Increased Momentum Surges Q4

The office space momentum in Houston for the fourth quarter 2021 is showing some signs of movement for office tenants, over and beyond movement from the prior three quarters of the year. This seems to be limited to tenants who have strategic needs, but the fluidity of leasing conversations are certainly on the rise as we near year-end. While stats for this quarter have yet to be determined, what seems to hold true is that there is an overall “feeling” on movement on both sides of the table; much more so than in the recent past.

The likely explanation is that every tenant can't sit stagnant forever. Leases expire, businesses change, and there’s signs of how to live in a post-pandemic world on the horizon; driving the need to now make a decision. Tenants are adapting to the novel world of the work-from-home model, which is driving the need for reconfiguration sooner than later. With the desire for the end-user to be more functional closer to the house, there’s signs of increased suburban leasing activity for tenants evaluating the hub and spoke model for the hourly office worker. On the other side, with the uncertainty of the market future, not every landlord can sit on vacant space indefinitely either. Therefore, an environment is being created out of necessity for change directed to motivate and attract tenants to deals they couldn’t ever achieve in any other marketplace.

Shift of the Investment Towards Office Space

Tenants have been forced to reinvest in themselves throughout this pandemic. They’ve had their vacations cancelled, their favorite restaurants closed, and a lot of time to think about what the next step for their business might be. While working from home for most was exciting at first, it’s not sustainable for collaborative business cultures to remain isolated all the time. Nor can you function with a playing child in the background stuck at home because their school is closed due to a COVID-19 scare for a week. Work must continue.

Pandemic downtime has created an environment where tenants have more savings, a better focus on their goal, a more flexible thought-process, and the ability to make business decisions with a long runway of consideration rather than as a quick reaction to a lease expiration. Spaces are hitting the sublease market on one end, while tenants shop for new deals on the other trying to find their future. Tenants with leases expiring are finding themselves with great optionality, and tenants without leases expiring are rightsizing to take advantage of these opportunities.

Well-funded landlords have also seen lack of investment opportunities in new acquisitions, but rather have been forced to reinvest in their own assets to attract and retain users. Landlords have also found themselves in the most-competitive race they have seen, with the assets that have make-ready and renovated spaces moving the quickest. Landlords that are in tune with market conditions are renovating their assets to create such creative spaces to compete with the work-from-home model. This is creating movement on both sides with quality avails, creative lease provisions, and concessionary packages of monumental proportions to absorb the space.

Just the Beginning?

As the market recovers and leasing trends change, this may only be the beginning. Tenants don’t know what they want and how their footprint will look in the future, and landlords are struggling trying to conform to a dynamic tenant marketplace. Some tenants will focus on the hub and spoke model, which will move spaces to the suburbs to allow home workers the option to find an office environment closer to the house. Some will try coworking, although the elevated pricing model and culture found in most coworking spaces doesn’t appeal to the enterprise user and is likely not sustainable long term. So ultimately, over time, workers will migrate back towards the traditional office space; but this may be 24-36 months away.  But what is known, in Houston, for some time in the future, there will be plenty of options to go around.

So confidently, tenants looking for options in the Houston market will be able to find them in every asset class going forward for the foreseeable future…and at the right price. Landlords that are paying attention and know how to market directly to the end-consumer with the right tools will be able to effectively incentivize users and attract them to their assets. We’re moving spaces at our buildings; it can be done everywhere.

Global Factors for Houston:

• With so much supply in a city, it's going to take a while for the market to right size to the demand.
• Past recoveries have been driven by industry changes, with a global market to thrive overnight. New trends may show signs of suburban leasing activity with hub and spoke models.
• In absence of a similar industry shift or new industry entering the local market, it will take population growth to absorb the remaining oversupply of overall vacancy. Elevated oil prices will help if they say high, as well as, employers that require the office user to occupy the offices.
• There's not enough organic growth to generate absorption for all the current vacancies. And development hasn't completely stopped. Something will have to give, otherwise it's a waiting game.
• Functionally obsolete assets still make up maybe 10% of the Houston market, stealing competition from newer asset classes. This further inhibits real momentum and confuses the overall market supply of quality avails.
• In addition, office trends are shifting where businesses are downsizing footprints, becoming more efficient, implementing open-concept planning, and work-from-home concepts like: hoteling and hot seats, which is further hindering demand for new direct office deals.
• This is driven by the need for employee retention, which then drives business owners to consider a restructure of their overall footprint such as open planning and a smaller square footage, or flexible work models.
• The drivers to boost demand are not currently in place outside of healthcare, engineering, tech based and financial jobs... which will likely not be enough to fill all of the holes for some time.
• With that predicament, landlords are focused on tenant retention at all costs, but also have to satisfy their investors.
• So, landlords will continue to dish out concessions and keep rental rates flat over the next few years until the market shifts back more in favor of the landlord when demand increases.

Submarket Specific:

• Houston is a large place with many different sub-cities throughout the 50-mile radius. Not all submarkets are underperforming.
• Those preferred submarkets will be the first to recover, followed soon thereafter by others immediately surrounding.
• Areas in high demand such as the Inner Loop and Energy Corridor markets have the highest rate retention due to the desire for the young professionals to live close to good schools.
• However, for the foreseeable future, tenants will find market conditions favorable in regards to their office space needs and landlords struggle to fill vacancies in their buildings.

 

By: Chris Lewis

Chris Lewis is a co-managing principal at Lee & Associates – Houston. He specializes in landlord and tenant representation in the office sector of the Houston commercial real estate market. Lewis has more than 18 years of real estate expertise with extensive knowledge in tenant relocation, tenant expansion, lease negotiations, market analysis, and property marketing.

Lee & Associates - Houston is a fully-integrated, commercial real estate company. Our business-minded brokers specialize in office, industrial and land real estate investments. As the fastest-growing, broker-owned firm in the nation, we are uniquely qualified to support our clients’ needs in the local, national and international markets. To learn more visit www.lee-associates.com/houston.