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Houston is No Place for Vulture Funds: The Q&A With John Fenoglio

John Fenoglio

John Fenoglio

Over the past 12 months, energy prices have declined to prices not seen in years.  So what about real estate? Are deals still getting done?  Is the sector returning to the energy disruption Houston experienced in the 1980s when the city was home to ‘see through’ buildings – structures that had no tenants?  To find out, Realty News Report talked to John T. Fenoglio, Executive Vice President at CBRE’s Debt & Structured Finance Group. Fenoglio co-founded Holliday Fenoglio in the 1980s and under his direction, the HFF firm became the largest commercial mortgage-banking firm in the United States with $10 billion in annual production and a mortgage-servicing portfolio of $7.6 billion.

This is Part One of Fenoglio’s assessment of the real estate situation in Houston. Come back to on Thursday for Part Two: Fenoglio’s Flashback to the 80s and how Houston’s CRE Market has evolved since that crash.

Realty News Report: You’ve been involved in Houston commercial real estate for more than three decades. With energy prices falling so sharply there’s been concern about the economy. How would you rate the health of Houston CRE today?

Fenoglio: Surprisingly strong. If you look at midyear statistics by property types, there is tremendous strength. Consider retail. Retail is 94% occupied, rents are increasing and absorption basically equals construction. The City of Houston sales tax revenue for midyear 2015 rose 5 percent and we continue to see tremendous interest in Houston by retailers. There is a lot of new construction but much of it is preleased.

Industrial is doing fantastic with a 95% occupancy rate and very good absorption. There’s a lot of construction but the new product is leasing up. There is a lot of activity on the east side with the Port of Houston. We’re seeing manufacturing jobs increasing. Daikin Industries (the Japan-based manufacturer of heating, cooling and refrigerant products that acquired Goodman Global Group) is building a new $400 million, 4 million square foot campus here that is expected to eventually employ 4,000 people. Because Houston is now perceived as a regional market rather than just a satellite, we’re seeing larger retailers and suppliers coming to city looking for chunks of space.

Realty News Report: And the office market?

Fenoglio: Office is probably the sector experiencing the most stress. At midyear, the office vacancy rate was 13.4% with a positive absorption of 1.4 million square feet. We’re seeing leasing slowing, though. Through mid year, there were 36 buildings under construction totaling 11.8 million square feet in Houston.  Of that amount,  55% was preleased. If you break it down further, of those 36 buildings, 11 totaling 4.9 million square feet are spoken for. The remaining 6.9 million square feet is about 23% preleased, so we will have some vacancy hitting market in the next year or so. The other trend we’re seeing in office is sublease space. It hit a high of 6.8 million square feet in the first half of 2015. The Katy and Far West region where energy companies are cutting back has the most spec construction, and that’s where we’re going to see vacancies increase and more sublease space come on the market. The vacancy rate in Houston’s Far West jumped from 16.8 to 23% in 2015 second quarter, primarily due to one building being delivered. Overall, though, the health of commercial real estate in Houston in very good shape. That surprises a lot of people from out of town who are expecting gloom and doom. We’re just not seeing that in the market right now.

Realty News Report: Since oil prices fell beginning in the fall of 2014, many investors shied away from Houston. What are you hearing from around the country? What is the general perception of Houston today in the capital markets?

Fenoglio: The most telling sign is the recent Emerging Trends report that was released at the Urban Land Institute Fall Meeting last week: Houston fell from No. 1 to No. 30 for investment preference. There is a lot of concern among investors about Houston and many have pulled to sidelines and are going to be there for a while unless the energy situation improves dramatically. There also are people who have totally distorted perceptions of what is happening in Houston. At least once a week, I get a call from a vulture fund that wants to buy trouble buildings at bargain basement prices. It’s just not happening.  Most of properties today have been capitalized with a lot of equity unlike other cycles when buildings were over-leveraged.  There is a lot of equity in the current deals, so there is no panic.  Most buildings under construction have larger equity components and stronger institutional partners than in the past.

Realty News Report: Because of the energy downturn, deal flow dropped off and the market has been stagnant. There are rumors that a couple of large office building sales are in the works. If a $300 million office building sale were to close, would that restore investor confidence in Houston?

Fenoglio: Obviously, any sale of that magnitude will certainly help.  Will it bring the buying herd back tomorrow? That’s not going to happen. Markets don’t move that way. One transaction may not be the catalyst that ignites the whole market, but it helps. Pension funds and investors seeing numerous buildings in Houston commanding good prices certainly helps too.  But the pool of buyers for real estate in Houston has shrunk. Many investors are taking a wait and see position.

Realty News Report: How tough is it to get a commercial loan in Houston right now? What about construction loans?

Fenoglio: Commercial loans are abundant. Capital is plentiful. In Houston, our volume at CBRE is up 25% year to date and we are busier than  ever. Insurance companies, banks, CMBS lenders, debt funds, mortgage REITs and others are all doing deals in Houston. Fannie Mae and Freddie Mac are active in the multifamily market. There is lot of money at work here.

Construction loans are probably just harder to find, but they are still being written and require significant equity and substantial financial guarantors. Construction lenders are scrutinizing supply and demand dynamics, and for the right project, money is available. New lenders are coming into the Houston marketplace that perceive voids in the construction loan sector including REITs, private lenders, and equity funds. Such voids get filled; when one financing source pulls back, another takes its place.  Sometimes, though, the new money is higher priced.

Realty News Report: Are there any property types that are more appealing to investors than others? Office or multifamily?

Fenoglio: There’s an appetite for all property types at a certain level. A grocery anchored shopping centers are in high demand. Investors feel these are low risk properties and a great buying opportunity. Fully-leased bulk warehouses are in high demand. Multifamily remains in great demand. We just got a quote on a portfolio of older, Class B apartments that was excellent. Office is getting more scrutiny now. Lenders really examine rent rolls to see exposure to energy companies.

Come back to on Thursday for Part Two: Fenoglio’s Flashback to the 80s and how Houston’s CRE Market has evolved since that crash.

Oct. 27, 2015

Realty News Report is a Texas-based publication edited by veteran real estate journalist Ralph Bivins.

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