HOUSTON – (Realty News Report) – Houston’s central business district’s office market has seen better times With 2 million square feet of sublease space on the market, the downtown availability rate is around 20 percent. In addition, new office towers such as Hines’ new office development on the former Houston Chronicle site will further increase pressure. But downtown still is attractive to companies not only because of its location but also for landmark properties such as Pennzoil Place. To find out where the market is headed, Realty News Report sat down with Tyler Garrett, vice president for the Houston office division of Transwestern, who is responsible for leasing office space citywide. Over his 13-year career, Tyler has leased approximately 2.5 million square feet valued in excess of $750 million. Tyler joined Transwestern in 2016 and prior to that, was responsible for leasing at Skanska.
Realty News Report: What’s happening with the downtown Houston office market? Vacancy is at its highest level in years. Why are vacancies continually rising?
Tyler Garrett: There is no question that vacancy is at the highest level since the 1980s. Interestingly, the 80s are partly to blame for today’s vacancy. A large portion of Houston’s downtown skyline was built in the early 80s. And then the city was hit with a massive downturn in energy and the savings and loan crisis. Because of that, Houston went over 15 years without any new office product constructed in the Central Business District as the market slowly turned toward equilibrium. Tenants never had a chance to upgrade into newer buildings. Once given the opportunity, tenants showed they are willing to pay more for nice space in newer buildings. The result is that new office buildings in the Central Business District have leased and performed well during the last 16 years. This theory continues to prove itself today, even in the current downturn, as Hines and Skanska have kicked off construction on new office towers in the middle of a significant energy downturn. This shift has presented challenges for older, non-differentiated buildings. There are certain buildings that will never regain the status they held before the downturn. For the most part, these buildings are in what can be considered marginal locations and lack special features to set them apart, such as floor-to-ceiling glass or iconic architecture. The vacancy should be topping out soon, as we have seen plenty of good news regarding the energy business and job creation. We expect to start seeing positive absorption in the next six to 12 months.
Realty News Report: Is the problem that companies are shrinking the amount of office space per employee? Or more employees telecommuting? Or companies like ExxonMobil moving to the suburbs?
Tyler Garrett: The energy downturn caused a massive focus on efficiency in the oil and gas business. That, coupled with technology, has led to a simple result – it takes fewer people than before to produce oil and gas both at the well and in the office. The downturn was preceded by a buildup of hiring that then had to reverse itself for the companies to stay afloat
Realty News Report: When do you think the market the downtown office market will recover? 2020? 2021?
Tyler Garrett: We are near the bottom of the downturn right now, and we expect to see a slow and steady recovery beginning in 2019.
Realty News Report: Transwestern has represented the owner of Pennzoil Place for a while. How’s the leasing effort going?
Tyler Garrett: Yes, Transwestern currently leases and manages Pennzoil Place and has been since 2009. Pennzoil no longer has a presence in the building. Leasing efforts are going well, and we will be announcing some exciting new tenants soon. The building was ahead of its time in many ways. We are fortunate that the building has floor-to-ceiling glass, 2.5-foot window mullions and restrooms accessible from both sides of the core. These attributes are being incorporated into new construction today, yet Pennzoil Place has been reaping the benefit of these modern features since it was built in 1975.
Realty News Report: Downtown, the Energy Corridor and Westchase all took it on the chin when oil prices crashed in 2015 and 2016. Sublease space is still big and vacancy rate could be better. How long will it take the office market to recover? What ‘s going to prompt the office market turnaround?
Tyler Garrett: The Energy Corridor is typically the first to be hit and the quickest to recover. It mirrors the energy business itself. True, there might not be as many jobs as before, but production is higher now than it has ever been. A few of the major companies have shifted to owning campuses rather than leasing space. The market will keep heading toward recovery as long as we continue to see prolonged profitable energy pricing, which we have experienced for all of 2018 thus far.
Realty News Report: If Class A space is difficult to fill up, what about Class B & C space. What will happen to that space? Will it be turned into other uses?
Tyler Garrett: Class B and C product will likely be forced to convert to other uses. The alternative would be to compete on price, which some landlords are not in position to do.
Realty News Report: Is there an increase in concessions to lease space? What’s typical amount of free rent being offered?
Tyler Garrett: Lease concessions are highly dependent on the submarket and the particular building. However, a general rule of thumb for new deals is one month of gross free rent per year of term.
Realty News Report: Downtown is getting more residential and hotels. Is that going to make a difference for downtown office?
Tyler Garrett: Without a doubt, the Central Business District is becoming a true live/work/play environment. The massive amount of development in the multifamily and hospitality sectors will continue to spur retail development. The real estate pricing for other popular inner loop retail locations has been driven so high that the Central Business District is now considered a great value for restaurants and bars. The north side of Main Street and the east side of downtown are becoming true destinations for entertainment, which will only continue.
Realty News Report: What do you see downtown over the next 10 years? Robust market? Declining sector?
Tyler Garrett: Downtown is better positioned now than it ever has been. There is more activity on the street level as people are frequenting sporting events, restaurants, and other entertainment venues. This was almost nonexistent 20 years ago. Looking into the future, the plan to lower the Pierce Elevated section of Interstate 45 will have a very positive effect for downtown and midtown. The only real threat to this growth is the tunnel system, which has split residential and office into distinct locations. Until now, the approach has been that sites that can connect to the tunnels will be office buildings, and sites that cannot connect will be multifamily or hotel project. That has created a lack of street-level retail in the interior of the Central Business District. We look forward to the day when a new office tower is constructed without tunnel access and ushers in a new mix of uses and an even more dynamic downtown Houston.