within the past two years, the supply of it seeking investments still remains very high. According to Real Capital Analytics (RCA), private, public and institutional investors have spent nearly $2.9 billion within the past 12 months through March 2006 to acquire office properties in the Greater Houston area. With an abundance of capital trying to make its way into the market, competition for high quality office assets has remained intense and optimism is being bolstered by the positive leasing activity. The sky rocketing demand within the office investment market has strengthened by an exceptionally stronger Class A leasing market. The most popular assets within the past year have been Class A buildings, located primarily in the CBD, Galleria and West Houston.
In the year ahead, active buyers will remain plentiful and a considerable amount of institutional capital, free from the burdens of debt leverage, will be available. With prices being bid up quite high for guaranteed-income properties (with high occupancies and quality tenants), aggressive, risky investment strategies with upside potential will become more appealing to buyers. In 2006, the investment sale market will see pricing peak, cap rate compression end (with some reversion) and performance slow down as value gains level off.
Interest Rates Start to Move
We have all been waiting to see when the first shoe "would drop" and the juggernaut of the investment market would start to reflect market realities. With the recent major increases in the 10 year treasury (on which almost all mortgages are based), we have seen the first signs of a slowdown. Those properties which are fully leased and fully stabilized will be the first to drop in price. As regards "value ad" deals, the slowdown will not be as acute as long as lease rates and leasing possibilities stay ahead of the pace of interest rate increases. My personal opinion is that we will see a pronounced slowdown in the investment market in late 2006 as the realities sink in to the sellers in the market. For anyone who has a property to sell, I strongly recommend that you get it on the market and get it sold immediately because you are unlikely to ever see this combination of growth and low interest rates again.
Houston Office Leasing Market
June 2006
By Ariel Guerrero
Grubb & Ellis
Houston's employment numbers are on the rise and have had a significant impact on Houston's economy. In 2005, Houston gained 60,100 jobs that triggered strong absorption, falling vacancy and rising rents in the office market.
Houston's office leasing market posted 873,574 sq. ft. of positive net absorption in the first quarter of this year, with over 2.7 million sq. ft. of positive absorption recorded in the past 12 months. Overall, the suburban office market has largely contributed to the highest citywide absorption levels for Class A product, taking down more than 850,000 sq. ft. during the first quarter. As a result, Houston's overall vacancy reached its lowest level in three years by 24 basis points, from 18.6% in 2005 to 17.3% this year.
The increase in leasing velocity within the past year stems from soaring profits posted by energy firms and pent-up demand for office space. For instance, The Central Business District (CBD) is lively with more than 1.5 million sq. ft. of leasing activity within the past six months, including Chevron/Texaco at 465,000 sq. ft. and EPCO at 400,000 sq. ft. In addition, it is speculated that additional energy companies are looking for additional space to expand operations in Houston.
As the Houston leasing market continues to gain momentum, asking rents have steadily increased in Class A properties, but remain well below the peak recorded in the expansion cycle five years ago. In the year ahead, job growth is expected to rise another 3%, thus causing high-quality spaces in the most desirable to disappear. As rents rise for better space, tenants will begin to trade quality for rent. As the available options to sizable tenants dwindle, landlords, primarily within the suburbs, will be able to hold firm to their quoted rents and pull back on concessions that will result in a 2% to 3% gain in effective rents.
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